Life Insurance Company of Alabama - Notice of 2020 Annual Meeting

We just posted this morning on some shareholder activism developments at LICOA.

We also just got a copy of their notice of annual meeting and summary annual financials, which are embedded below. The annual meeting is scheduled for November 9, 2020 at the Gadsden Country Club in Alabama.

Something shocking from the 2019 annual report: "the aggregate amount paid to all officers and directors, including director's fees, totaled $2,880,607." The figure for 2018 was only $2,492,713.

In 2018, they had a loss from operations of -$843,375. In 2019, the loss from operations was -$94,740. If the officers and directors had not received a pay increase of $387,894, the company could have had a gain from operations of $293,154 instead of the loss.

2020_10_19_12_54_09 by Nate Tobik on Scribd

Life Insurance Company of Alabama Update: Shareholder Dissatisfaction and Share Repurchases

If you haven't been following Life Insurance Company of Alabama (LINS / LINSA), see our previous LICOA posts from the past year: original post in November 2019, shareholder activism post in May 2020, and shareholder letter in June 2020. Below, we will update with some new developments.

We saw a new letter posted on the Concerned LICOA Shareholders website,
To this stockholder (and, I daresay, to many others), both your President’s “update” to stockholders and LICOA’s 2019 financial statements are far more of a cause for concern than comfort.

Your update claims that LICOA “had a net gain after taxes for the year”. This is patently untrue. In fact, according to the “Summary of Operations”, LICOA had a pretax loss from operations of $843,000 and an after-tax loss of $276,000.

Your letter also presents the capital expenditure which “will flow through the income statement over time” as though this is a positive development for shareholders. In fact, the considerable depreciation expense will reduce both future earnings and stockholders’ equity. Moreover, it is difficult to see how a mere increase in appraised value of self occupied premises will ever deliver direct value to stockholders.

Finally, your statement that LICOA is “committed to providing a positive return for investors” is certainly a worthy aspiration, but your letter fails to communicate any plan to accomplish it. There is no effective market for LICOA stock, the annual dividend is a negligible 1% of stockholders’ equity, and the difference between 2019’s miserable results and an acceptable rate of return on shareholders’ equity is most certainly not just the difference of 50 basis points on a portfolio of bonds.

LICOA has not been managed successfully in the interests of all its owners in many years, and there is no visible indication that things will change for the better in the long-term future. Under these conditions, I appeal to you: please take steps to sell LICOA to an entity capable of providing an acceptable return to stockholders, or take LICOA private. Continuing to run LICOA for the benefit of the extended Daugette family rather than for the benefit of all shareholders is an ongoing disgrace.
Something else very interesting has been posted on the activist website:
In July 2020, LICOA agreed to repurchase stock from the family of Mayo Clark. The price paid was $400,000 for 5,346 shares of LINSA class stock and 1,440 of LINS class stock. Since the LINS stock has 5 times the economic interest of the LINSA stock, this is economically equivalent to repurchasing 12,546 shares of the LINSA stock, which would be equivalent to paying $31.88 for LINSA stock. This was higher than the lowest trade price in July 2020 of $11.85 per share, but lower than the amount of capital and surplus per A share.

This was disclosed in the LICOA board minutes for July 2020. The LINSA shares of LICOA are currently offered for $17 on the OTC. 

Obviously, there's no way to know whether the dissident shareholders will be successful, and we don't know everything that transpired between the company and the family of Mayo Clark, but interesting nonetheless.

Interview with Abbott Cooper of Driver Management on Activist Investing in the Banking Sector

Earlier this week, we did an interview about small banks with Sam Haskell of Colarion Partners. Today, we have an activist bank investor, Abbott Cooper of Driver Management. He was quoted in this morning's WSJ article about the First Citizens and CIT merger. 

Tell us about yourself and Driver Management... what do you do and how do did you get started?
I started out my career as an M&A and securities lawyer, then moved into investment banking where I covered banks. I finally made the jump to investing and ran a bank focused strategy at a small asset management firm for about three years before setting up Driver. I have always been interested in activist investing and for a long time thought that such a strategy would be successful when applied to banks. Clearly, there are a number of other activist investors in the bank space, but it is such a target rich environment, I figured there would be plenty of opportunities.

I would also say that my background has been incredibly useful in activist investing. My experience as a lawyer is very helpful in terms of the nuts and bolts of managing an activist campaign and identifying board actions that appear to be in violation of duties owed to shareholders, etc. The investment banking experience is also valuable—I tend to think of activist campaigns as a pitch, where the client is not the company but its shareholders. The biggest difference, however, is that it is a rule of thumb for investment bankers to never pitch a bank to sell itself—given the obvious conflict of interests, it is a sure fire way to never get a meeting with a CEO again—yet often that is the best way to maximize value for all shareholders.

Are you a concentrated activist fund, or are you a more diversified banking sector fund that takes activist stances when appropriate? How many activist situations are you involved with at a time? How many other bank positions? All small banks, or do you go up and down the sector in terms of size.
Right now, Driver focuses exclusively on activism in the bank sector. We have a number of positions and have two that we are particularly focused on now—FUNC and ESXB. We focus on small banks because I think they present the greatest opportunity for value creation through activism. As I mentioned, often times, the best way to create value for shareholders is through a sale and, generally speaking, the larger the bank, the fewer (if any) potential buyers who can or will pay a significant premium.

We know you've gone activist on First United Corp (FUNC) in Maryland, can you tell us about that idea - how you decided to go activist on it and what the opportunity looks like now? We saw that management tried to pull some dirty tricks and throw sand in your face, but it looks like you're fighting through it?
We are in the midst of litigation with FUNC right now, so I don’t want to say too much about that situation other than bank directors who interfere with the election of directors by exploiting bank regulations or manipulating bank regulators should be held to the same standards for determining whether those actions represent a breach of fiduciary duty as directors of non-banking institutions who do the same through “regular” corporate actions such as bylaw amendments or dilutive share issuances. Put another way, there is no carve out to bank directors’ duties to shareholders just because they can figure out a way to use bank regulations as an entrenchment device.

What has your experience been as an activist communicating with the fellow shareholders of banks? We always wonder why anyone would ever vote against a dissident director nominee, given that activists tend to be significant shareholders putting up substantial amounts of time and money to fix what they perceive as problems. Are you any closer to figuring out the psychology of shareholders who vote for incumbent directors that own little or no stock?
To answer the last question first, in some cases it is not psychology, it is self interest that leads investment managers to vote for directors even though the manager is unhappy with the bank’s performance. Some firms will have other business they want to do with under-performing banks where they are an investor and don’t want to jeopardize potentially profitable relationships while others believe that adopting a universal pro-management approach will mean they get the first call when there is a below market private placement or the like.

To me, it is pretty simple—either an investor is satisfied with the performance of a bank (in which case, go ahead and vote in favor of the incumbent directors) or they are not (in which case they should vote against the incumbent directors). There is a great story in Bob Iger’s book about how one year he was unpleasantly surprised to find that there were a ton of votes against four Disney directors who were up for re-election and Iger found out that the votes belonged to Steve Jobs, who was on the board and one of Disney’s biggest shareholders. When Iger asked Jobs about it, Jobs said he voted against the four incumbents because they were a “waste of space.” Unfortunately, even when firms are not guided by other motives, many asset management firms really have a hard time deviating from the proxy advisors’ recommendations. I personally think that is an egregious abdication of responsibility, but that is a topic for another time.

It looks like there are a set of unprofitable or barely profitable small banks trading at half to two-thirds of TBV and a set of solidly profitable (7%+ ROE) banks trading at more like three quarters of ROE. Would you agree? How do you decide between them, or do you buy both?
I think that is probably generally right, but I wouldn’t really buy either at this point. I don’t think that there is a lot of urgency right now to invest in the banking sector and valuations could easily get cheaper rather than more expensive. That said, if anyone ever feels a burning need to invest in bank stocks, I don’t think you can go wrong in investing in stocks with proven CEOs who can make money in all environments and who own stock worth multiples of their take home pay. Tom Broughton at ServisFirst and David Rainbolt at BancFirst are two examples of that type of CEO who immediately come to mind.

We see a split in bank investors (like Colarion, who we profiled earlier this week) who think the best trade is well run, higher ROE banks even though they are more expensive, versus a set of really dirt cheap banks which often have problems and recalcitrant managements that need activism. You seem to come down on the side of activism - does that make you more of a value investor?
I guess it does, but only because I know that I will provide the activism. Unless there is an activist already in the stock (or there is a likelihood that one will surface), there are a lot of dirt cheap banks out there where the management and board are just going to continue with business as usual and if an investor hopes that management team and board suddenly wake up one day with a burning desire to increase shareholder value, they are in for disappointment.

What are the features that distinguish between banks at a premium to TBV and banks at a big discount? Is the market right to distinguish but just wrong on price?
I would say generally it is profitability since return on average tangible common equity remains highly correlated to price to tangible book value but there are also a number of banks that public market investors just seem to hate despite strong numbers. Bank OZK (OZK) is a prime example of a very profitable bank but one where the public market just can’t get comfortable. Given OZK’s excess capital and the fact that the CEO owns more than 4%, they should be thinking about buying out the public shareholders that just seem unlikely to value the stock correctly.

A statistic we saw is that "75% of banks today trade below TBV — more than 2011 (71%) and 2009 (66%)". What are you seeing? Do you think this is a singular opportunity?
Again, that seems right and it is probably an opportunity but since I think valuations are going to stay at this level for a while, I don’t know that I would say it is a singular opportunity.

Would you agree with the notion that some sectors like FAANG/tech are a bubble, and some like banks are an "anti-bubble" right now?
Maybe—although I am sure that there a number of bank investors out there that would love to get a little more air in bank stocks

How are you constructing a bank portfolio right now to take advantage of the valuations and negative sentiment?
Unless someone is prepared to be an activist, I think the best strategy is to buy stocks that don’t drive you nuts when you look at them on the screen every day. By that I mean quality franchises in good markets with excellent management teams—the type of stock that should deliver excellent returns over time, whether through capital return or stock price appreciation. Those might not be the cheapest stocks right now, but they will probably let you sleep better at night.

Do you have any overlap with the Stilwell bank portfolio? We took a look at the eight banks he mentions in his Section 13 filings as current targets, and we see that they are almost all profitable, between half and 85% of book, and do not have majority owners. Is that your wheelhouse or do you prefer a different slice of the bank market?
I think that type of bank is generally in our wheelhouse—we look for franchises that other banks are going to want to buy (for a premium) but are unlikely to really become high performers on their own, which is generally due to out of whack costs and/or an intractable commitment to an inefficient branch network, as well as a culture where the management and board are not held accountable for poor performance. I don’t mind seeing a bank with a higher efficiency ratio because that makes it easier for a buyer to justify paying more, since there should be low hanging fruit in terms of cost saves. We also like to identify banks where management and the board do not have a lot of skin in the game and where there is a history of poor corporate governance practices.

What are your thoughts on the First Citizens and CIT merger that was announced this morning? How many more of the ultra-low P/TBV banks do you think will get picked off?
On the CIT/FCNCA deal, I don’t think there are a ton of read throughs for M&A generally, although it is always good to have precedents where the deal was enthusiastically received by investors. 

On other ultra-low P/TBV banks, it is hard to say—I think that there were compelling strategic rationales for CIT/FCNCA and I don’t know if that applies to any other bank on that list.

Followup on Our Small Bank Posts

Calculating P/TBV for First Step Mutual Bank Conversions
A reader writes in about our small bank cannibals post,
"As of their June 30, 2020 report, they had total shareholder equity of $58.4 million and no goodwill or intangibles versus a market capitalization of $47 million at $7.75 per share for a P/TBV of 0.80x."

In GAAP terms this is the true P/TB value, in reality though it is not true.

That is in regard to First Seacoast Bancorp, a partially demutualized bank where the mutual holding company still owns 55% of the bank's stock. We simply took tangible shareholder equity and divided by the total shares outstanding, including the ones that are owned by the mutual holding company. This is technically correct, although it does not account for the fact that the MHC shares are not really "owned" by anyone.

There are several ways that you can adjust this calculation to reflect that. You could make the assumption that the unsold MHC shares will be sold at some given P/TBV multiple, or that they will be sold for the current market price of the shares that have already been sold. So, depending on how you think about this, the FSEA could be at a more attractive discount than 20% below tangible book value.

"Looking for bank stocks in the dumpster? Not everything can be salvaged"
Our friend at Colarion (who we interviewed earlier in the week) wrote a post about the pitfalls of investing in the very lowest P/TBV banks. The list he gave includes CIB Marine (CIBH), which we have written about numerous times in the Oddball Stocks Newsletter. He cautions against investing in value traps,

run by managements indifferent to their ownership base. Banks are particularly susceptible to this because activists are uncommon across much of the country and it can be expensive and draining to run against entrenched managements

He has some good suggestions for how to avoid these, like "not located in a demographic / fiscal hazard zone area." 

Whether to go for high ROE, reasonable P/TBV or to "dumpster dive" for the biggest P/TBV discounts is just another instance of the value vs quality debate. We have plenty of friends on both sides, and each side can learn from the approaches of the other side.

Oddball Stocks Newsletter Issue 31 - General Commentary

At the end of every Issue of the Oddball Stocks Newsletter is our "General Commentary," which has our thoughts on topics of interest to Oddball investors. Some recurring topics are "Academic Corner," where we review interesting economics or finance journal articles; "Delaware Chancery Corner," where we look at new court opinions out of Delaware that may be relevant for Oddball investors, and often we write small notes on the banking industry. 

We thought we'd share the General Commentary section from our most recent Issue (#31) in August, which was heavy on small bank coverage. (Issue 31 is available à la carte).

Academic Corner
A 2019 research paper by Stanford University GSB professor Charles Lee titled “ELPR: A New Approach to Measuring the Riskiness of Commercial Banks” addresses some failures of the current “risk weighted assets” framework. This new approach focuses on the covariance of the default rates of the 14 classifications of bank loans (e.g. construction, residential, farmland, agricultural). It suggests that banks with loans concentrated in categories that have a high covariance with each other, even if they appear diversified, are more likely to fail than the traditional metrics based on capitalization suggest.

As one example, they show a Nevada bank called Silver State Bank that was closed in September 2008 at a cost to the FDIC of $500 million. It was regarded as well-capitalized up to a year before its failure, even though its loan composition was 60% construction and 23% nonfarm/nonresidential real estate. Essentially, Silver State was all-in on loans to land developers and housing developers, and a metric that considered the high covariance of default rate of those two categories would have flagged the risk, while the traditional, primitive capitalization ratio metric did not.

The pairwise correlation in the default ratio of Silver State's two primary loan categories was 0.86. Other pairs of the fourteen loan classifications have weaker, or even negative, pairwise correlations. Table Two from this paper, “Correlations of Aggregate Delinquency Rates across Loan Categories” might be something to pin above your desk whilst analyzing the bank stocks from this Issue. 

Delaware Chancery Corner
We have a few notable cases at the Delaware Court of Chancery to mention since our last update in Issue 28. First, there is In Re HomeFed Corporation Stockholder Litigation, concerning a squeeze-out merger and acquisition of HomeFed by Jefferies Financial Group.

The issue before the court was whether this complied with the framework set forth in Kahn v. M & F Worldwide Corp. (“MFW”) for subjecting a squeeze-out merger by a controlling stockholder to business judgment review rather than the entire fairness standard. Company managers will always want to benefit from a presumption that their decisions were correct – business judgment deference by courts – and unhappy minority shareholders will always want them to be judged without such deference or presumption. In the MFW case, the court established six conditions that must be satisfied to invoke business judgment review of a squeeze-out merger by a controlling stockholder:

“[T]he business judgment standard of review will be applied if and only if: (i) the controller conditions the procession of the transaction on the approval of both a Special Committee and a majority of the minority stockholders; (ii) the Special Committee is independent; (iii) the Special Committee is empowered to freely select its own advisors and to say no definitively; (iv) the Special Committee meets its duty of care in negotiating a fair price; (v) the vote of the minority is informed; and (vi) there is no coercion of the minority.”

This means that if a minority shareholder plaintiff can plead a set of facts showing that any or all of those conditions did not exist for a transaction, then their pleading states a claim for relief and they are entitled to conduct discovery. And if, after discovery, triable issues of fact remain about whether either or both of the two procedural protections (special committee and informed vote) worked, then a case can proceed to trial. In this HomeFed case, the court concluded that Jefferies, which was the controlling shareholder, may not have met the conditions and so rejected the defendants' motion to dismiss.

Another recent case further clarifies the MFW framework: In Re Dell Technologies Inc. Class V Stockholders Litigation, disputing the redemption of a tracking stock that was issued when Dell acquired EMC Corporation. The court emphasized that to have the business judgment protection of the decision, “the controller [must] irrevocably and publicly disable itself from using its control to dictate the outcome of the negotiations and the shareholder vote.” And again, “if a plaintiff... can plead a reasonably conceivable set of facts showing that any or all of those enumerated conditions did not exist, the complaint states a claim for relief that entitles the plaintiff to proceed and conduct discovery.”

Then there is a fantastic Section 220 demand case, Sahara Enterprises, Inc., between a privately held investment fund and a shareholder who “became concerned that the Company was paying its officers and directors, paying highly compensated fund managers, and paying professional consultants to help select the fund managers, yet achieving subpar results.” When the shareholder made a books and records demand, the company gave a list of stockholders and a copy of the bylaws, but otherwise refused on the grounds that she lacked a proper purpose and/or the scope of the demand was too broad. The company eventually provided a summary of director's fees being paid, but otherwise stonewalled.

This particular Section 220 case was decided impressively quickly. She sent the demand on August 8, 2019, did not file suit until March 2, 2020, and even with the pandemic taking place the court had a trial (on the paper record) on May 21st and decided in her favor on July 22nd. One of the company's futile arguments was that the shareholder's purpose for the inspection of records of “valuing her shares” was insufficient and that she needed to demonstrate why she needed to value them. That was slapped down by the court: “Delaware law does not require that a stockholder establish both a purpose for seeking an inspection and an end to which the fruits of the inspection will be put.”

More interesting was the court's reasoning regarding the second stated purpose of her inspection, which was to investigate wrongdoing or mismanagement. He ruled that while the company's recent poor performance “has not been sufficiently protracted or extreme to draw an inference of wrongdoing,” the company's litigation posture itself bolstered her investigative purpose:

It is, of course, permissible for a board of directors to delegate management responsibilities to officers, employees, and outside advisors. What the board invariably retains—and must fulfill—is the obligation of oversight. It would be an exceptional board of directors that could satisfy its duty of oversight without creating any books and records—no minutes, no resolutions, no actions by written consent, no reports, no policies, no nothing. Yet that is what the Company claimed by arguing that this action was “moot” because the Company did not have any responsive books and records. The Company’s own arguments thus established a credible basis to suspect corporate wrongdoing. Woods has therefore established a proper purpose for an inspection.

The opinion goes on to outline Delaware law as it pertains to determining the scope of a shareholder books and records inspection, once it has been established that it is for a proper purpose.

Importantly, as pertaining to minority investments in micro-cap, OTC-listed companies, the holding is:

[H]ow directors and senior officers are compensated and whether they are the beneficiaries of any related-party transactions are basic facts that stockholders are entitled to know. Section 220(b) defines a proper purpose as any purpose reasonably related to the stockholder’s interest as a stockholder. Some information is so foundational that a desire to have that information is itself a proper purpose. A stockholder should be entitled to obtain a general description of the company’s business, the identities of its directors and senior officers, and basic information about how they are compensated. Directors and officers are fiduciaries who have a duty to act loyally, in good faith, with due care to maximize the long-term value of the corporation for the benefit of its residual claimants. The residual claimants are entitled to know how their fiduciaries are taking money out of the corporation. A stockholder should not have to point to a valuation purpose or assert suspicions about corporate wrongdoing to be able to learn how much money the directors and senior officers are receiving.

We have never seen that stated so explicitly in a books and records case, and it seems eminently true and necessary. Think of all the Oddballs that refuse to disclose management compensation or the existence of related-party transactions. This is a Delaware chancellor flatly stating that shareholders are entitled to at least upper management and director compensation information, and related-party transaction information, period, without having to state any “purpose.”

One last shareholder victory for this Issue. In a case between an individual investor (Robert Elburn) and Investors Bancorp, Inc. where he alleges that the company's board approved excessive compensation awards in breach of their fiduciary duties, the Chancery Court refused to certify an interlocutory appeal of the Court's denial of the bank's motion to dismiss. The motion to dismiss turned on the issue of whether a demand on the board by the investor for it to pursue the breach of fiduciary claim would have been futile (which the Court ruled it was). In the application for certification of interlocutory review, the bank argued that the case involved an issue of first impression. This was smacked down beautifully: “There was absolutely nothing unusual about the demand futility allegations addressed by the Opinion, or the means by which the Opinion addressed them. Determining the sufficiency of demand futility allegations is steady grist for the Chancery mill.”

The Narrow Bank USA Inc.
Historically, banks have tried to do two incompatible jobs: safely store the medium of exchange, and also make long-term investments in productive enterprise. Because of the incompatibility, they have done both imperfectly, with “imperfectly” meaning manias followed by panics and human misery. Past attempts to solve this have consisted of deposit insurance, with attendant moral hazard, or regulation, which tends to force everyone to make the same mistake at once, like treating a no-interest long-term government bond as completely risk-less.

A real solution to this would be to separate those two incompatible functions. Where society's long-term investments were being financed by loans, these would be originated and assembled into something akin to closed end funds. The investments would not be redeemable on demand but there would be a secondary market for the portfolios of loans. There would not be maturity transformation “alchemy” that makes promises it can't keep, which has historically required bailouts and government subsidized deposit insurance. But the price would not be that volatile. (Think how little price volatility conservatively underwritten home loans have, for example.)

For storing the medium of exchange, you need something like what a group of bank entrepreneurs actually proposed a few years ago: a “narrow bank”. Their startup, The Narrow Bank USA (TNBU) wanted to take deposits and invest 100% of the money in interest-paying reserves at the Federal Reserve. Their plan was not to offer accounts to the public at large, but only to mutual funds and megacap companies with cash balances to invest that are far beyond the limits of deposit insurance. They would have held 100 percent of their assets derived from customer deposits as Federal Reserve Bank balances, earning interest at the interest on excess reserves rate (IOER), and paying interest to depositors at a slightly lower rate, thereby earning a modest profit.

In order to get in business, TNBU needed a master account at the Federal Reserve Bank of New York, but the Fed was not excited about his business because it would have been a huge “disruption” to everyone else in the industry, closing the gap between IOER and what banks pay depositors. The Fed refused to accept or deny the master account application and so TNBU sued. In March, a federal court dismissed the TNBU suit on the grounds that TNBU “lacks standing to pursue its stated claim and its claim is both constitutionally and prudentially unripe.” The court decided that the “delay” in approving the application for a master account has not been long enough to constitute a “denial”: “If TNB had been waiting 30 years for a decision, I would have no trouble finding that the FRBNY had constructively denied TNB’s application, and thus that TNB had an injury in fact sufficient for standing.”

Small Banks
In our essay “What is an Oddball Stock?” in Issue 25, we quoted something from the book Panic, by hedge fund manager Andy Redleaf, pertinent to the dearth of information that the minority shareholders of Oddball companies have about their investments. (We think that his book is so worthwhile that we handed out copies of Panic to everyone who attended the Oddball Meetup in February 2019.) So it is with great interest that we have watched Redleaf sell his stake in his hedge fund management company (Whitebox) and buy a small bank in Minnesota: Park State Bank. From a Forbes interview with him:

Another pocket of safety can be found, counterintuitively, in regional U.S. banks. “Small banks have privileged access to capital too,” and Redleaf himself bought one of these institutions in 2015. “Even as a very small bank I think we’ll continue to have privileged access to capital.” The business opportunity comes from the large number of potential borrowers “that really are bankable but don’t have access to cheap capital.”

His thesis is that certain players (the largest mega cap companies, and all banks, since they can offer depositors the mispriced, government subsidized deposit insurance) have access to incredibly cheap capital that has a tight spread to the government's nearly zero Treasury yield curve. And then there is a divide between them and smaller companies that pay much more for capital, whether equity or debt. The opportunity that he sees is to get paid a big spread to bridge that gap. Just like earlier in his career, as a hedge fund manager, when distressed debt and equity markets were less connected than today, and it was possible to arbitrage distressed companies' capital structures.

Small Bank Share Cannibals

In our recent interview with Sam Haskell of Colarion Partners, we talked about small bank "share cannibals" that are taking advantage of cheap valuations (low P/TBV) and excess capital to do major share repurchases. One example that we had already blogged about in August is Crazy Woman Creek Bancorp (CRZY), which borrowed money at 5% and bought back 15% of its outstanding stock.

We can infer from CRZY's press release and financials that they paid about $14.50 for the shares, which means book value should now be $13.2 million ($24.96 per share) versus the market cap at $16.45 per share of $8.7 million. The P/B should now be around 66%. If you haircut the $3.4 million of premises and equipment and subtract $132k of goodwill, adjusted book would be $9.7 million for a P/aTBV of 90%. With equity now down to an estimated $13 million after the repurchase, and $138 million of assets (9.4% equity/assets), the company has less of an excess of capital to spend on repurchases. They earned an average of $1 million in annual comprehensive income for 2018 and 2019 (averaging about 7% ROE) so that could potentially fund more repurchases.

Still, it is worth looking for more banks that are going to do big repurchases, with more catalysts on the horizon rather than the rear-view mirror. We would ideally like a low P/TBV, high equity/assets, and a high ROE. We can start with other banks that have recently announced share repurchases. 

The holding company for PlainsCapital Bank, Hilltop Holdings Inc. (HTH), has tendered for between 18.5% and 21.3% of its own stock:

As of September 21, 2020, we had 90,251,015 shares of common stock outstanding. At a Purchase Price equal to the tender offer’s minimum price of $18.25 per share, we would purchase 19,178,082 shares if the conditions to the tender offer are satisfied or waived and the tender offer is fully subscribed, which would represent approximately 21.3% of our outstanding shares as of September 21, 2020. At a Purchase Price equal to the tender offer’s maximum price of $21.00 per share, we would purchase 16,666,666 shares if the conditions to the tender offer are satisfied or waived and the tender offer is fully subscribed, which would represent approximately 18.5% of our outstanding shares as of September 21, 2020. If the conditions to the tender offer are satisfied or waived and the tender offer is fully subscribed at the minimum price, we will have 71,072,933 shares outstanding immediately following the purchase of shares tendered in the tender offer (based on the number of shares outstanding as of September 21, 2020). If the conditions to the tender offer are satisfied or waived and the tender offer is fully subscribed at the maximum price, we will have 73,584,349 shares outstanding immediately following the purchase of shares tendered in the tender offer (based on the number of shares outstanding as of September 21, 2020).

As of June 30, 2020, HTH had a book value of $2.3 billion of which $291 million was goodwill and intangibles. That's a book value per share of $25.40 or a tangible book value per share of $22.17. So, Hilltop is willing to pay 95% of tangible book for its own stock. For the first half of 2020, Hilltop had comprehensive income of $191 million, which if annualized is a 16.6% return on total equity. 

In the August Issue of the Oddball Stocks Newsletter (Issue 31), we published scatterplots showing the relationship between P/TBV and ROE. There's a relationship: higher ROE banks tend to sell at higher TBV multiples. But, note that HTH was trading for almost 20% less before the buyback was announced, or under 80% of tangible book.

The holding company for CommunityBank of Texas, CBTX, Inc., (CBTX) announced that they are going to repurchase close to ten percent of their outstanding shares. As of their June 30, 2020 report, they had shareholder equity of $537 million and tangible book value of $452 million, compared with a market capitalization at $18.50 per share of $458 million. Shares have rallied by 20% after the buyback, which makes it look like management is pushing the price up to around TBV with their repurchases. 

CBTX earned $50 million of comprehensive income on average annually for 2018 and 2019, or close to 10% on average total equity. A couple of other noteworthy things here. First, directors and officers own 30% of the company which is impressively high. Second, loan deferrals were $545 million at June 30th but that has dropped to $129 million as of an investor presentation given August 30th.

The holding company for MVB Bank, MVB Financial (MVBF) announced that they have authorized for repurchase up to 3% of their outstanding shares. As of their June 30, 2020 report, they had total shareholder equity of $229 million and tangible book value of $209 million versus a market capitalization at $17.70 per share of $212 million. For the first half of the year, they have earned comprehensive income of $18 million, which annualizes to a return of about 16% on total equity.

The holding company for Centric Bank, Centric Financial Corporation (CFCX) announced that they have approved the repurchase of up to 8.25% of outstanding shares. As of their June 30, 2020 report, they had shareholder equity of $82 million and tangible book value of $81 million versus a market capitalization at $7.25 per share of $63.5 million. This is a bigger discount to TBV (0.78x) although it is worth noting that as a smaller institution, it has a higher share of assets in premises and equipment ($17.8 million). They earned about $8 million in comprehensive income in 2018 and 2019, which once again is a 10%+ ROE. Centric's directors and officers own 11.15% of the company. There are two funds with stakes: EJF Capital with 9.7% and Banc Fund Co. LLC with 9.1%.

The holding company for First Seacoast Bank, First Seacoast Bancorp (FSEA) announced that it is buying approximately 5.0% of the currently outstanding shares owned by stockholders other than First Seacoast Bancorp, MHC. (FSEA demutualized in July 2019, and 6,083,500 shares of common stock of the Company are issued and outstanding, of which 55% are issued to the MHC, 44% were sold to the Bank’s eligible members, the ESOP, and certain other persons in the stock offering, and 1% were contributed to the Foundation.) As of their June 30, 2020 report, they had total shareholder equity of $58.4 million and no goodwill or intangibles versus a market capitalization of $47 million at $7.75 per share for a P/TBV of 0.80x. 

For the first half of 2020, FSEA had comprehensive income of $1.26 million, which annualizes to a return of about 4% on their total equity. Their shareholder equity is 12.4% of total assets. Premises and equipment are 9% of shareholder equity; sometimes we deduct this in calculating an aTBV so that we don't end up buying too many buildings that belong in the Bank of Utica Small-Town Bank Headquarters Hall of Fame.

The last one we'll mention today is the holding company for EagleBank, Eagle Bancorp, Inc. (EGBN), which announced that it was lifting the suspension of its previously established share repurchase program. As of their June 30, 2020 investor presentation, they had tangible common equity of $1.1 billion, which was $33.62 per share, compared with a current share price of $30. The share price has run up significantly from $25 in late September. Once again, the announcement of repurchases - and maybe the repurchases themselves - have been a catalyst for a revaluation.

Of this set of recent share repurchasers, you will notice that the larger banks are in the high ROE, higher P/TBV bucket. They may interest you if you think you are able to handicap the businesses and judge that those fat profits will continue. But as Oddball investors, we are always more interested in the non-public, small companies at huge discounts to liquidation value. Sometimes traits like profitability exhibit momentum, but almost everything eventually reverts to the mean, which means that it may be smarter to buy shares in a cheap company with a fixable problem than pay a premium for a company where things have been going perfectly. In the upcoming Issue of the Oddball Stocks Newsletter (Issue 32 in November), we will be surveying the dirt cheap small banks.

Small Bank Interview with Sam Haskell of Colarion Partners

We recently noticed a new account on the Twitter, @colarion, a "bank-centric avatar," tweeting about a subject we've been thinking about recently: small banks. Here's our interview with the author, Sam Haskell of Colarion Partners.

Tell us about yourself and Colarion Partners... what do you do and how do did you get started?
Colarion Partners, named for two daughters, isn’t actually a partnership but an advisory managing separate accounts. The name was a twist of history back when I considered a fund, but ultimately chose an advisory because the structure was more client friendly.

I spent two years after college at Morgan Stanley in New York, before coming to help grow the bank-focused capital markets business at a hometown brokerage firm of Sterne Agee. I worked with financial-focused fund managers there from 2002 until 2014. After leaving, a former client with a large account we worked on successfully together through the years reached out for some help, and that began Colarion.

The firm manages both bank-specific strategies and broad-market strategies. As a result I have two jobs: (1) Get clients’ asset allocations right by turning the “aggression” dial. The most common tools are stocks, cash, and metals; we do little bonds outside of a handful of preferreds. (2) Outperform the financials sector. Not every client has the same approach but we generally have been able to do with room to spare, particularly in the first quarter of this year.

A statistic we saw is that "75% of banks today trade below TBV — more than 2011 (71%) and 2009 (66%)". What are you seeing? Do you think this is a singular opportunity?
To your first question, the market strongly dislikes spread revenues. The short-term concern is over credit and margins. However, credit marks in recent mergers are 1/6 the level of 2009 mergers. In other words, PNC took a 17% loan mark when purchasing National City, but the average of 6 recent merger credit marks is around 3%. This is after a deep third-party dive from people whose job is to mark loans. It’s not clear the broader market has grasped this signal. On margins, again the market is downbeat, but many banks forecast slight margin rebounds in 3Q and 4Q as PPP is forgiven and deposit surges are spent down. Still, keeping margins up will require intensive management in the years ahead.

Longer-term, there is an underlying concern that our debt levels are slowing growth and building fragility, while we are becoming European or Japanese. I address this at my blog, with the point being that our economy may have excess debt but our banks are too well incented to step on rakes to the same degree foreign banks have.

On your second question of opportunity the answer is generally yes. Both good and bad banks are being bunched together under book value, and over the course of 2021 their performances will diverge widely. On the one hand, broken business models such as Ameriserv or Carter Bank and Trust are prone to maintain wide discounts until or unless they are fixed. Others, such as MVB Financial or FS Bancorp are motivated and differentiated and could return to a multiple above tangible.

Most Colarion bank portfolios are in that latter group of banks  - carrying a catalyst to bring money flows in, yet trading below tangible book value.

Finally and to be more specific on catalysts, these will include repurchases, followed by both pickup in mergers and upward EPS revisions, which in turn bring quant and allocator monies back into the sector. In combination these inflows could be sufficient to rerate the sector 20-30% higher, with management teams that repurchase earlier seeing more EPS pickup than management teams who wait.

Would you agree with the notion that some sectors like FAANG/tech are a bubble, and some like banks are an "anti-bubble" right now?
I don’t foresee a FAANG collapse, just a broader dispersion of the Federal Reserve’s $4 trillion springtime injection that was forced into that element of the market. Just as US consumers shut off travel spending and piled into durables sold by Home Depot et al in mid-2020, so the market shut off financials and energy and piled into tech and utilities, among others, for short-term gains. Today, travel spending has gradually rebounded, and so too have some of the cyclical stocks started to show life.  

With that said, investors are still looking for these themes in banks. Live Oak Bank, which focuses on fintech, is up over 100% in the past year, and First Republic Bank, which caters to wealthy investors and is seen as particularly stable, is up 33%. Do not be surprised if investors begin to look deeper into the sector and spend on other differentiated banks in the months ahead.

What are the features that distinguish between banks at a premium to TBV and banks at a big discount? Is the market right to distinguish but just wrong on price?
“Management” is the simplest answer, because managements can control capital use, efficiency, credit and net interest margin. Together these drive long-term profitability and valuation.

One of the most important tools of management today is capital management.  At deep discounts to tangible book, at which banks are akin to the “Net nets” that Benjamin Graham sought, is management doubling down on a low-value loan strategy or will they add to tangible book by repurchasing shares?

Use two Richmond banks as examples - Bay Banks and Essex Bank. BAYK, which recently chose a merger partner, has chosen to take risk at small spreads by growing loans. The management, which owns little stock, has even considered a dilutive equity offering. ESXB however is working to protect margin and would like to repurchase with its excess capital. Over time ESXB shareholders may be happier with their investment.

It looks like there are a set of unprofitable or barely profitable small banks trading at half to two-thirds of TBV and a set of solidly profitable (7%+ ROE) banks trading at more like three quarters of TBV. Would you agree? How do you decide between them, or do you buy both?
Many of the cheapest banks are value traps because they put shareholders down the list of priorities.  Some, like Ameriserv or Amalgamated, are upfront about that but most, like Glen Burnie or Peoples of Biloxi, think they are executing as they should. The only reason many of these are even as high as 50-60% of tangible book is the possibility of a 70% premium merger, as happened with Standard Bank (STND) in Pittsburgh a few weeks ago. Still, these mergers are usually too slow and too infrequent to warrant ownership.

It is another story if there is a twist, such as the new management at First Bancshares of Missouri a few years ago, a buyback at First Financial of the Northwest, or a potential “double barrel” like buyback and ultimately Russell inclusion, which is a possibility at 3-4 banks trading in this range.

We did a blog post about the big share repurchase at Crazy Woman Creek Bancorp. You've been tweeting about a big Hilltop Holdings repurchase. Are these cannibals the best bet? What else is in your "bank buyback basket"?
I believe the opportunity is mostly behind us for those two. While their tangible book and earnings per share will now jump, they appear to be spending most or all their excess cash. Ideally we want to own banks at the front end of this catalyst. There are about 35 banks repurchasing and another 50 or so who may soon begin, so we should soon have plenty to choose from.

To be more specific on buyback catalysts, the ones we like include: (1) Thrift conversions with stable credit and 15%+ capital well under TBV. Clients own 3 of these. These companies can repurchase for years, generally up to tangible book. (2) High quality management teams. Holdings in Washington state and West Virginia fit this criteria. Mortgage gains fuel recent buyback activity at these two companies. (3) “Double barrels”: 10-15 banks are repurchasing or will soon repurchase and are possible entrants into the Russell 2000 index in coming years.  Colarion is currently raising funds to allocate into this strategy.

In contrast, highly inefficient banks, banks with limited excess capital, or banks trading at or above tangible book value are less appealing buyback candidates.

How would you construct a bank portfolio right now to take advantage of the valuations and negative sentiment? Would you do a big diversified basket, or concentrate based on quality or some other feature?  
There are too many flawed companies in the sector to pursue a diverse basket.

Current themes in client portfolios include accretive buybacks, fintech elements, Puerto Rican oligopoly / stimulus /  buyback trade, and Russell 2000 potential. A commonality across these positions is to locate a future significant buyer (buyback, ETF, spinoff or merger) for a given position.

What do you think of activism for banks? Is "elbow grease," kicking out management, the way to create value? Do you see easy ways to improve profitability if you could get control of a small bank? Or is it better to go with a diversified basket strategy?
I am increasingly writing letters to boards in the event there are easily remedied issues. A California bank that historically has posted strong results recently had issues with a merger, decided against joining the Russell 2000 without knowing exactly why, and fired a strong CEO without having a successor in place. Colarion shared some thoughts with the board and I may become more proactive depending on their response.

Activists typically use force and fear with management teams, but I try to use greed, done outside the public eye. This is the same strategy that has been used very successfully by two long-term investors in the sector.

Do you have any overlap with the Stilwell bank portfolio? We took a look at the eight banks he mentions in his Section 13 filings as current targets, and we see that they are almost all profitable, between half and 85% of book, and do not have majority owners.
I often overlap with Joe, including three positions in 2019, but part of the trick with these positions is it helps to be in an active M&A market, and it helps to be in positions he is focused on. His portfolio is much broader than in years past and he cannot fight 10 proxy fights at once.

Also - and I believe Joe understands this - the M&A market is changing, as branches used to be considered an asset but may now be considered a liability. We can’t simply own thrift conversions and assume a buyer will appear in the third year. The value is often in the underlying commercial relationships, not the brick.

Do you like banks as a business for the long term, or just the cheapness right now?
I like unique stories with motivated managements, and appreciate that many are currently at low multiples. I dislike most commodity banks. Clients don’t own Regions or Key today and likely won’t in the future. Truxton (TRUX), Esquire (ESQ), or Live Oak (LOB) are the types of banks typically in client portfolios.

How exposed would a basket of undervalued banks be to a big macroeconomic shift, like a big rise or fall in interest rates, or a bad recession?
It depends on the positioning. In 2009 both the balance sheets and the shares were demolished, because bank capital levels too low, the recession hit the wealthy, and investors entered the turnover-exposed.

In 2020 balance sheets held up because the recession largely spared the wealthy and capital levels are 40% higher. Shares were hit however because again, many investors were fully allocated / levered.

If another recession hit, I would expect far less impact on shares and bank results, if only because both investors and companies have been de-risking as regularly happens in a cycle. The more time passes however, the more susceptible the group would be to a shock.

A final point here – Louisiana Bancorp was an example of an overcapitalized conversion that made it through 2008 down 2% if memory serves, outperforming the S&P by 80% over its life before selling in 2015. Consistent repurchase capacity is usually undervalued in the market.

What distinctions do you draw between banks like CRZY or HTH and the mega-cap low P/TBV banks that you'd see in this S&P list of low P/TBV banks. Are CIT and C cheap too, or just superficially cheap?
Citi has a 2.14% margin and CIT is at 1.70%. In other words, their baseline customer is borrowing at Libor + 200, and if either bank is adding any value, they certainly are not charging for it on either side of the balance sheet. Further, when margins are this thin, it’s difficult to earn 10% return on equity without using elevated leverage. The bank is therefore in a trap and the market has accurately diagnosed their ongoing business as being basically worthless and suggesting the bank wind up.  

However, these banks haven’t gotten the message and attempt to continue to grow.  So instead of running off low margin business, building capital and repurchasing, as Bank of Hawaii and City Holdings of West Virginia did in years past to drive shares much higher, they have become call options on higher interest rates, which is how I would use them in a portfolio.

Crazy Woman and Hilltop have different models with much more flexibility, though Crazy Woman seems to need scale.

Sometimes we liken small banks trading below TBV to closed end funds trading at discounts. Except you'd probably never see a fixed income closed end fund with non-defaulted debt trading at half of NAV. Is this an apt comparison? You wonder why Bulldog Investors / Special Opportunities Fund doesn't trade out of their discounted CEFs and into banks at a bigger discount?
Banks are closed end microcap bond funds but with a special funding stream added on. To the degree banks can continue to lower expenses by closing branches but holding onto customers, they will become more like these funds. Many could then reduce their discount assuming proper underwriting. In meantime, any fund or bank can grow per share NAV by using excess capital to buy those shares in. It’s valuable information in the near and long-term to see who chooses this route.

WSJ: "SEC Bolsters Safeguards Against Penny-Stock Fraud"

For the past year, Oddball investors have been worried about a proposed SEC rule change that threatened to make it more difficult to trade in opaque micro cap companies. Over a hundred people wrote in to comment, almost all in opposition, including well-known investors, firms, and funds like: Mitchell Partners, the OTC Markets Group, and the Oddball land company Aztec Land and Cattle Company, Ltd..

The astute comment letter writers raised important objections and proposed workable alternatives. Unfortunately, the investor feedback seemed to fall on deaf ears at the SEC, and the rule change seems to have been approved with little modification:

Still, the proposal drew opposition from critics who said the SEC was going too far in its effort to protect investors, by effectively barring people from investing in small, unlisted companies.

Dozens of public comment letters were filed in opposition to the plan, many of them from value investors who look to the OTC market for opportunities overlooked by others in the market. Such investors will sometimes seek financial data from companies directly, even if the companies don’t post it publicly.

There is a long history of investors seeking undervalued stocks in the OTC markets, where prices were once quoted in a publication called the Pink Sheets.

It is sad because some micro-cap companies are keeping investors in the dark - in violation of their obligations under state law - and this does not address that problem in any way. In fact, it may encourage companies to be even more opaque in order to shut down the OTC trading market in their shares (which they don't control) and more readily enable them to squeeze out shareholders.

Some other highlights:

  • The amended Rule has a compliance date that is nine months after the effective date of the amended Rule, and the compliance date for paragraph (b)(5)(i)(M) of the amended Rule is two years after the effective date of the amended Rule. Prior to the compliance date, broker-dealers may continue to publish quotations in reliance on the piggyback exception even if an issuer’s paragraph (b) information is not current and publicly available.
  • However, the Commission understands that market participants may have unique facts and circumstances as to how the amended Rule affects their activities, and the Commission will consider requests from market participants, including issuers, investors, or broker-dealers, for exemptive relief from the amended Rule for OTC securities that are currently eligible for the piggyback exception yet may lose piggyback eligibility due to the amendments to the Rule (217).
  • In considering whether an exemption from the Rule (pursuant to Section 36 of the Exchange Act and paragraph (g) of the amended Rule (218) under these circumstances is necessary or appropriate and in the public interest, and is consistent with the protection of investors, the Commission may consider a number of factors, such as whether, based on data or other facts and circumstances provided by requestors, the issuers and/or securities are less susceptible to fraud or manipulation.
  • In this regard, the Commission may consider, among other things, securities that have an established prior history of regular quoting and trading activity; issuers that do not have an adverse regulatory history; issuers that have complied with any applicable state or local disclosure regulations that require that the issuer provide its financial information to its shareholders on a regular basis, such as annually; issuers that have complied with any tax obligations as of the most recent tax year; issuers that have recently made material disclosures as part of a reverse merger; or facts and circumstances that present other features that are consistent with the goals of the amended Rule of enhancing protections for investors, particularly retail investors.
  • The Commission encourages requests to be submitted expeditiously during the nine month transition period of the amended Rule to avert potential interruptions in quotations in such securities that may occur on or after implementation.
  • Issuers and investors that may be interested in requesting any such exemptive relief may coordinate with broker dealers to submit requests. Because the amended Rule governs publications or submissions by broker-dealers, the requirements of the amended Rule and any conditions of any such exemptive relief would likely be undertaken to be complied with by a broker-dealer rather than an investor or issuer.
  • See infra Part II.L. Paragraph (g) of the amended Rule states that “[u]pon written application or upon its own motion, the Commission may, conditionally or unconditionally, exempt by order any person, security, or transaction, or any class or classes of persons, securities, or transactions, from any provision or provisions of this section, to the extent that that such exemption is necessary or appropriate in the public interest, and is consistent with the protection of investors.”

We will be continuing to cover this regulatory change in the Oddball Stocks Newsletter. If you haven't yet, give us a try.

State Farm to Acquire GAINSCO ($GANS)

From a press release today:

State Farm Mutual Automobile Insurance Company, America’s largest property and casualty insurance provider, and GAINSCO, Inc. announced today that they have entered into an agreement pursuant to which State Farm will acquire GAINSCO for approximately $400 million in cash.

The transaction is expected to close in early 2021, subject to approval by GAINSCO’s shareholders, the expiration or termination of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, obtaining regulatory approvals, and satisfaction of other customary closing conditions.

GAINSCO concentrates on the non-standard personal automobile insurance market, specializing in minimum-limits personal auto insurance.

The transaction is the first acquisition of an insurance company by State Farm in its 98-year history. [...]

Under the definitive merger agreement, upon closing State Farm Mutual will acquire 100% of the stock in GAINSCO, Inc., the holding company of MGA Insurance Company, Inc., a Texas-domiciled insurance company, and GAINSCO shareholders will receive approximately $107.38 per share in cash. GAINSCO will continue to operate as a separate company and brand with continued focus on its current objectives. Over time, the parties expect to provide State Farm agents the opportunity to distribute GAINSCO products in addition to State Farm products and services.

Shares of GANS had been trading in the mid-$30 range. We mentioned Gainsco in Issue 25 of the Oddball Stock Newsletter back in June 2019. Here is what we said at the time:

GANS is a Texas-based holding company with an insurance company subsidiary (MGA Insurance Company, Inc.) that specializes in minimum-limits personal auto coverage. The company apparently also owns and operates a Hyundai dealership in Dallas! It had been a public company until 2011 when it terminated its SEC registration and went dark. The company had shareholders' equity of $102.7 million as of the end of 2018, on which they had comprehensive income of $14 million in 2018 compared to $15 million in 2017.

Of course, for an insurance company that's earning double-digit returns on equity, you are going to have to pay up... at the ask price of $38 a share the company market capitalization is $182 million, a price-to-book ratio of 1.77 times. Management seems to think that this is cheap because they repurchased 292,958 net shares of stock in 2018, which was 5.8% of the outstanding. The average price paid, though was $25 – the share price chart over the past five years has been parabolic. There is actually a pretty small public float on this – as of the last proxy statement filing (which was in 2010) the directors and officers as a group owned 74% of the stock.

Minimum-limits policies are obviously a different breed than GEICO. One of the many one-star Yelp reviews says, “Pray you never get hit by someone insured by this company.” It is crazy that anyone is allowed on the roads with the bare bones $25,000 of coverage that Texas allows.

Go figure - you would have almost tripled your money buying the minimum-limits car insurer (with its own Hyundai race car) at a P/B of 1.77x (and a ROE of 14%). Maybe the clue was the aggressive share repurchase?

Nate Tobik on Investor Summit Virtual Happy Hour Discussion

In this Investor Summit Virtual Happy hour Ian Hunter, Dave Waters, and Nate Tobik discuss the valuation gap between small and large stocks.

Pardee Resources in Oddball Stocks Newsletter ($PDER)

We've mentioned Pardee Resources (PDER) on the blog several times lately, and it's one we write about frequently in the Oddball Stocks Newsletter as well. We thought we would share a couple of excerpts from the Newsletter, so that blog readers who haven't experienced it can get a feel for the types of things we discuss in the Newsletter.

Issue 22 (November 2018)
On August 16th [2018], Pardee announced a self-tender for its shares. They offered to purchase up to 26,463 shares at a price of $188.94 per share, which represents a market capitalization for the company of $130 million. The share price was determined as the volume weighted average price over the ten days ended August 15th. We had just been asking “why buy table grape vineyards instead of repurchasing shares” and apparently the company has come to the same conclusion.

We recently obtained and read a copy of Calvin Pardee, 1841-1923: His Family and His Enterprises which is a family history written by descendants (and Pardee executives) C. Pardee Foulke and William G. Foulke. Copies of this are scarce and expensive because it was a small printing of a family history for a wealthy family. A certain number were given to outsiders and have ended up on the used book market. Ours was originally given to Manford O. Lee of VF Corp – a big deal apparel company both now and back when the copy was sent in May 1981.

The Pardee presence in America was founded by a Parliamentarian ancestor who came to New Haven during the English Civil War. During the 19th century a Pardee got interested in Lehigh Valley anthracite coal, and that is where the story of wealth starts. The one mistake they made, or the reason they did not become a household name like Carnegie, is that they did not follow the coal and steel industry west to Pittsburgh. (The reason for the westward shift was that steel-making using bituminous coking coal made more sense in Pittsburgh, nearer to deposits of that type of coal. Plus the market for steel rails was in the expanding west, not the east.)

Ultimately, though, Calvin Pardee did take the cash generated by the eastern PA mines and reinvested it towards the end of the 19th century in lands in Louisiana (timber, later oil and gas), West Virginia, Kentucky, and Virginia (the latter three all coal). The Louisiana lands that were bought based on timber value but proved to have oil were the big winner. That leaves PDER as a family owned resource company that has been mining coal, growing timber, and producing oil and gas for more than a century. I can't think of anything else quite like it. Texas Pacific Land Trust has been around since 1888 but is not actively managed.

Last Issue we also did a comparison of Pardee and Keweenaw based on implied timberland value, but of course the valuation of Keweenaw has fallen to $641 per acre for the timber. If you assumed, just for ballpark, that the acreage of Pardee was worth the same as KEWL, then the almost quarter acre per share of land at PDER would be worth $154 now instead of $192 when KEWL was trading at a higher price.

Inverting this calculation, the market capitalization of Pardee is about $789 per acre of timber, ignoring the value of the other resources. Given that Pardee has paid over $1,000 per acre for some of its timberland, why not up the ante on share repurchases? We'll see what the company does.
Issue 25 (June 2019)
We recently attended the 180th Pardee Resources annual shareholder meeting on May 16th [2019] at the top of the BNY Mellon Center building in downtown Philadelphia. While management was friendly, gave a very detailed presentation, took almost a dozen audience questions, and even served a (cold) lunch, we came away with a pessimistic view on the principal-agent problem that exists here.

[O]ne thing that has been bothering us recently are the paltry earnings from Oddball companies' timber holdings. In most investors' sum of the parts valuations of Pardee, timber is the single largest asset. If you value the timber at anything more than $704 per acre, it covers the entire enterprise value with the stock at $170 per share. However, with its 165,000 acres of timber, Pardee's timber division earned $2.1 million in 2018 and $2.9 million the previous year. In 2016 it earned $2.6 million. That is $15 per acre, average, per year. The company's land and timber is on the books at $45.2 million (which is $274 per acre). If you take those three year average earnings and capitalize them at a 5% cap rate it's $50 million; about book value. This is way less than comparable transactions for timber or the prices that Pardee has bought and sold timber, and yet... why would you want to pay more than this? At the $1,000/acre numbers that are bandied about, you get a 1.5% plus or minus inflation, very long duration cash flow that might be attractive to a college endowment or an insurance company, but how is it attractive to a micro cap value investor? (If nothing else, the timber could be dumped just as a way to get less long of long term government bonds.)

Sure, we believe that if all the assets of Pardee were sold the proceeds would be more than the current enterprise value. The shares might be worth double. Even selling the timber alone would probably result in proceeds greater than the current enterprise value. But management is not incentivized to do that, and the biggest shareholders (some of whom might be, if they knew) seem more concerned with keeping the company around as a family monument than maximizing their net worth. (If you want your descendants to maximize the value of a family business, leave your name off of it.)

Here is the problem with management's incentives. They have $189 million of assets at book value. The annual SG&A expense is $6.95 million which is 3.7% of this. If they were to sell land at anything over $700 per acre after tax, which they probably could, they could buy back stock at the current price of $170 and get the rest of their coal, oil, gas, solar, and agricultural assets for free. (Note that their current book value of land and timber is about $45 million, so a hypothetical sale of 165,000 acres of timber for after-tax proceeds of $116 million is not totally implausible.) But shrinking the asset base, and pre-SG&A operating income, would leave the company with a top heavy, too-high expense structure and overhead burden. A Pardee executive pointed out during the meeting that the company has only 26 employees, one fewer than 20 years ago. Unfortunately, it is also about the same number that Berkshire Hathaway has at the Omaha headquarters with 4,000 times more assets.

This incentive misalignment was made awkwardly clear at the meeting (which was the best attended we have seen this season, with some writers from Motley Fool, some institutional asset managers, and a number of private value investors). Many of these shareholders asked questions during the Q&A, and the questions fit into two categories: will you promise not to dabble in any more weird investments, and will you buy back more stock?

Two shareholders mentioned Texas Pacific Land Trust and its capital allocation policy that has consisted of dividends and share-cannibalization. The name did not seem to ring any bells with Pardee management, which is sad because it is one of the most successful non-operating resource investment vehicles of all time. The Chairman said that more money has been returned to shareholders than used to buy assets over the past five years, and they do not want to decapitalize the company by buying back “too much” stock. Also, and specifically regarding SG&A at 20% of revenues, the Chairman said that they still have the same expense base that they had when revenue was much higher, and they would rather have higher revenue than try to cut expenses.

So now we know why the company has been experimenting with solar and agricultural investments instead of dumping overpriced timberlands and returning that cash. The company has been forced out of its comfort zone with predictable results: as they said at the meeting “wild cards & skunks” like the mobile solar generator Ponzi scheme and the table grapes that had a $2.1 million loss because of unseasonably warm followed by unseasonably cold weather. (The CEO did say that they are going to “take a breather” and are not investing in subsequent phases of the grape and almond projects.)

Our current thought on Pardee is as follows. If management is not going to sell the timber at a once in a lifetime high valuation (due to low interest rates) then those need to be capitalized at a reasonable interest rate. Book value seems like a reasonably attractive price. If you make that assumption, then all of a sudden you really need to sharpen your pencil on the coal, oil, and gas assets. We did a little digging on Pardee's coal mines. The operator of their biggest tract actually went bankrupt, although is continuing to operate and made good on its royalties. But the West Virginia metallurgical coal is high enough cost that there is a risk that mining could one day stop.

Meanwhile, the SG&A burden ticks on. And the need to replace the asset base creates pressure to do deals – like the agriculture, solar, or the biggest recent one: the $54.5 million invested in oil and gas in 2013. That was year that crude hit $110, before collapsing into the $20s from the second half of 2014 through the beginning of 2016.
Keep in mind these excerpts are from a couple years ago. If you want to stay up to date with what's happening at Oddballs like Pardee Resources, join the Oddball Stocks Newsletter.

Hanover Foods FY 2020 Annual Report

Hanover Foods is a classic Oddball that has been written about on this blog a number of times over the years: the original posts (parts 1 and 2) back in 2012, and an update in 2013, their quarterly results this June, and the recent obituary of John Alan Warehime.

It has been a year since we last looked at Hanover Foods Corp's FY 2019 results, and now the FY 2020 annual report has arrived in the mail.

At a share price of $75 for the HNFSA (non-voting) share class, the market capitalization of the company (with 715,205 common shares outstanding) is now about $54 million, compared with net current assets of $126 million ($176 per share), and a book value of $245 million ($342 per share).

Hanover's results improved from FY 2019 to FY 2020. Their revenue went from $395 million to $401 million, but more impressively gross profit grew from $32 million to $41 million. Meanwhile, SG&A shrank by $2 million, with the result that operating profit went from just over breakeven to $12 million.

We'll have more about Hanover Foods in the upcoming November Issue of the Oddball Stocks Newsletter.

Pardee Resources Reports Q2 2020 Results

In June we posted Pardee's annual meeting slides. Also see our recent posts on Pardee's 2019 annual report and its share repurchases. We just received the second quarter (2020) report for Pardee:




Quick takeaways: met coal was idled because of covid, so their coal division income fell from $8.3 million for the first half of 2019 to $2.4 million for the first half of 2020. Oil and gas division and timber were both down as well. Interestingly, the alternative energy division produced more power and had higher revenue than in the year prior.

We will have more to say about Pardee in the November Issue of the Oddball Stocks Newsletter.

Nate Tobik on "The Widest Valuation Gap This Millennium!" - Tonight

Nate Tobik is going to be on a panel for the Investor Summit this evening from 6pm-7pm ET. He will be discussing the valuation gap between small caps and the market in general. You can register here.
Right now we are experiencing the widest valuation gap between value and growth stocks in decades. What does this mean and how can we act on this opportunity?

Thursday, August 27th at 6 PM EST

Panel
The Widest Valuation Gap This Millennium!

Panelist
Ian Hunter from Hunter Value Capital
Nate Tobik from Oddball Stocks
Dave Waters from OTC Adventures & Alluvial Capital

Agenda
6 PM Opening remarks from CEO Fred Rockwell
6:15 PM Panel
6:40 PM Table talks and open networking
7 PM Event ends

Making Progress at Conrad Industries ($CNRD)

We have been writing about barge-builder Conrad (CNRD) on the blog for years. Last year we published a sample from the Newsletter, and Nate wrote about it twice back in 2012.

Conrad is a rare Oddball with good, friendly management, but their business is really challenged by the lack of oil and gas activity in the Gulf of Mexico. However, they signed a big job this year:
Our backlog increased to $133.0 million at June 30, 2020, compared to $79.2 million at December 31, 2019 and $116.8 million at June 30, 2019. The increase in our backlog is primarily due to the signing of our largest contract to date, a 6,500-cubic-yard-capacity Trailing Suction Hopper Dredge, which will be constructed at our Deepwater South shipyard in Amelia with expected delivery in the first quarter of 2023.
The market capitalization is currently $61 million. Current assets net of all liabilities are $57 million. They also got a PPP loan of $8 million.

Here is a table showing their results for Q2 2020 showing a big improvement year-over-year. Gross profit up with revenue down, and big SG&A reduction, for a nice increase in income overall.



We'll have more coverage of Conrad in upcoming Issues of the Oddball Stocks Newsletter. (Try a sample here.)

Big Share Repurchase at Crazy Woman Creek Bancorp, Inc.

Nate mentioned CRZY in Issue 13 of the Oddball Stocks Newsletter, back in July 2016. Here is what he had to say at the time:
The company has a market cap of $8.5m with 632,842 shares outstanding. The company has issued slightly over 1m shares and repurchased approximately 400k of them, including 8,329 shares in 2015. The continual buybacks are a positive sign for investors and demonstrate appropriate capital allocation.

The bank has a book value of $11.7m ($18.58 per share) and could be worth $15m ($24.06 per share) in an acquisition according to our CompleteBankData acquisition valuation model. Both book value and acquisition value are significantly higher than where shares currently trade at $13.50.
[P/B at the time was 0.73x]

The bank could be a potential acquisition target for a larger bank looking to get into the Wyoming market, or for a bank in the region looking for a bolt-on acquisition. At current prices this is a great bank to add to the cheap bank basket.
CRZY traded above $20 earlier this year, then fell as low as $13.95 after the March crash. They've recovered to $15.62 as of today. They've also paid $1.26 of cumulative dividends since Nate mentioned them in the Newsletter.

On Wednesday (August 18th), the company put out a press release about a big share buyback funded by a issuance of ten year debt:
"...Buffalo Federal Bank, today announced the completion of its private placement of $2.0 million of 5.0% fixed-to-floating rate subordinated notes due 2030 (the “Note”) to a Wyoming bank. The Note will initially bear a fixed interest rate of 5.0% per year for five years and then reset quarterly to the three-month SOFR rate, plus a spread of 460 basis points, payable quarterly in arrears to the August 14, 2030 maturity. The Company may redeem the Note upon the end of the fixed rate period, or at any time upon certain other specified events. The primary use of the proceeds was to fund a block repurchase of 93,000 outstanding shares, or approximately 15%, of Crazy Woman Creek Bancorp’s common stock. The transaction is expected to increase book value per share by approximately $1.57. At June 30, 2020, book value per share was $23.40 with outstanding shares of 623,103.  After giving effect to the repurchase of 93,000 shares, outstanding shares are 530,103."
If their calculation is accurate, that would bring book value up to almost $25, making the current P/B ratio 0.62.

Total assets for CRZY at June 30, 2020 were $138 million, there is $3.4 million of premises and equipment, and only $132k of goodwill. Shareholder equity (then) was $14.6 million.

Guest Post: Northeast Bank ($NBN) by Dave Anderson

[This guest post is by Dave Anderson who works for Anbec Partners, LP, which focuses on value and special situation investments. They are long shares of Northeast Bank.

Issues of the Oddball Stocks Newsletter will typically have a guest piece like this one. Try a sample of the Newsletter to see what it's like.]

Summary
Northeast Bank (NBN - $18.50) is an interesting opportunity at current prices due to its strong loan portfolio, capable underwriting, and a new income stream from a recent PPP relationship that is not reflected in its most recent earnings. While this is a summary write up, the company provides very useful information in their quarterly earnings presentations.

Despite its generic name, NBN is more than a sleepy regional bank. It is a sophisticated national player with strong capital allocators at the helm. The CEO, Rick Wayne, a skilled owner/operator, has an impressive track record purchasing loans in the secondary market and is committed to conservative underwriting standards. Board members include Chair Robert Glauber, the former Chairman and CEO of NASD (now FINRA), and Matthew Botein, the former co-head and Chief Investment Officer of BlackRock Alternative Investments.

While the stock has rebounded from a COVID-related decline, during which the Company re-purchased nearly 10% of the common stock, we believe there is still considerable long term value at current prices. And I believe that NBN is poised for strong earnings going forward given: (i) loan portfolio quality, (ii) insider purchases and share repurchases, (iii) balance sheet capacity to acquire and originate profitable new loans, and (iv) earnings from the new PPP loan relationship with Loan Source not yet reflected in financials.

Background
CEO Richard “Rick” Wayne co-founded Atlantic Bank & Trust Company in 1988. In 1993 the bank began purchasing quality assets in the secondary market, primarily from regulators who had taken over failed competitors. The strategy proved very successful. The bank went public in 1996, changed its name to Capital Crossing in 1999, and was ultimately acquired by Lehman in 2007 and surrendered its bank charter at that time.

In 2009 Wayne raised funds for FHB Formation, LLC with the intent of investing the capital in a financial institution. At the end of 2010, FHB Formation, LLC merged with Northeast Bancorp. NBN remained as the surviving entity. At the time, NBN was a sleepy community bank with ~$600M in total assets and net interest income of roughly $16M. The bank specialized in lending in its local region primarily in Maine. At 6/30/20 NBN had total assets of $1.3 billion, TTM net interest income of $60 million and a national loan footprint.

Today NBN operates three business segments: the Loan Acquisition and Servicing Group (“LASG”), Community Banking, and Small Business Administration (SBA) lending. LASG, which purchases and originates commercial real estate loans nationally, has historically been the earnings driver. But a new PPP/SBA business relationship with Loan Source, discussed in the 6/30/20 earnings call, could add meaningfully to future earnings.

Loan portfolio quality
In the 3/31/20 earnings call, management laid out the portfolio LTV and provided color on current reserves. Active insider purchasing in the spring (see below) would certainly seem to indicate their faith in the portfolio value.


Insider purchases and share repurchases
Insiders were active purchasers in March and April. Importantly, since May 2019 the Form 4s have been filed with the FDIC, not the SEC, making them less obvious to investors.

The Company aggressively repurchased common stock in late calendar Q1 and Q2 (NBN has a June 30 FY end) as shown below in the 6/30/20 investor deck provided by NBN.


Balance sheet capacity
As of 6/30/20, NBN has loan purchase/origination capacity of $500mm. If we assume NBN utilizes 50% of that capacity to add net new loans to the balance sheet, we get the following incremental net income. Note, this could be conservative given COVID-driven loan purchasing opportunities - see 3/31/20 earnings call comments from CEO:

In reviewing the historical growth of NBN’s LASG loan book note that, until recently, the bank had been constrained by certain capital requirements imposed by regulators at the time of NBN’s founding merger. After the 2019 corporate reorganization and a subsequent 2020 capital requirement change, NBN earning power has increased. As an example, prior to the 2019 reorg, Purchased Loans were limited to 40% of Total Loans. Post-reorg, that limit increased to 60% permitting NBN to bid more competitively while maintaining credit quality, according to the CEO.

In the 4/23/20 earnings call, Rick Wayne made the following comment:

“I'm pleased -- very pleased to report that the remaining regulatory conditions have been waived. The bank's Board has reduced the Tier 1 leverage ratio limit from 10% to 9% and the total capital ratio limit from 13.5% to 12%. The impact of this change is shown on Slide 4, where based on capital at March 31, loan capacity has increased by $143 million from $255 million to $398 million. With this change, we are now in conformity with the capital limits of many other banks, and we have additional capacity to prudently, and I say prudently, grow our balance sheet.”

New PPP loan relationship with Loan Source
In the 6/30/20 earnings call, management discussed their new relationship with Loan Source related to PPP loans. This relationship, in addition to providing meaningful one time gains (Fiscal Q4 2020) on sale of PPP loans (with potentially more to come), also includes ongoing servicing income (for the life of the PPP loans) and correspondent fees (to be amortized over the life of the loans). Other than the gain on sale, these components were not meaningfully reflected in the 6/30/20 earnings but will hit in the quarters to come and their impact is material:


Valuation Summary

Noteworthy Risks
  • Reserves/LTV - Management gave a thoughtful response to an analyst’s question in the 3/31/20 earnings call regarding the values used in the LTV analysis shown above and NBN’s allowances for losses. You can see the detailed analysis here (as of 3/31/20) and additional portfolio data here (as of 6/30/20)
  • Interest rate sensitivity
  • New loans - how quickly can NBN appropriately deploy their capital. The CEO says he will not compromise on underwriting standards, and he does not have a history of write-downs.