Friday, June 10, 2022

Mr. Bank Investor, I Have Two Questions

I recently delivered remarks at a bank institutional investor conference titled "Don't Be Mr./Ms. Irrelevant." The conference included a panel of recognizable bank stock investors who waxed eloquent on their criteria for making and maintaining their interest as an investor in your financial institution.

As a follow-up to their remarks, I asked two panelists and an additional institutional investor two questions and got their permission to print their answers for your benefit. Before you browse away because you are not public, or have few institutional investors, know that your relevance depends on how you are perceived by outside stakeholders. And outside stakeholders with money at risk can teach us about value whether or not your financial institution is valued by shareholders every day.

First, here are the investors:

Jim Deutsch, Partner, Patriot Financial Partners. Jim is a 40 year industry veteran that serves on numerous bank boards because Patriot favors making investments where they obtain board seats. Jim led a de novo institution from its birth to an 11-branch, $750 million institution in less than six years. He held various executive positions at recognizable names such as Commerce Bancorp and Summit Bancorp.

Anton Schutz, President and Chief Investment Officer, Mendon Capital Advisors. Anton formed and has led Mendon Capital for over 25 years. He is a regular contributor to CNBC and other respected news outlets on bank stock investing. Prior to starting Mendon he worked for Tucker Anthony Capital Markets working in the banking sector, and before that worked in Structured Derivates at Chase Manhattan. 

Mark Lynch, Retired Partner, Wellington Management
. Mark was a senior financial analyst at Wellington since 1994 and a partner from 1996 until his 2019 retirement. He was also a portfolio manager of mutual funds, hedge funds, and institutional portfolios focused on the banking sector over that period. Prior to Wellington, he was a US regional bank analyst with Lehman Brothers and Bear Stearns. He currently serves on the board of Bermudian bank The Bank of N.T. Butterfield and Son Limited.

Question 1: What is the one thing a bank must have before you consider an investment?

Deutsch: Very hard to say just one thing, so I guess it's management. I believe there are lots of different ways to make money in banking which was evident in the room in Key Largo (bankers at the conference). As important as a core deposit franchise is, the most profitable bank in attendance has the highest cost of deposits. Another that operates above a 15% ROE operates in a state that investors hate and therefore won't buy the stock much above 115% of tangible book value. Some have low loan to deposit ratios and some are over 100%. Some have no branches and some have plenty of them. 

When considering long-term viability, I think the bank has to develop something that others will covet. Most often that is a loyal customer base. Once I acquire loyal customers, then I can use many levers to increase my profitability even if I don't have optimal scale.

Schutz: Strong management with plenty of skin in the game.

Lynch: It's very different for institutional and individual investors. Institutional investors are investing for someone else. The client views it as an asset allocation and has a time frame on average about 18 months and doesn't put much importance on the taxes paid. So, as a manager, you can maybe stretch the (investment) time horizon out to 30 months and with a lack of emphasis on taxes, that means (institutional portfolio) churn is a fact of life. So for the bank, the one important thing is A WAY TO MAKE THE COMPANY MORE PROFITABLE EVERY YEAR.

Retail investors hate paying taxes and hate losing money, particularly since in banking there's little chance of a community bank being the next Microsoft. So (investment) portfolio churn plummets and the importance of a stable underlying business is much higher. So, the one important thing is GROWTH IN CHEAP DEPOSITS as manifestation of a relationship with customers that's based on service rather than price or easy credit.

Question 2: What should every bank's strategy address?

Deutsch: Strategy sessions must include a BRUTALLY honest SWOT analysis which is rarely seen. You think your team is a strength? Really, you have better people than Goldman or JPMorgan? Technology? Really? Better than Amazon or Google or Square (Block)? Strengths have to be measured as something that is top decile, not just better than average. For most community banks, the business products are a commodity that the bank tries to craft into something that looks custom.

What I think many banks often overlook are intangibles that are really valuable and not easily copied. Things like reputation, culture, legacy customers, etc. Those things can be valuable to a significant customer base which can ultimately be sold to an acquirer for a premium (or be used to get premium pricing while the bank operates independently.)

And for any bank that has a large, independent shareholder base, the opportunity to sell the bank (get a better price by trading into a better currency) must be analyzed every year. Directors have to measure the value of independence vs. sale. That is a mathematical analysis, which then has to be judged against short-term and long-term variables.

Schutz: Every public company must justify its independence every day. A well run company does just that. A poorly run company has much more to prove.

Lynch: The strategy part is easy = what sort of customers does (the bank) want to attract and why should those customers choose them over other providers, i.e. what is the bank good at and how do they get paid for that skill?

Questions to consider when crafting and executing strategy.

Hope this has been helpful to you.

~ Jeff

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