Banking's Total Return Top 5: 2016 Edition

For the past five years I searched for the Top 5 financial institutions in five-year total return to shareholders because I grew weary of the persistent "get big or get out" mentality of many bankers and industry pundits. If their platitudes about scale and all that goes with it are correct, then the largest FIs should logically demonstrate better shareholder returns. Right?

Not so over the five years I have been keeping track.

My method was to search for the best banks based on total return to shareholders over the past five years. I chose five years because banks that focus on year over year returns tend to cut strategic investments come budget time, which hurts their market position, earnings power, and future relevance than those that make those investments.

Total return includes two components: capital appreciation and dividends. However, to exclude trading inefficiencies associated with illiquidity, I filtered for those FIs that trade over 1,000 shares per day. This, naturally, eliminated many of the smaller, illiquid FIs. I also filtered for anomalies that result from recent mutual-to-stock conversions and penny stocks. 

Before we begin and for comparison purposes, here are last year's top five, as measured in December 2015:

#1.  Independent Bank Corporation (Nasdaq: IBCP)
#2.  Fentura Financial, Inc. (OTCQX: FETM)
#3.  BNCCORP, Inc. (OTCQX: BNCC)
#4.  Carolina Bank Holdings, Inc. (Nasdaq: CLBH)
#5.  Coastal Banking Company, Inc. (OTCQX: CBCO)

Here is this year's list:

Independent Bank Corporation celebrates its second straight Top 5 recognition, and BNCCORP celebrates its third straight year on this august list. Congratulations to them. A summary of the banks, their stories, and links to their website are below. 

#1. Independent Bank Corporation (Nasdaq: IBCP)

Independent Bank dates back to 1864 as the First National Bank of Iona. Its size today, at $2.5 billion in assets, is smaller than it was a decade ago. It is a turnaround story because the bank was hammered with credit problems between 2008-11, when it lost over $200 million. In 2011, at the height of its problems, non-performing assets/assets was nine percent. Today that number is 3.6%. Exclude performing restructured loans, and that number plummets to 0.62%. The result: those investors that jumped onboard at the end of 2011 were well rewarded. Their total return was greater than 1,500%. You read it right.


#2. Waterstone Financial, Inc. (Nasdaq: WSBF)

Waterstone is a single-bank holding company headquartered in Wauwatosa, Wisconsin. It has $1.8 billion of assets and operates eleven branches in the metropolitan Milwaukee market, a loan production office (LPO) in Minneapolis, Minnesota, and 45 mortgage banking offices in 21 states. The mortgage bank has more than 3x the employees of the bank. Year-to-date, the company has generated more fee income, at $95.2 million, than it has in operating expense, at $95.0 million. I don't know any other bank that accomplished this. I'm sure there are some. But I haven't heard the tale. This tale is true. That means their year-to-date $31.8 million net interest income after provision... is gravy. And that is a key reason why their five-year total return exceeded 1,000%!


#3. Summit Financial Group, Inc. (Nasdaq: SMMF)

Summit Financial Group, Inc. is a $1.7 billion in asset company headquartered in West Virginia, providing community banking services primarily in the Eastern Panhandle and South Central regions of the state, and the Northern and Shenandoah Valley regions of Virginia. Summit also operates an insurance subsidiary. In 2011, the company had net income of $4.1 million on assets of $1.5 billion. Today, the company has annualized net income of $16.8 million. A reversal of fortune from a 0.28% ROA to a 1.09%. How did they do it, from my perspective? 1: Margin expansion, and 2: Expense discipline. Annual operating expenses were $36.6 million in 2011, and are $33.2 million today. And that includes some of the expenses associated with an acquisition that is set to close shortly. So they grew. And spent less to do it. A bank that viewed its operating expenditures as investments. Amazing!


#4. MBT Financial Corp. (Nasdaq: MBTF)

In 1858, while Lincoln and Douglas debated for a US Senate seat, Benjamin Dansard started Dansard State Bank to operate from the back of Dansard General Store. Ultimately renamed Monroe Bank and Trust, this bank pre-dates the Civil War! Similar to IBCP above, MBT is a turnaround story. In 2011, non-performing assets/assets was at 7.7%. Today they are at 1.8%, and below 1% if you exclude restructured yet performing loans. The asset quality issues led to a $3.8 million loss in 2011. Since that time, nothing but black ink, leading to a year-to-date ROA of 1.10%, and ROE of 10.13%. How did they get there? A dramatic improvement in asset quality, a process and efficiency initiative that led to reduced costs and improved processes, and motivation. Insiders own over 22% of the company. That's motivation! Well done!  

#5. BNCCORP, Inc. (OTCQX: BNCC)

BNCCORP, Inc., through its subsidiary BNC National Bank, offers community banking and wealth management services in Arizona, Minnesota, and North Dakota from 16 locations. It also conducts mortgage banking from 12 offices in Illinois, Kansas, Nebraska, Missouri, Minnesota, Arizona, and North Dakota. BNC suffered significant credit woes during 2008-09 which led to material losses in '09-10, and the decline in their tangible book value to $5.09/share at the end of 2010. Growth, supported by the oil boom in North Dakota's Bakken formation, and a robust mortgage banking business, is challenged due to  the decrease in oil and ag commodity prices. But earnings continue to increase in spite of the challenges. This has resulted in a tangible book value per share at September 30th of $22.51... a significant recovery and turnaround story that landed BNC in our top 5 for the third straight year. Your investment five years ago would have resulted in over an 800% total return!

Here's how total return looks for you chart geeks, with the lower green, and flat line being the S&P 500 Bank Index.

There you have it! The JFB all stars in top 5, five-year total return. The largest of the lot is $2.5 billion in total assets. No SIFI banks on the list. Ask your investment banker why this is so.

Congratulations to all of the above that developed a specific strategy and is clearly executing well. Your shareholders have been rewarded!

Are you noticing themes that led to these banks' performance?

~ Jeff

Note: I make no investment recommendations in my blog. Please do not claim to invest in any security based on what you read here. You should make your own decisions in that regard. FINRA makes people take a test to ensure they know what they are doing before recommending securities. I'm sure that strategy works well.

Too Small to Succeed in Banking

Conventional wisdom: The onslaught of new banking laws, regulations, and regulatory activism requires scale to absorb costs. Or, the rapid pace of technological change and the sophistication of hackers requires resources not found in small community banks.

There is truth to conventional wisdom. But with all generalities, there are exceptions. And in banking, lots of exceptions. How do I tell the $250 million in asset client that I just visited that they are too small to make it, even though they sport a 1.47% ROA? The financial institution landscape is littered with banks and credit unions like my client.

Almost two years ago I wrote that bank shareholders were changing. (see The Coming Bank Consolidation) Community bank investors used to be the local insurance agent, mortician, and family that sits next to us in church. Today, many of traditional bank investors put their money in mutual funds, and leave the investing up to fund managers. No longer does the local barber show up at our annual meetings complaining about the pastries. Instead, professional money managers call to tell us how to run the bank.

As we migrate towards greater institutional ownership, stock liquidity is becoming increasingly important. Occasionally money managers call me with their criteria for their fund. One criteria is typically float and volume. Under 10,000 shares trading volume you say.... fuggedaboutit! 

My firm is occasionally called upon  to value banks that don't trade. Part of the valuation includes a discount for the lack of liquidity. Not a term foreign to other industries, by the way. In determining the discount, we look to trading markets to see the discounts applied, if any, to thinly traded bank stocks compared to their high volume brethren.

I recently ran an analysis of banks that trade over 10,000 shares per day, to those that trade 500-10,000 shares per day. The results are in the table below.

I controlled for financial performance (greater than 1% ROA), and asset quality (less than 2% NPAs/Assets). Of course, more performance and market data factor into trading multiples, but I couldn't control for everything. The result: Low Trading Volume financial institutions trade at a price/tangible book ratio of 110.5%, and a price/earnings ratio of 12.1x, compared to High Trading Volume FIs at 160.6% and 13.2x respectively.

What do I think community banks can do about the disparity?

1. Get a real investor relations program. Bankers think we should actively court investors when we need capital. Not so. Trading multiples are a direct result of supply and demand. If you want greater multiples, build demand... always.

2. Focus on retail investors. Community bankers think they can tap the institutional market. Investment banking firms tell them so. The truth is, institutions willing to invest in a bank that trades 2,000 shares per day are typically those that expect to exit the stock by selling the bank. How else can they exit your stock at such low trading volume? One benefit of having local, retail investors is they tend to have greater patience when implementing strategic change. To institutional investors, you are a number on a spreadsheet. If you take institutional money, plan their exit before they invest anything.

3. Perform. There is a positive correlation between financial performance and condition, and trading multiples, period. 

Banks that trade at low trading volumes trade at lower multiples and may be shut out of the institutional market for capital. Those that don't build retail investor demand for their shares may be required to sell if they need capital. You may be too small to succeed, but not because you can't deliver superior performance. But because nobody will invest in your bank.

~ Jeff