Banks On Sale

My bank stock portfolio was comfortably in the black, with a solid 2.5% dividend yield at year-end. My have times changed.

Before I begin, I feel compelled to disclose that I am not a registered broker or financial advisor. I am not giving you investment advice.

At December 31, 2019, the SNL Bank & Thrift Index stood at 193% price/tangible book, 13.6x EPS, and a 2.63% dividend yield. Then Covid-19.

At April 14, 2020, I measured all banks and thrifts with total assets between $1 billion and $10 billion. Still community banks, and have decent trading volume for more efficient pricing. At the median, these banks had a market metric slash line (P/E, P/TB, Dividend Yield): 8.8x / 95% / 3.39%. But the differences among banks varied greatly. The greatest drop in market price was Marlin Business Services Corp., at 64%. At the other end of the spectrum, Community Bancshares in McArthur, Ohio GAINED 8%! Do they finance respirator production?

I should point out that Marlin Business Services has many subsidiaries, most of them finance companies, but one is a bank.

Statistics

On average there was a significant drop in valuations. But "on average" is a pesky phrase. What is the standard deviation? Recall from statistics class, which gave me math stress by the way, the closer the standard deviation is to zero, the lower the data variability and the more reliable the average is. The higher the standard deviation, the more variation there is in the data and the less accurate the average is. The standard deviation of stock price decline between December 31st and April 14th for the banks I measured was 11.8. Yikes!

That means, within the data, there is opportunity. And I hear about this opportunity from bankers that really, really want to buy back their stock at these valuation levels. But an abundance of caution because of the unknown, plus optics, is preventing them from doing so. 

Fear of the unknown and the gravitational pull that whispers in our ear to buy high, sell low may be holding back the rest of us. It is tempting to be as liquid as possible during this period of uncertainty. But it is the uncertainty that has otherwise healthy and profitable banks trading below book value. Some comfortably below book value.

First Quarter

Early earnings releases, primarily by the big banks may be fanning flames of fear. Citi announced a $7 billion provision for loan loss in 1Q, up from $2.1 billion the quarter prior. JPMorgan announced a 1Q provision of $8.3 billion from $1.4 billion. But $1.3 billion in assets MainStreet Bancshares in Fairfax, Virginia announced a provision of $350 thousand, down from $358 thousand the quarter prior. 

I think it likely though that most community banks will announce increases in provision, and some significant increases, due to early forbearance and payment deferment requests. And, as I said to a bank publication reporter yesterday, big banks take more of a macro-economic approach when assessing their loan portfolio. Community banks are more credit-by-credit. And that may not come to bare until the second quarter. 

Spreadsheets

And this is likely contributing to the wide variation in valuations we are seeing. The below two tables represent the top 10 price declines in banks with $1 billion to $10 billion in total assets from December 31st to April 14th.

Some of the above banks have stories. For example, at first glance, First Defiance looks compelling. A 1.50% ROA, 12.15% ROE, only 63 basis points non-performing assets/assets and a 9.58% tangible capital ratio. Even if NPAs spiked, they have a loan loss allowance as first defense and their capital was very good. Why in the heck did their stock drop 53% and now trades at a 6x earnings and a nearly 6% dividend yield?

Probably because they closed on a previously announced all-stock acquisition of a $2.9 billion in assets bank on January 31st. After their December 31st earnings, but before quarter end. And before the precipitous Covid induced bank stock decline. The deal value at January 31st was actually greater than at announcement! 

So there is uncertainty there, at least until FDEF announces 1Q earnings, which is not anticipated until April 28th. Even then it may not be clear because it would be challenging for FDEF to get their arms around the Covid impact to their own loan portfolio, let alone another, almost equally sized bank. Uncertainty equals discount.

And so it goes with many of the banks in the $1 billion to $10 billion in assets cohort. They have stories that are not easily analyzed by summary spreadsheet. Investors must look at loan types, non-performing loan trends, capital levels and trends, and percent of allowance to total loans. And, perhaps most importantly, management. Because good management rarely falls victim to bad circumstances over the long haul.

There are deals out there. You have to put in the work to find them.

~ Jeff

Are Banks Overvalued?

The S&P 500 Bank Index is up 41% in one year. US Regional Banks' price-earnings multiple was 16.6x and price to tangible book value was over 2x (see chart). So are banks over-valued?

It depends. One way to compare is to look at the p/e ratio compared to the market. The S&P 500 p/e currently stands at 24.6x. So it looks like bank stocks are not overvalued.

But hold on. One ratio that can help us out is the PEG ratio. Remember that in Finance class? It's the p/e ratio divided by the earnings growth rate. According to Peter Lynch's iconic book One Up on Wall Street, a stock is fairly priced if its PEG ratio was 1. Meaning if it's p/e is 16.6x, like the US Regional Banks mentioned above, then the earnings growth rate should be 16.6%. I know I'm comparing a multiple to a growth percent. But, hey, I didn't invent the PEG ratio.

The challenge with banks' PEG ratio, as the chart shows, is that it is way over 1, by a factor of over 5 (5.7). I checked it against other industries in the Financial Services sector. Insurance brokerage has a PEG of 3.4. Specialty Finance: 0.4. The regional banks' PEG ratio, if I do the reverse math, implies that earnings are growing around 3% for the banks in that index. Which is very close to the 3-year annual net income growth for all FDIC insured banks.

So by the PEG ratio, banks would appear to be over-valued. Which may be true. But I want to bring up two mitigating points about banks:

1.  Banks are capital intensive. We must contemplate that implicit in their p/e ratio is some level of their tangible book value.

2.  Banks are not, in general, growth stocks long term. Risk management and the legions of regulators work in tandem to limit growth. 

Relating to 1, I did a data run of all banks and thrifts between $1 billion and $10 billion in total assets that were profitable. I checked their median p/e ratio. I then took their market cap and deducted their tangible common equity to deconstruct their p/e between tangible book and their market cap over tangible book (see chart). 

It is true that other industries can deconstruct p/e in this fashion. But would such an analysis of other industries equate 56% of an industry's p/e to it's tangible book value?

Even if we deducted tangible book from p/e, the industry PEG would still be 2.53 (7.6x / 3% growth), more than double Peter Lynch's prediction of fairly valued.

Which brings me to 2. How long can a company, a sector, and an industry grow faster than its markets? Certainly not forever. And for many, earning their p/e's means stoking growth either through acquisition, or greater risk taking. One is risky, and the other can be deadly. 

For these reasons, bankers may want to consider more moderate growth objectives, maximize earnings, and pay a larger portion of shareholder returns in dividends. 

What is your opinion on bank valuations?

~ Jeff

Note: I make no investment recommendations in my blog. I have a difficult time with my own portfolio. 

What Did a Trump Victory Do To Bank Stocks?

The S&P 500 futures plunged during November 8th's vote count when Donald Trump started pulling ahead. The nosedive gave the news media, who could hardly bare to report good news for Trump, some bad news to deliver. The market was betting a Trump win would be a disaster for equities.

But in a surprise turnaround, the next day when the dust settled and pundits were begrudgingly calling Mr. Trump President-elect, the market turned the tide. Traders were indecisive during the first 90 minutes of trading the next morning, and then came a buying spree that elevated the index to a gain of 1.43%. When things settled down, the final tally for November 9th was a 1.11% gain. So much for that Citi prognostication of an immediate 3%-5% haircut. How much do those analysts get paid?

But what happened with bank stocks? Surely there would be volatility with Trump's carping about over regulation. No industry suffered through more regulation since 2008 than the banking industry, right? And the Consumer Financial Protection Bureau, that reports to no one and has carte blanche to regulate institutions over $10 billion in assets, would surely not sit well in a Trump presidency.

Let's take a look. I analyzed the difference in stock prices of all publicly traded financial institutions that trade over 10,000 shares per day on US markets. I used October 31st as the base period, and the closing price on November 9th. Highlights can be found in the table below.

Disaster, averted.

In fact, the biggest loser in the systemically important >$50B category (SIFI) was a Canadian bank. Yes, I know they don't count towards our SIFIs, but still. A little humorous that a Canadian bank would suffer a decline. They are about to receive a significant amount of our celebrities! Looking further up the list for the next worst SIFI, I find National Bank of Canada, then Bank of Montreal. I had to go all the way to Huntington Bancshares to find a US-based SIFI. And they gained 2.9% from Halloween until November 9th!

I should note that three of our clients are in the Top 10 Gainers. I'm not trying to claim causation, just putting it out there.

The average stock price gain of all US publicly traded financial institutions between Halloween and November 9th was 4.2%. There was no catastrophe. No meteoric rise. Just another day at the office.

~ Jeff