Two Types of Bank Investments; Thoughts on Asset Sensitivity; FCNCA's Value
Summary of bank investment strategy (bargains and compounders); Asset sensitivity might be misunderstood; a comparison of FCNCA vs other regional banks
Our portfolio currently holds two types of bank investments. We have what I think of as a Ben Graham basket of banks trading at 50-70% of book value that I think would make good acquisition targets. These tend to be banks that have the following attributes:
low P/B (ideally a 50% discount to what another bank will pay)
excess capital
strong credit history
a long history (often 100 years or more)
conservative management
retail deposit base (as opposed to wholesale funding)
are buying back shares with their excess capital
These banks are cheap but are often too sub scale to be earning good profits (although a few of them are earning over 1% ROA’s). In general, these banks have balance sheets that would be worth much more in the hands of another (larger) bank.
Most banks like this end up selling between 1.2 to 1.5 times tangible book value, often approaching 2x for the higher quality deposit bases. The median valuation of banks getting bought since 2024 is 1.32x tangible book. For banks without excessive concentration exposures or credit issues that check the boxes listed above, a P/B of 0.7x or less might be a 50 cent dollar. In the meantime, many banks are using their excess cash to buy back shares, which only increases the book value per share and widens the potential payoff if and when they do get acquired. Over time, the consolidation in community banking will continue, so this is a long-term tailwind for the industry. At the right valuation, I feel comfortable owning these in the coffee can.
More on these stocks in another post, but I think that this first group of banks will inevitably get consolidated:
We used to have 14,000 banks and we’re closer to 4,000, and that will continue to fall over time for a number of reasons:
Many small bank stocks are cheap
Synergies by combining to deposit bases (and cutting out a layer of unnecessary management)
Regulatory costs are harder for small banks to absorb; this fixed cost is better spread out over a larger asset base
Banks (and credit unions) almost always have management teams that make more money personally by getting bigger (this is perhaps the biggest driving force)
I think bank consolidation is a certainty over time, and there are opportunities for value investors to buy balance sheets at a big discount before deals are announced and occasionally buy stocks in the merger targets after the deal is announced, which sometimes offer surprisingly large spreads of 20-30% IRR’s or more.
Two current examples in our special situations bucket are MSVB and PMHG: both traded at a discount to book value (and a bigger discount to fair value), both are simple community banks with retail deposit franchises and good credit histories, and both are getting bought by credit unions that want to get bigger (MSVB traded at 9 when it received its offer; the stock initially traded between 13-14 for months, still a healthy 25% spread to the deal’s value. PMHG’s spread is tighter but still offers a 9% return, or a ~20% IRR if the deal closes early next year as expected). But to illustrate the opportunity that exists in many other small bank stocks today, MSVB was offered a 75% premium to its last trading price; PMHG received over 100% bump. There is a large gap between price and value in many bank stocks, and deal premiums like this are more common than some might realize.
The second group are banks that are playing offense and are doing the consolidation.