Just note that a stock like this is illiquid and to really do your own research. The price swings and the huge bid-ask means you have to be comfortable not being able to sell your shares whenever you want for a reasonable price. The only way you'll ever have the confidence to do that is if you do your own research to back up the investment. That being said, Versailles Financial, a small bank in Ohio, looks like a business that one can get comfortable holding through uncertainty.
In the back of my mind, I'm recalling a circa 2008-2009 CNBC news report on how it was such a great time to be opening up a bank. The logic still applies. Interest rate spreads are high. A new bank doesn't have to work through any bad legacy assets. Loans written today are comparatively safer than loans written in the credit bubble. Versailles Financial in many ways possesses these characteristics, trades at a fraction of its capital, and is in the process of conservatively expanding its banking operations. One can evaluate management's underwriting track record as well. Their loan book held up well over the past few years with very manageable NPLs and little risk to maintaining strong capital ratios. In many ways this is better than investing a a greenfield bank, which I don't think is possible for retail investors anyway.
Versailles Financial is a tiny savings and loan bank located in Versailles, Ohio where their high school students win state championships and score high in state testing . Despite converting in January 2010, it still trades at 57% of tangible book value and 52% of book value. It is over capitalized, earns modest profits, trades at a substantial discount to tangible book value, and has a clean loan book. Management and the board own 27% of the company in addition to 8% through an ESOP. The stock trades very thinly, which is probably a big strike in the eyes of many investors. Outside of management, there is only $3m worth of stock to be bought at current prices.
The share offering was done at $10/share and 427,504 shares were issued. At the current price of $13/share, the market capitalization is $5,557,552. The tangible book value is $9,602,000 ($22.46/share) and book value is $10,714,206 ($25.06/share). The stock trades at a huge discount to tangible book value despite practically no problematic loans – any bank would wish it had only 1.04% of loans past 30 days due and 0.21% considered nonperforming (Versailles current state). This is what happens when management owns 27% of a small town bank. NPLs/Loans peaked at 1.28% in 2008. They know exactly to whom they are lending and on what collateral/cash flow. Versailles has a tangible capital ratio of 21.8%, and a tier 1 risk-weighted capital ratio of 37.1%. The strong performance of the loan book indicates that problems should be minimal, but in the case that issues arise, the bank has tons of capital. The bank has performed extremely well throughout the current recession.
The company is earning a runrate of about $200k for 2011, which means that stock trades at a steep 28x earnings. There might be room for additional profits on the margins now that the company is public and incentivized to increase profitability. The bank's efficiency ratio (non interest expenses/revenue) is just below 60%, they are near the bottom limit of necessary expenses and will need to increase revenue to leverage their costs if profits are to expand.
Management and shareholders are aligned. The CEO made $137k and $133k in 2010 and 2009 respectively. In the conversion offering, he purchased $100k worth of stock. The chairman and several directors purchased even larger sums. The directors take home $14-16k in compensation, which pales in comparison to individual ownership stakes ranging from $192-$390k (purchased for $150-250k). The CEO has been at the bank since 1994. The board is mostly comprised of local businessmen. This is an anachronistic small town bank that is conservative and modest.
With such an owner-oriented board and management, the loan book is not likely to get out of hand. The loan book has never had any subprime loans or new fangled financing vehicles. The loan book is divided 75/20/5 in residential real estate, non-residential real estate (agriculture and business), and assorted consumer. The loan book is showing very little trouble. The bank worked its way through higher NPLs since 2008 to where the ratio of total nonperforming assets to total assets is 0.08%. On June 30 2009 and 2008 NPLs to total loans was 0.76% and 0.87% while nonperforming assets to total assets was 0.65% and 0.71%, respectively. To get down to a tangible capital ratio of 10% from loan write downs, the current level of NPLS of 0.21% would have to grow to 11.3% and write-downs would have to be drastic.
Other than expanding the loan book, the only other plan with the raised capital is to build or acquire a large home office which will allow it to offer more traditional bank products. Versailles currently doesn’t have designated parking at their bank. They don’t offer checking or money market accounts. They don’t have an ATM at their location. This might seem like peanuts, but would offer upside in the form of attracting low cost deposits. Its competition consists of 3 other banks in town: Farm Credit Services of America, US Bank, and Second National Bank (division of Park National Corporation, a roll up of local banks). The larger banks benefit from the law of large number watering down poor underwriting policies (theoretically) but Versailles has well incentivized feet on the ground to do business in Versailles, Ohio. If this costs $1.3m (cash held at the holding company level), the bank has the excess capital to devote to it. It is a worthwhile investment as management and the board have the local connections to draw in customers. They have yet to acquire any land for a branch, so they don’t seem to eager to pay over the odds. If the $1.3m fizzles up and the bank only breaks even with the branch, there is still $20/share in TBV.
The banks funding sources might be considered the weak link in this bank. It is 55/26/19 split between CDs/savings accounts/FHLB advances. This is a relatively expensive funding source, although net interest margins were at 3.78% in the most recent quarter. The bank has room for improvement in its efficiency ratio, currently at 80%. As the bank progresses with opening up another office, the potential to attract checking deposits or money market accounts will help diversify funding and decrease its cost. This decreased funding costs should be balanced out by an increase in the efficiency ratio. This still does not justify trading at 57% of tangible book value.
Just theorizing, but this bank could earn a 3% ROE. If they have a pay out ratio of 50% of earnings, that would equate a 5% dividend yield at current levels, which would drive shareholder interest. If earnings are retained and continue to generate a 3% ROE, the return would be 10% annually assuming the bank eventually attracts the attention to be priced at 1x TBV.
To recap – extremely well capitalized bank, incentivized management, well performing loan portfolio, low price. The near term catalyst of a buyback is more likely since the 1 year statutory limit on recently public thrifts has now passed. The worst that could happen would be the bank underperforms and gets acquired when the 3 year statutory limit on a thrift conversions change of control provisions. That is about 1.5 years away as the offering occurred in January 2010. Arguably the easy money has been made since the offering with the stock going from $10 to $13, but the stock still trades at a pretty steep discount that can be reversed through buybacks, a successful new home office, a repricing of bank stocks as a whole, or a buyout by a larger bank.
Talk to Andrew about Versailles Financial
Andrew:
ReplyDeleteInteresting post. I've looked at a lot of bank stocks and have come to the conclusion that the micro cap ones may have a difficult time (from a shareholder's perspective). They are so small, and have such limited assets, that the employees will "gobble" up almost all the earnings.
How do you figure this would be a good investment IF they could earn a 3% ROE?
That would give an investor a 6% return(if they buy shares at 50% of book value).