December: You Don't Have to Pick the Perfect Merger Target to Win
CEO Retirements at OZK and NBN, CFBK a target?, NYC multifamily is holding up; Mythbusting at Customers Bank (CUBI), Versa (VBNK), why are Marshall Reynolds' banks struggling?
I hope all readers have a Happy Thanksgiving tomorrow!
DC, Virginia and Maryland readers, I’ll be through DC seeing friends, clients and prospects on Jan 7-8 if interested in visiting.
Acquire or Be Acquired-Attending Readers I will be in Phoenix at the tail end of that conference late January if you’d like to meet.
It seems that writing 5 Points monthly does not reduce content - this note is longer than usual. Ideas tend to come to me at a constant rate. Pardon the length of the post, which focuses on overturning conventional wisdom, and feel free to skip around. If I had just 2 minutes I would not miss the discussion of retirement at NBN and OZK at the end.
In this note:
First, brief notes:
You don’t have to be an expert to make money in the bank M&A wave, you just have to play.
Smart bankers are opening branches, not closing them.
The (7) points:
Why hasn’t NYC rent-stabilized lending blown up?
Little CF Bancshares (CFBK) of Ohio - a Russell 2000 candidate, sale candidate, or both?
(subscriber break)
VersaBank (VBNK), the little Canadian bank up 50% this year. Or is it an American bank? One specific datapoint might give you pause given the amount of execution now priced in.
What went wrong at Marshall Reynolds’ two banks - SSBI, FGBI - as they struggle on credit and profitability?
Customers’ (CUBI) mythbusting
Banks (mis)managing capital: Skip Hageboeck at CHCO wonders why he can’t run his bank with 0% TCE. This exercise brings up questions about how banks manage capital, which many are not doing efficiently.
When are star bankers Rick Wayne (NBN) and George Gleason (OZK) going to retire? I asked them and got entertaining answers.
Brief notes:
You don’t have to be lucky to win in a bank merger wave, you just have to participate
As more mergers happen, more banks will be discussed as targets, creating demand for shares.
Word in bank circles is the acquisition pipeline is today as deep as it has been in years.
There is no data but the rationale is obvious. In the House of Representatives, there is currently a competition for chair of the Financial Services Committee, between a Rep with a proposal to auto-approve mergers after 120 days and another who has introduced bills to remove regulation and streamline the bank merger process. For comparison, many mergers have been taking almost a year and a half plus material community reinvestment commitments.
Many years ago when I was in institutional sales, fund managers would ask questions like “What do you think this bank is worth in a sale?” or “Who do you think the potential buyers are?” Sometimes it was all people wanted to discuss all day long.
Little banks traded 13-18x earnings and 1.5-2x tangible book, even paying higher tax rates than today, because most would be bought in 3-5 years. There were several merger announcements a week and as each one was announced, the market asked “who’s next?”
We won’t get back to 2005 levels I suspect but Colarion has nonetheless populated a small merger basket for clients on the knowledge that:
a) PNC and others are likely to announce high profile acquisitions in 2025 at notable premiums. PNC trades at a premium to most targets and the CEO has been clear about his intentions to add hundreds of billions in assets.
b) Beyond PNC, most smaller regionals are trading at 150 - 200% of tangible book and would like to trade that stock for targets not in the Russell 2000 or Nasdaq that enjoyed less “Trump Bump” and are currently trading at 100 - 125% of tangible book. CFBK as an example is profiled below.
c) Generalists and allocators should notice this and increase commitment to the sector.
d) Beyond politics, obstacles such as bond or credit marks that may have halted mergers in 2024 are today perceived differently - these marks are part of future “accretable yield” entering 2025.
e) The streamlined timing paradigm already discussed.
We have discussed credit union targets extensively in prior 5 Points. We gladly now discuss a bank target later in this note as well!
Good bankers are opening branches.
George Gleason of Bank OZK is highly intelligent, has good ideas, and I recently got to speak with him for a session.
One of the things Gleason is doing is opening 20 branches next year. He acts like this is just something bankers do, as if it’s 1995. It was perplexing but he explains his branches have multiples more customer activity today than in years past despite less staff. Only recently have his branches become “fully utilized”.
Jamie Dimon at JP Morgan speaks similarly, with a focus of branches acting as small office buildings where his bankers start the day before calling on customers.
Tom Broughton at high-performing Servisfirst (SFBS) is following suit.
The banks closing branches are a who’s who of “easiest to compete against” including Truist, US Bancorp and Wells.
The fulcrum seems to be that the best banks have something to do - differentiated products to sell, superior bankers that want to work for them, better strategies for gather deposits. Those require branches.
Banks with weaker strategic outlooks don’t need the space.
On to the “Points”…
1) Why hasn’t New York rent stabilized lending fallen apart?
Readers of 5 Points are well aware of the dysfunction of New York’s micro-mis-managed housing stock, and if not they are welcome to spend a few minutes watching this cartoonish 2024 meeting of the Rent Guidelines Board.
In NYC, $110bn apartment lender Signature failed and $120bn New York Community almost went down behind it. Among other issues, nobody wants these multi-family loans.
Except the loans don’t seem to be defaulting.
I got to visit recently with an executive from Peapack Gladstone (PGC). The bank has had 3 difficult loans from its New York multi-family book - out of several hundred.
ConnectOne (CNOB) of Northern Jersey just merged with First of Long Island (FLIC). Both carry rent-stabilized books, but on the 3Q call it wasn’t even an issue.
Esquire (ESQ) put 1/4 of their loan book into multi-family and have not had any issues except one condo conversion misfire.
Customers (CUBI) has not had issues with their NY multi-family book.
Flagstar (FBC) seems as concerned about office as they are multi-family, despite vacuuming up the largest and most questionable non-recourse, slowly amortizing piles of problem loans in the city.
Why are sponsors paying?
There are a few reasons but the biggest seems to be math around the tax bill.
New York is different. These are not sunbelt fix and flip apartment complexes, they are buildings are often owned by families for decades. The buildings are fully depreciated and have been refinanced and assuming depreciation, the owner’s basis is often close to zero.
If you owned a building that has fallen in value but today is still worth $25 million and has zero basis, the tax rate may be over 30% including state and city taxes (yes NYC charges typically around 4% capital gains tax!)
In this example your choice is to front $7.5 million taxes or pay something like a $50k monthly cash flow shortfall. You would eat the shortfall and try to change insurance and find loopholes to boost rent or just shutter apartments when tenants move out. Ideally your building would just empty out.
At some point City Hall will notice what Argentina did to fix the housing shortage issue overnight and reward landlords for bringing mothballed units back online.
Until then many landlords are choosing to wait, defer taxes, and amortize their loans down.
2) CF Bank (CFBK). A takeover? A Russell entry? Both?
In light of the above merger wave discussion, let’s discuss one potential target among many, $2bn asset CFBK, trading at 1.1x tangible book value and earning about 10% ROE. CF is a rare bank operating in both Columbus and Indianapolis, two desirable markets:
We know that:
CFBK CEO Tim O’dell is 70 and owns $6 million worth of stock. It would be a shame to put this retirement at risk by holding into the next recession!
O’dell is not the largest holder. That is Castle Creek Fund 7, a bank private equity fund. Castle Creek’s exits are typically through sale of the bank. Fund 7 began its investment in 2019 so this investment is creeping toward a typical 7-year maturity phase.
CF Bank is surrounded by banks that want to buy other banks, including Park Bancorp (PRK), $9.9bn trading 3.0x tangible book. If Park wants CF, as fiduciaries there’s not much CF can legally do to stop it (and Castle Creek would likely have no problem). CF expands Park’s presence in Columbus and Cincinnati (PRK branches in blue below) and enters them into business-friendly Indianapolis.
S&P CapIQ Others that could also engage CFBK include:
WSBC, $27bn, 1.6x TBV
FNB, $48bn, 1.7x TBV
FFBC, $18bn, 2.1x TBV
PEBO, $9bn, 1.8x TBV
(FFBC branches are in orange, WSBC is in pink, and PEBO is in purple below. FNB not shown is mostly Pennsylvania and North Carolina).
During a Biden presidency, with regulators hostile to mergers, these acquirers all chose to “wait and see”.
Under Trump, they have more incentive to extend interest.
While some target banks can say “We aren’t ready yet” and milk board fees while performing at industry average, it’s harder for CFBK to get away with this due to their private equity partner.
CFBK may find its way into many investors’ merger basket.
But wait there’s more!
CFBK carries a $175mln market cap and is Nasdaq listed. That means it may be eligible for inclusion in the Russell 2000 next year as things stand. Supposedly the cut-off is currently estimated to be below $150mln, though that always fluctuates between now and June when reconstitution takes place.
Over the years Russell entry candidates typically outperform by 10-20% going into Spring of the year of inclusion, due to forced ETF buying.
But is this bank any good?
“Good” is relative due to its 2.4% margin, but beyond CFBK’s attractive markets, buyers look at deposit and asset quality. Deposits are 15% non-interest bearing and 40% CD. This is fine.
Bad loans are 0.71% of assets, also about average.
The margin is low because deposit costs are 4.04%. Efficiency is 55%, ROE 10% as mentioned.
CF is like Goldilocks - not good enough to thrive independent, but good enough to be a target.
Castle Creek charges substantial fees to deliver results; let’s see if they can earn them here.