Mid August: Key's Disease
The Key to misery, Dilution affairs, CARE upside, Would SFBC sell? Webster's insight
Good morning,
This quarter’s $5k donation will go to the Cystic Fibrosis Foundation. CF suffocates young people from the inside but medical advancements are thankfully turning it into less of a death sentence.
4Q will be another gift to the local Ronald McDonald House. Your support enables this so thank you. Paying subs - please share any worthy small children’s charities that you may be passionate about, so they may be considered.
In this edition:
A look at why KEY shares are flat vs when I graduated high school in 1996, with warning signs for other banks showing similar symptoms of “Key disease”.
Life is short; don’t have an affair with dilutive management teams.
Carter Bank (CARE): the upside of collecting from “Whiny Baby” Jim Justice.
Last edition we looked at why Bayfirst (BAFN) would prefer not to ride the merger wave. This time a look at why Sound Financial (SFBC) is in a different boat.
Webster Bank (WBS) has an insight that other banks haven’t caught up with yet.
1. How did Key Bancorp (KEY) get here?
Q. How do you outperform the market?
A. Buy every stock except Key Bancorp:
On a price-only basis any professional investor that followed buy and hold with Key is asking to be let go:
On a total-return basis Key is positive but the comparison is equally embarrassing:
Key is in the news because it just attracted a $2.8bn equity investment from Bank of Nova Scotia, itself a long-term under-performer, at a slight premium. Key will use the funds to sell underwater bonds and rebuild capital.
This transaction is interesting but it also reminds readers what not to invest in when looking at banks. What plagues Key?
First the “TLDR” and then the detail:
For the impatient reader:
KEY tangible book per share at year end:
1996 - $8.79.
2023 - $9.96
Dividend:
1996 - $0.76.
2023 - $0.82.
EPS:
1996: $1.86,
2023 $0.92 (2022 was $1.98).
It’s a combination of doubling the share count in 2009 plus unremarkable performance in the other years.
Details:
Key is a follower in its markets - the bank has #4 marketshare in Ohio, #11 in New York, #6 in Washington, and every other state they are outside the top 5, except Maine where they are #5 and Alaska at #4 behind Wells, Northrim and First of Alaska.
Maine, Alaska, and a few branches in South Florida - a branch footprint their executive pilot must love.
S&P The bank does not pursue unique niches.
Fifth Third invests in embedded finance. Webster partners with private credit and creates deposit verticals. US Bank focuses on payments and trust. Regions pays 0.01% to older retail customers who don’t read statements, because of leading share. Citizens is trying to be a private bank; First Citizens has Silicon Valley.
Key lacks differentiation, a commodity producer in a capital intensive industry. Like a farmer, or steel manufacturer, you must be an skilled and efficient operator to do well in this circumstance.
The usual merger malaise. Key did a merger of equals with Society ($27bn) in 1994 and an acquisition of $39bn First Niagara in 2016. Mergers are challenging and Key has not shown an aptitude for doing them opportunistically.
They have been challenged finding good borrowers
Related to point #2 above, in 2009 KEY had to recap not because of a particular concentration in Florida, Georgia or California, but rather the combination of light capital and a variety of low-quality business lines they decided to exit at the bottom:
Legacy Shareholders had to pay for the company’s mistakes at $4.87 / share
Size over shareholder value.
While KEY’s tangible book, EPS, and dividend are the same as they were when I graduated high school, assets have grown from $67bn to $188bn in this time.
CEO Gillespie made $1.6mln total comp in 1995 while CEO Gorman made $10.6mln in 2023. 2023 was moreover a particularly difficult year for Key.
I cannot blame Key for growing assets, but would encourage them to grow around high-skill teams in specific verticals, or find ways to improve their risk-adjusted margin.
The company is trying to grow wealth management, investment banking, and embedded finance, although nobody thinks of Key when they think of any of those verticals. Recognition through excellence is a goal they can aspire to.
Swaps
Most recently, Key has managed to accumulate not only a $5bn loss on securities but also a $1bn earnings headwind from swaps layered on top, which is shown below as a “future tailwind”. They are one of the banks that seems to have misfired “coming and going” in this rate cycle.
The strongest point of this discourse is that capital-intensive commodity banking is difficult to execute and unattractive to the market.
Avoid commoditized banking!
Truist just sold its insurance business - what is their strategy? Can NYCB wish its way out of the current rut and will they simply layer on participations funded by CDs? How long can Regions milk its depositors?
All these regionals among many others have questions to answer to avoid “Key disease”.
2) Life is too short for affairs with dilutive management teams:
Three times in the past 6 months I have gotten a call offering stock in a bank at a discount to book. One was at 71% of pro forma tangible book per share, one at 50% of tangible, and one at 85% of tangible with warrants.
For banks like New York Community just trying to survive, these deals are understandable, but for banks looking to grow they lack sex appeal. Pricing looks good from far but once we who we are getting in bed with the offerings seem far from good.
Consider the adulterous affair analogy. The issuer is the married person looking around. The stock is an affair. Legacy holders are the poor spouse.
You have the affair opportunity, but once you own the stock, you are in bed with management who, instead of selling their bank for a premium, sold stock at a dilutive discount.
Members of the church of bank capital management consider that an immoral act.
We can rationalize that things will turn and management will sell for a large premium now that they sold stock to me at a discount, but why would they do that? You enabled them, and they have new capital to grow into.
Some examples.
Community Heritage (CMHF): Instead of finding a strategic partner, Maryland community bank Community Heritage chose to sell $13 million of stock at 77% of book in late 2022. Perhaps management was looking to create scale after mortgage began to slow, but today CMHF is still at 77% of book and still not very efficient with a ratio over 70%.
The market also seemed to have trust issues with CMHF judging by what they sought to raise vs what they ended up with:
White River (WRIV) was a recent deal from May 2024, a promising Arkansas bank with challenges meeting peer profit levels due to efficiency.
The company did not file its intended amount to raise so I cannot prove that this was a near mirror of CMHF, but to quote a former President “many people are saying” it was, with WRIV ending up with $12 million at 76% of tangible book.
Performance improved slightly post raise in 2Q, but I’m not sure capital fixed the bank. I would think White River could have renewed its vows with patient legacy holders by leaning expenses and then raising at a nicer valuation, rather than raise and then pursue efficiency.
Penns Woods (PWOD) of Pennsylvania sold $20mln or 450k shares through an at-the-market offering at approximately 90% of TBV in 3Q-4Q23. I have spoken to a bank interested in buying PWOD, and one would presume they might have paid more than 90% of book value. Jilted at the boardroom.
First Guaranty (FGBI) sold $10mln at 64% of tangible book value in December 2023. FGBI, influenced by large shareholder Marshall Reynolds, has made strange strategic decisions, such as expand into West Virginia from a base of Louisiana. Do they remind you of a crazy partner? Yet even Crazy Woman Creek Bancorp (CRZY) is a relative outperformer over FGBI for the latest 3 years.
