Bank Deposits as a selling point

Quick note from an article on SNL today that confirms my priors (just being honest…), and I thought it to be worth sharing as low beta, core deposit funding is a key component I look for in the majority of my community bank investments. From SNL (emphasis mine):

“Matt Kennedy, vice president at investment bank Banks Street Partners, said in an interview that a strong deposit base has move up acquirer wish lists of late. He said lower funding costs attract more potential buyers and thus drives deal prices higher. ‘The conversations when we talk to these acquirers have centered and focused on deposits and the deposit base more over the past two or three quarters than they did previously,’ he said.

Buyers are also increasingly seeking targets with lower loan-to-deposit ratios, Kennedy said, as acquirers want to take that deposit base and use it as a funding source for future loan growth.”

Source: ($)


BankFinancial Corporation (BFIN)

The current valuation of BankFinancial Corp (BFIN) provides an attractive entry point to invest in a bank franchise nicely positioned in an acquisitive market geography with several balance sheet and operating characteristics that should benefit BFIN as a standalone enterprise and attract takeout offers.

Management has been busy over the past three years in right-sizing the equity position via share repurchases (3,085,168 at cost of $42,494,000) and dividends ($16.5 million) since Jan 1, 2015. As a result, we are starting to see what a ‘normalized’ return on equity looks like for BFIN. Benefitting from the lower tax rate, declining equity base, and increasing net income, ROE hit 9.4% in Q2 2018 and I don’t see any reason that management cannot continue hit a ~10% ROE over the rest of the current cycle.

Primary drivers setting up BFIN shareholders for a nice investment over the near- and longer-term:

  1. Compounding Earnings: As I mentioned above, management has done a nice job of lowering the equity/capital base to a more optimal level. Given the easing regulatory and tax environment, it is entirely reasonable to expect ROE’s anywhere from 9-12% during expansionary cycles.
  2. Dividend Income: BankFinancial pays a current dividend yield of ~2.48% and has been aggressively increasing that figure over the past 3 years, likely to distribute out excess capital. The current payout ratio is nearly 50%, but with the equity/capital position no longer as offside as it was in 2014, I don’t expect management to continue ramping the dividend as aggressively as recent history suggest. That said, paying a 2% yield at a 30% payout ratio doesn’t seem unreasonable given recent performance.
  3. Potential M&A Upside: BFIN has a lot of things working in its favor when it comes to marketing itself as an attractive takeout target:
    • Market & Size: Chicago is a market share driven market. There are some very large institutions looking to scale in the area and the recent deals from Canadian Imperial (PrivateBancorp purchase) and Fifth Third (MB Financial) is going to pressure the next tier of names (some listed in prospective buyers section below) will feel need/pressure to scale up as well. BFIN, at ~$1.5B in total assets, is in a really good spot for a $5-20B bank to scoop up and integrate.
    • Low-Cost, Stable Deposit Funding: BFIN’s funding structure is very attractive. While deposit costs have increased over the past year as short-term interest rates have increased, the total interest cost of BFIN’s interest-bearing deposits totals just 0.58%.
    • Asset Quality: NPL/Loans metric is 0.18% and the NPL’s are currently 3.5x over-reserved.
    • Balance Sheet & Capital: Balance sheet is short and sweet – no funky intangibles, no messy wholesale funding, only ~$1mm of OREO, and very small securities portfolio. And as I mentioned previously, BFIN remains overcapitalized, and that is a good problem to have (as an acquirer).
    • Valuation: At 145% TBV, this is a straightforward deal to structure up as a stock transaction. Plenty of banks trading at 225%+ TBV that can make the M&A numbers work – it is immediately accretive to book value.

Some concerns that could pressure earnings/profitability/growth to keep an eye on:

  • CRE Allocation/Exposure
    • Under a prior regulatory regime, regulators set a soft limit on CRE loan concentration equal to 300% of Total Risk-Based Capital; any concentration above that threshold would bring additional regulatory scrutiny. BFIN’s current metric is ~375%, a level it has fluctuated around since FY 2011 (the majority of the CRE allocation is in the Multifamily portfolio). The CRE/Multifamily allocation is not surprising giving BFIN’s geographic footprint and targeted national markets (Austin, Denver, Dallas, & Tampa) for its Multifamily portfolio.

BFIN Multifam

Bank Description & Geography

BankFinancial Corporation is the holding company for BankFinancial, NA, a national banking association providing depository, wealth management and trust services to individuals, families and businesses through 19 full-service banking offices, located in Cook, DuPage, Lake and Will Counties, IL and also providing selected commercial loans and leases on a local, regional and national basis.



Financial Overview

bfin fins

Notable Ownership

  • Directors / Named Executives – 5.8%
  • ESOP / 401(k) – 8.5%
  • PL Capital Advisors – 9.4% (John Palmer is a Board Member & Standstill Agreement in place)
  • Dimensional – 8.8%
  • Blackrock – 6.7%

Prospective IL-based Buyers (active market a lot of potential buyers)

  • Fifth Third ($140B Assets / FITB)
  • Bank of Montreal ($106B / BMO)
  • Wintrust Financial ($29.4B / WTFC)
  • TCF Financial ($23.1B / TCF)
  • First Midwest ($14.8B / FMBI)
  • First Busey ($9.6B / BUSE)
  • Byline ($4.4B / BY)

Croghan Bancshares (CHBH)

Brace yourself as I introduce Croghan Bancshares (CHBH), a boring brick-and-mortar bank franchise operating in Ohio around Toledo and Sandusky with approximately $850 million total assets.

What Croghan lacks in glitz and glamour (and market liquidity…), it more than makes up for by producing superb operating profitability and delivering shareholder returns. The bank’s profitability metrics (ROA/ROE, see “Financial Overview” section) are nothing short of spectacular.

Working in favor of long-term shareholders is a nontrivial lack of market liquidity. CHBH shares trade with a very shallow volumes and, as a result, the institutional community bank investor base will likely ignore Croghan as an investable opportunity. Likely due to the liquidity issue, the current valuation of CHBH is cheap relative to peers and very compelling consider they deliver best-in-class performance. I’ll highlight the three potential drivers I see working for long-term shareholders (note: multiple expansion should not be expected to contribute forward returns given the aforementioned liquidity issue with the shares):

  1. Dividend Income: Croghan pays a current dividend yield of ~2.75% and has been diligent about boosting its per-share payment over time. The company maintains plenty of optionality in its dividend policy as the current annual dividend equates to a manageable ~30% payout ratio.
  2. Compounding Equity: any earnings not paid out as dividends are either reinvested into the growth of the franchise or simply booked as equity and allowed to grow over time for the benefit of CHBH shareholders (since year-end 2013, CHBH has grown tangible book value by ~52%). Given the easing regulatory and tax environment, it is entirely reasonable to expect ROE’s anywhere from 9-12%.
  3. Potential M&A Upside: At ~$850 million in total assets and attractive adjacent geographies, Croghan has runway to grow as a standalone bank via organic growth and smaller bolt-on acquisitions. Should management ever consider selling, there are many OH-based suitors that make a ton of sense. Given the quality of deposit funding (cost of interest-bearing deposits is just 0.43% and its deposit costs have hardly moved since 2013!), Croghan would surely garner a hefty premium from potential buyers like Civista (CIVB), First Defiance (FDEF), or United Community (UCFC).

Taking items 1. and 2. together, it shouldn’t surprise that CHBH has delivered a 13.9% annualized return (dividends reinvested) over the past 5 years. Given where we are in the economic and banking/credit cycle, I think it foolish to expect similar shareholder returns over the next 5 years. We will get a economic downturn and banks will have to operate through a credit cycle, likely beginning at some time in the next 1-3 years.

Warning aside, I’m not intelligent enough to attempt to market-time a recession and credit cycle. What I am comfortable doing is investing alongside a management team and franchise that has successfully operated through a significant liquidity and credit shock (hello 2007-2009). How did CHBH weather the financial crisis? Well, the *worst* year it had was FY 2009 when it still printed a 0.7% ROA and 5.6% ROE, not to mention its NPAs couldn’t even crack above 2.4% (as a percentage of assets). Even if you invested in CHBH right at the top in its share price (peaked in May 2007), shares have a returned 7.8% annualized from May 2007 to August 2018.

Overall, CHBH should continue to deliver steady long-term returns for its shareholders. It is a wonderfully operated banking franchise that should appeal to investors that don’t require the liquidity and can tuck it away for the long-term. And even though it currently trades a little high from a P/TBV perspective (150%), I think the superior earnings performance, low-cost deposit base, and low P/E multiple (11.5x) more than offsets the P/TBV level.

Bank Description & Geography

Croghan Bancshares, a financial holding company incorporated, owns all of the outstanding shares of The Croghan Colonial Bank, an Ohio state-chartered bank incorporated in 1888 and headquartered in Fremont, Ohio, and Croghan Risk
Management Inc., a captive insurance company, incorporated in 2016.

The Bank offers a diverse range of commercial and retail banking services through its 17 banking centers as well as one Loan Production office. Products are comprised of traditional banking services such as consumer, commercial, agricultural and real estate loans, personal and business checking accounts, savings accounts, time deposit accounts, safe deposit box services, and trust department services.

CHBH geo

Financial Overview


Prospective OH-based Buyers

  • First Financial ($13.1B Assets / FFBC)
  • First Defiance ($3.0B Assets / FDEF)
  • United Community Financial ($2.5B Assets / UCFC)
  • Civista Bancshares ($2.0B Assets / CIVB)

Middlefield Banc Corp (MBCN)

The current valuation of Middlefield Banc Corp (MBCN) provides an attractive entry point to invest alongside a premier management team operating a well-capitalized, conservative community bank with growth and takeout potential. Primary drivers that should benefit MBCN shareholders over the near- and longer-term:

  1. Earnings Power
    • Middlefield has a proven track record. Annual ROA’s have exceeded 0.85% every year since 2012 and ROE’s exceed 8.5% over the same timeframe. Both metrics should see upside due to recent tax and regulatory relief.
    • No-nonsense strategy with earnings – outside of shareholder dividend, equity and capital positions allowed to compound in order to drive long-term growth and expansion. Both Tangible Equity and Tier 1 Capital have more than doubled over the past 5 years (2012-2017).
  2. Attractive P/TBV valuation
    • 132% P/BV and 155% P/TBV provides an attractive entry point, relative to peers, in the current marketplace and leaves a M&A takeout as an upside opportunity.
  3. Tax and Regulatory easement
    • Corporate Tax Reform and continued benefit of less punitive regulatory environment will benefit the expense side of the income statement.
  4. Seasoned, Proven Management Team
    • Management team, led by Thomas Caldwell as President/CEO, has an average tenure of 14 years at the bank. Bank worked through the financial crisis with impressive asset performance (charge-offs peaked at 0.65% in 2011) and did not print a single annual loss (worst year was 2009 with a 0.36% ROA and 4.90% ROE).
  5. M&A Upside Scenario
    • Impressive franchise, nearing size/scale to entice larger OH-based acquisitive banks, reasonable P/TBV multiple for stock-based transactions. M&A scenario likely comes at a 50%+ premium to current standalone valuation.

Some concerns that could pressure earnings/profitability/growth to keep an eye on:

  1. Deposit Beta given ~100% Loan/Deposit Ratio
    • While majority of deposits are in noninterest bearing accounts (~23%) and/or lower-cost account offerings (~32% Transaction & ~36% Money Market Savings), the bank’s cost of interest-bearing deposits sits at 0.94% as of 6/30/2018. MBCN’s deposit costs never dropped below its 0.68% low in 2015, which is a relatively high figure given the rate policy backdrop at that time. With a ~100% Loan/Deposit Ratio, odds are MBCN will be more sensitive to demands from its deposit relationships should they seek higher yielding offerings; if MBCN’s deposit beta outpace peer banks, it could prevent improvement in profitability metrics and result in shareholder underperformance.
  2. CRE Concentration
    • Under a prior regulatory regime, regulators set a soft limit on CRE loan concentration equal to 300% of Total Risk-Based Capital; any concentration above that threshold would bring additional regulatory scrutiny (this threshold held up bank M&A transactions prior to 2016). MBCN’s current metric is ~350% and it has grown substantially since 2016 when it sat at 253%. Given the shift in regulatory oversight over the past 18 months, it is unlikely this become a regulatory concern. That said, the heightened growth in CRE credit risk at MBCN should not be ignored; for now, I will invest alongside a management team that has executed in these markets for multiple credit cycle but will watch for any deterioration in asset quality.

Bank Description

Middlefield Banc Corp., headquartered in Middlefield, OH, is the bank holding company of The Middlefield Banking Company with total assets of $1.2 billion at June 30, 2018. The bank operates 14 full-service banking centers and an LPL Financial brokerage office. The Company is positioned between rural and metropolitan communities surrounding the Cleveland/Akron/Youngstown and Columbus markets.


The Middlefield Banking Company operates 14 brick & mortar branch locations as well as one loan production office.


Financial Overview


Notable Ownership

  • Directors / Named Executives – 6.97%
  • Siena Capital – 2.63%
  • Banc Funds – 2.37%
  • Stieven Capital– 2.17%

Prospective OH-based Buyers

  • Chemical Financial ($18.7B Assets / CHFC)
  • First Financial ($13.1B Assets / FFBC)
  • Park National ($7.5B Assets / PRK)
  • Peoples Bancorp ($3.9B / PEBO)
  • United Community ($2.8B / UCFC)
  • Peoples Bancorp ($3.9B / PEBO)