MOI Global - Three Differentiated Small Banks: UBAB, Northeast Bank, FFB Bancorp
The discussion highlights the potential in banks that have been overlooked due to past financial crises, such as the Silicon Valley Bank debacle. These banks, particularly those with growth opportunities, present interesting investment prospects. However, investors must consider issues like leverage and asset-liability mismatches. The importance of strong management and a robust underwriting culture is emphasized to ensure loan performance and adequate reserves. Historical banking trends, including deregulation and consolidation, have shaped the current landscape, creating opportunities for smaller and mid-sized banks with growth potential. The video also explores strategies like demutualizations and government incentive programs that have historically generated value in bank stocks. Additionally, the concept of banking as a service is discussed, where banks provide backend services to fintech companies, generating non-interest income. The criteria for selecting growth banks include high returns on assets and equity, growth lending, and maintaining low non-performing asset ratios. The video concludes with examples of banks leveraging niche services like transaction processing and brokerage to drive growth.
Key Points:
- Banks with growth potential are overlooked due to past crises, presenting investment opportunities.
- Strong management and underwriting culture are crucial for ensuring loan performance and reserves.
- Deregulation and consolidation have created growth opportunities for smaller and mid-sized banks.
- Banking as a service is a growing area, providing backend services to fintechs and generating non-interest income.
- Criteria for selecting growth banks include high returns on assets and equity, and low non-performing asset ratios.
Details:
1. 📉 Navigating Banking Challenges and Opportunities
- Certain banks with high growth potential have been overlooked following the crises of First Republic and Silicon Valley Bank, presenting opportunities for savvy investors to capitalize on undervalued assets, provided these banks manage risks effectively.
- Growth investors have pulled back from the banking sector, but this presents a chance for those focusing on long-term growth potential and risk management.
- The main risks include excessive leverage and mismatched asset-liability durations, which need to be carefully managed to prevent future crises.
- Successful mitigation strategies involve evaluating a bank's management track record, ensuring a strong underwriting culture, and maintaining robust loan performance metrics.
- Banks must address asset and liability duration mismatches by aligning maturities and interest rates to safeguard against interest rate fluctuations and liquidity issues.
- Despite operational success, asset-sensitive banks have experienced underperformance in stock markets, suggesting a disconnect that could be leveraged by informed investors.
2. 🏦 Banking History and Key Deregulatory Acts
- Banks have been an integral part of the financial system since the founding of the United States in 1776, with numerous establishments emerging throughout the 1800s.
- A pivotal change came with the Regal Interstate Banking and Branch Efficiency Act of 1994, which marked a significant shift in banking operations.
- Prior to the 1994 Act, banks were limited to a single branch per state, severely restricting their ability to expand and operate efficiently across state lines.
- The 1994 deregulation allowed banks to have multiple branches nationwide, greatly enhancing their operational efficiency and expansion capabilities.
- This legislative change not only facilitated growth but also increased competition among banks, leading to improved services and products for consumers.
3. 🔍 Evolution and Consolidation in the Banking Sector
- The Graham Leach Bliley Act of 1999 allowed banks to engage in investment banking and brokerage, reversing previous restrictions, thus reshaping the industry landscape.
- U.S. banks initially focused on commercial banking, with significant changes during the Depression which led to strict separation of investment and commercial banking.
- Deregulation post-1999 has seen a consolidation from 14,500 banks in the mid-1980s to 4,000 today, highlighting a major reduction due to mergers.
- The 2010 Wall Street Reform and Consumer Protection Act introduced stress tests for banks deemed too big to fail, aiming to prevent future crises.
- Big banks face growth constraints due to deposit caps, while smaller banks have more growth opportunities, particularly in untapped markets.
4. 📈 Growth Opportunities and Strategies in Small Banks
- Demutualizations have historically been a key growth opportunity, transitioning savings banks from mutually owned to stock-owned entities, allowing depositors to become shareholders.
- In the 1990s and 2000s, investors exploited demutualizations by placing small deposits in various banks to gain shareholder status as banks transitioned to stock ownership.
- Although the rate of demutualizations has decreased, these opportunities remain viable, albeit less frequently.
- Currently, the US Treasury offers incentive programs specifically designed to support growth in small banks, presenting new avenues for strategic investment and growth.
- Small banks can leverage these Treasury programs to enhance their growth trajectories and increase competitiveness in the market.
5. 💡 Government Incentives and Banking Programs
- New market tax credits and capital market fund credits are provided to encourage banks to lend to low-income communities, making projects more favorable from an equity and banking perspective.
- The ESIP program in 2022 provided lending institutions with low-cost funds, ranging from 0 to 2% preferred stock, making it economically enticing for investors to invest in these communities.
- Government programs leverage low interest rates to incentivize investment in low-income areas, making them more attractive for bank and other investors.
- Consolidation and deregulation over time have impacted the landscape of bank lending and investment in low-income communities.
6. 🌐 Banking as a Service: Fintech Collaboration
- Large banks have historically grown by acquiring other banks during stress situations, such as the 2008 financial crisis.
- The trend of Banking as a Service (BaaS) involves fintech companies partnering with banks to utilize their regulatory frameworks.
- Approximately six banks are particularly effective in providing BaaS, which generates substantial non-interest fee income.
- These banks also earn net interest income by sharing risks with fintech partners, enhancing their revenue streams.
- Successful banks in the BaaS sector are experiencing annual growth rates of 15-20% and are valued at high single-digit multiples.
7. 🔍 Criteria for Selecting Growing Banks
- Target banks with non-performing assets (NPAs) below 3% to ensure safety and minimize surprises.
- Aim for banks with 1.5% return on assets and 15% return on equity, with some performing even better.
- Focus on banks with mid-teens net income growth driven by growth lending.
- Select banks that retain most earnings to capitalize on growth opportunities.
- Look for banks with reserve ratios where NPA to reserves is about 150%, providing a safety margin.
- Prioritize asset-sensitive banks whose asset values increase with rising interest rates.
8. 💼 Managing Risks and Ensuring Growth
- Banks that generate high returns on equity and assets often leverage niche non-interest income services such as transaction processing, SBA loans, and treasury programs.
- Transaction processing creates float, which contributes to non-interest income.
- Treasury programs offer fee income and loan demand generation, often with loan guarantees and incentives.
- Banking as a service is highlighted as a significant non-interest income avenue.
- A critical metric introduced is the return on incremental equity capital, targeted at a minimum of 20%.
- Analyzing changes in equity and net income helps determine the direction of return on equity.
- Case studies of banks successfully implementing these strategies show a 15% increase in non-interest income within a year.
- Implementing these strategies requires understanding market demands and regulatory environments.
9. 🔎 Evaluating Bank Performance and Investor Returns
- Return on equity (ROE) exceeding 20% is a key indicator of potential upward trends in bank performance.
- Stock buybacks should focus on mid-teens returns on forward valuations, emphasizing buying back tomorrow's earnings at today's price.
- Consolidation within banks can lead to local and service synergies, enhancing geographic and service-related efficiencies.
- Aiming for a combination of EPS yield and growth to reach 40%, with examples showing high 30s, indicates potential for decent stock returns.
- Stocks growing at 15-20% with high single-digit returns can potentially double their valuation multiple, achieving four to five times growth over five years.
- Potential risks include market volatility affecting ROE and growth projections, highlighting the need for risk management strategies.
- Examples of successful bank consolidations and stock buyback strategies illustrate potential pathways to achieving high returns.
10. 🌟 Case Studies of Successful Bank Growth
- Banks achieving 15-20% returns on equity often utilize processing to generate revenue through fees (e.g., debit/credit card processing) and low-cost funds from float, as demonstrated by FFB Bank Corp's strategy.
- FFB Bank Corp is actively increasing its processing share within its business model to drive overall bank growth.
- Brokerage, asset management, and custody fees are key growth drivers, with banks like Axos Bank successfully leveraging these areas.
- The acquisition of 'orphan loans' offers significant growth potential, as seen with First Citizens' purchase of Silicon Valley Bank loans, which were available due to M&A activities or financial distress.