My favorite community banks with a discount to tangible book value.

Hi, i’m an small cap investor from Germany and interested in US Community Bank stocks.

Unfortunately not a lot of Germans are really into US Bank stocks and so I will try to write my today’s article in English.

I m a discount to tangible book value investor and look for picks with low priced assets with profitability and not too much trouble on the books.

Two of my favorite bank stocks -for the moment- are the Bank of Utica (BKUT) and (BKUTK) and the First Federal of Northern Michigan Bancorp (FFNM). Both banks trade at a discount to tangbile book value and have an histroy of profitabilty and dividend payments….

Bank of Utica – In a league of it’s own

The one-branch bank from Utica is one of the better known small-cap banks in the scene of community bank investors.

What meets the eye first is, that the non-voting stock of the bank (BKUTK) trades at 52,6% of book value. Ok, you could reduce this by a little bit because of taxes on their nearly 49 million dollars of undivided profits from their equity portfolio. Nethertheless… on the asset-side this bank is terrible undervalued.

One of the safest bank bets in the United States (maybe on the globe)

In my eyes this bank is a bank with the risk profile of an conservative insurance company. Of their 1004 million US$ balance sheet; 829,4 million dollars are in securities. As far as I know banks are only allowed to invest FDIC (Federal Deposit Insurance Company) deposits in investment-grade bonds.

All these bonds are as “Held to maturity” in the balance sheet. So even a rise in interest rates would have no influence of the stated book value of the stock.

Another plus-point in a rising rate environment could be, that only 207 million US$ of bonds have maturity dates of more than 3 years and only 53 million of these bonds end in more than 5 years.

This bank is more than well capitalized. 17% tier 1 capital to risk-based assets with this asset base. There is well capitalized and there is the Bank of Utica.

Why is this working?

This is of course the first question that entered my mind with this stock. Investment-grade bonds have to yield less than loans to private persons or smaller companies. How can a bank stuff so much of their assets in debt securities and still be profitable?

It s the efficiency, stupid.

With only one branch with over 800 million in deposits a lot is possible. The bank can make an average return of equity with under-average risk.

The return on equity was only 5,57% for 2015, this is really poor (even for the low-rate environment)!

There is something that is really missed with only starring on this number.

The Bank of Utica ended 2014 with 180,219 million US$ in equity. But only 95,364 million were placed in their core business. The rest of it was invested in equities.

Bank of Utica equity securities by ende of 2014 and 2015 , stocks, banken,versicherungen

The dividends from these equities were around 2,5 million US$ ( by simply using the 2014 annual report as a base of my estimation). So of their 10,31 million of after-tax earnings 2,5 million were dividends from stock holdings. So the core business made 7,531 million dollars.

7,531 million dollars of core-earnings on 95,365 of core-equity make a “Return of Equity” of 7,9%. This is not great, but it s not worser than other community banks (with much more risk on their balance sheet).

This stock is mispriced by the market because of three things ( in my opinion 😉 ):

  • This bank looks like a low return on equity business. Of course this bank is interest sensitive, but it shows that it can still make a average return on equity with the model ( show me a profitable, stable bank in the US that trades half the book value at the moment?! )

  • The equity portfolio is undiscovered by most investors. Simply looking at operating earnings misprices this stock, because a lot of the book value is in stocks. This makes the return on equity look much lower than it is. The stocks of their portfolio have nearly for sure a higher return on equity than the Bank of Utica receives in dividends.

  • The bank is not for sale. The banks owners do not plan to sell the bank and already have an succession plan with a young family member already working in the bank.

Catalysts for a higher stock price:

  • The bank buys back stock:). Of course this comes to mind first with such a discount to tangible book value. But I think this would just not work. The stock is just too thinly traded to buy much stock. The stock price would move up heavily with millions in stock buy-backs.

I would even say a really big buyback is not in the best interest of the long term holders of the stock (I mean year-long holders). The equity portfolio that is completely discounted by the market… why sell it and trigger a tax-event. It was bought at much lower prices. Because the bank’s CEO is not stupid (we have a history here)… i think the portfolio is high quality and so it could be better in the long term to receive dividends from it than to buy back your own stock. Ok, a little bit of stock buybacks would be nice. But I think it would not work to buy back 50 million of their own stock (even than the stock price suggests that).

  • The more likely catalyst would be that the company makes their equity portfolio public. It the portfolio is made of high quality stocks (I m pretty sure it is) the market will maybe see this more as an Markel or Berkshire Hathaway kind of stock and focus more on the discount to book value and push the stock price up. This could happen in the next years because we are near the SEC requirement to make the portfolio public (13F-HR).

My opinion:

This stock is mispriced and a great investment for people with a long-time horizon. The dividend will move up step by step and sooner or later the stock price will follow. The bank has a one-in-a-million cost structure with a low risk/average return business model at the core.

You can today buy the non-voting stock of the Bank of Utica (BKUTK) for 391 US Dollars (otc). So (Warren Buffett) spoken: You can buy a good business for 97,75 million US$. You pay a small discount to the core business and u get over 83 million dollars in a dividend-paying stock portfolio for free.

Hold it long term with the over 3% dividend-yield and you (very likely) will be lucky investor long term.

Thank You to for presenting this stock to me years ago.

Thank You for reading and of course I m no natural english speaker, but I hope it was all understandable. The second bank stock I wanted to discuss will follow the next days in a Part 2 (it became too late).

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