Banking stocks have been some of the most volatile investments over the last 10 years. The financial crisis of 2008 and 2009 saw their stock price relative to book value per share fall to under 50% for many money center banks, including the "too big to fail" trio of Bank of America (BAC), Citibank (C), and JPMorgan Chase (JPM).
Simply put, having a stock price below 100% of book value per share implies that the market believes your company is worth more dead than alive since liquidating the assets will pay off all liabilities with more than enough cash to pay off current market value per share. A 50% book value to share price ratio means you're worth twice as much dead as alive. Having the largest banks in the country worth more than dead than alive two times over was a bad situation. The U.S. Treasury stepped in to rescue U.S. banks with an injection of funds through the Troubled Asset Relief Program or TARP.
Borrowing U.S. Treasury funds through TARP financings to fix their broken balance sheets was an unprecedented and still controversial process since existing management was preserved in most cases even as foreclosures skyrocketed and bank executive salaries remained constant. Many bank execs now underplay the significance of the efforts to rescue them by the Fed and the Treasury, but the stock market is still discounting BAC, C, and JPM as well as many other financial institutions to prices well below accounting book value per share.
Regional banks, below the largest banks but much bigger than local community banks, were also TARP takers. They also exhibited some high profile and desperate capital formation events and cost cutting procedures in order to survive. Suntrust (STI) was forced to sell its holdings of Coca-Cola (KO) stock that it had held since the soda company's IPO in 1919 and Zions Bank (ZION) closed more branches than it opened for the first time since Brigham Young was CEO. Survival was in question for quite some time as loan quality continued to deteriorate well into the 2010 recovery for many lenders.
Typically, the outcome of this type of balance sheet crisis is to merge weak financial institutions into stronger. Bank mergers are projected to rebound back to 180 or more deals this year; however, current acquisition multiples are still severely compressed and may remain so for several years.
In a recent interview with the Wall Street Transcript, Matthew Schultheis of the Philadelphia investment bank boutique Boenning & Scattergood declared "Prior to the Great Recession, banks were being acquired for 2.5 or three times tangible book; now they are selling for 1.6 times tangible book." Tangible book value for a bank is book value after deducting goodwill and some other non cash capital sources. Since most banks have by now removed goodwill from their accounting, the tangible book value is often very close to actual book value.
Synovus (SNV) is a large regional bank that was severely compromised by the financial crisis. Synovus entered 2008 as a vast amalgamation of dozens of small community banks across a region of the country that was particularly dependent on real estate development and construction lending. Florida, Georgia and Alabama are key components of its banking footprint.
Consider the poor Synovus banker who had spent 10 years competing with others to lend to real estate developers in that region. When the music stopped in 2008 not only the developers but also construction companies and construction equipment leasing companies, and the McMansions mortgaged by all those folks, disappeared along with the capital they owed somewhere into the Okefenokee Swamp. The management of Synovus scrambled to escape total disaster.
No doubt the $935 million in emergency TARP funds it received from the U.S. Treasury was helpful as the TARP capital provided the cushion necessary to work out the bad assets. Currently, this is the largest amount still owed by a bank. Synovus has spent the last 4 years using that financial cover as it works bad loans through the process of reserving against them, extending or foreclosing, then selling off these assets at 30 to 50 cents on the dollar.
Synovus, along with the many other community and some regional banks with TARP money still outstanding, is feeling the heat of the impending increase in the interest rate payable to the U.S. Treasury from 5% to 9%. The Treasury has also started auctioning off the outstanding billions of dollars of remaining TARP Preferred stock to vulture, excuse me, hedge funds. Banks still owing TARP money are facing imminent harsh treatment at the hands of outside investors if they can't rid their balance sheets from the remains of the recession.
Four weeks ago, SNV management announced the sale of $530 million of distressed assets at a projected $155 million loss. $400 million of the assets sold were in the "non performing asset" category. Since as recently as September 30, 2012, SNV had only $900 million of assets in this category, at least 45% of all NPAs were dismissed from the bank's balance sheet.
This reduction in NPAs will facilitate the release of loan loss reserves, boosting profits, or at the least will provide the ability to shield the bank from additions to reserves as loan growth accelerates. The bank will also repay its TARP Preferred stock, not by diluting shareholders, but from its current cash holdings. This requires permission from banking regulators monitoring its debt/equity ratios, but Synovus management seems confident that this will occur. In addition, the bank also announced today that it settled some outstanding litigation.
Clearing the decks of the dead and wounded and repaying its TARP Preferred stock to the U.S. Treasury, will allow KPMG, the bank's auditors, to approve the reversal of the Synovus "deferred tax allocation" of $787 million. As any competent CPA can attest, reversing an accrual is much better than accruing a reversal.
The timing of these steps is soon and specific.
In the last quarterly conference call, the CEO of SNV stated:
"…based on the improvement in core profitability, credit quality, and earnings projections, we now believe that substantially all of the DTA valuation allowance may be reversed as early as the end of fourth quarter of this year. And should be reversed no later than the end of the second quarter of 2013. As we have said before, TARP repayment is likely to follow the DTA valuation allowance reversal…we believe that TARP repayment will be as early as the second quarter of '13. But no later than the beginning of the fourth quarter of 2013."
The result of the sale of the NPAs with losses recorded in 2012 and the subsequent accrual reversal will result in almost $1 billion of additional potential after-tax income for Synovus in 2013. This clears the way for a substantial increase in the book value of the bank. Even reducing the $1 billion estimate by a 25% haircut results in an increase in current tangible book value from $1.6 billion to well over $2.3 billion, quite possibly by the end of June.
Since the bank is now profitable and has a growing loan portfolio, this implies that SNV will trade to comparables at the top end of its peer group.
There are about 800 million shares outstanding, including employee stock options not already granted, so tangible book value per share for SNV could easily go to $2.88 per share. A takeover valuation of 1.6 times implies $4.60 per share, almost double the current price of $2.44/share.
Investment Thesis Confirmation
Other sophisticated money managers confirm this investment thesis. Jonathan S. Raclin is the Principal of Barrington Asset Management, and the Managing Director of the Enterprise Portfolio and has over 40 years of investment management experience.
Investing in individual securities is unusual for this long term value investor. In a recent interview, he stated that "the one outlier [in his portfolios] is Synovus, the first individual stock I've bought in several years."
Mr. Raclin goes on to explain:
"I had a number of clients tell me that they couldn't find the same person at their bank to speak to twice. Many clients are not that comfortable dealing with financial matters online, and they wanted a personal relationship. The larger banks, going through such tremendous upheaval, are so focused upon lowering their costs that their personal service has disappeared.
I investigated the local community bank, Coastal Bank, a part of the Synovus system. I found they had moved from being overly aggressive in their lending policies to becoming more prudently conservative. The environment seemed likely to improve for housing while the bank was rapidly moving to clear up numerous uncertainties on their balance sheet. It is admittedly a relatively high-risk, but potentially a high-reward opportunity. They recently announced that they had sold off a large portion of their bad loans. While I think it's very tough to make money in the banking industry with an incredible amount of regulation and with interest rates as low as they are, the news for Synovus going forward should be better.
There may also be some further consolidation in the banking industry, and Synovus is in a part of the world - Georgia, South Carolina, Alabama and Florida - which may prove attractive to an outside entity. We began to acquire the position at $1.50. It's now trading at approximately $2.50. We think it could be worth more as the housing recovery, especially in the Southeast, continues to show strength."
Another notable investor is Anchorage Capital, run by ex-Goldman Sachs (GS) distressed bond trader Kevin Ulrich, which owns 4.5% or about $85 million worth of SNV stock. Although this hedge fund was a net seller in the 3rd quarter according to SEC filings, the $85 million stake is still one of their largest positions. Anchorage specializes in leveraged investments into financially distressed situations and has some other interesting small bank investments.
For example, Anchorage has a 40% equity ownership stake representing $64 million worth of stock in Hampton Roads Bankshares (HMPR), a small Virginia based community bank. This is matched by a similarly sized stake from the famous investment manager Carlyle Group (CG).
Another bank in the Anchorage portfolio is Central Pacific Financial (CPF), with 34 branches in Hawaii. Like SNV, this bank will benefit from reversing its accrued tax assets this year and seeing a significant tangible book value increase as a result.
Clearing the decks for a TARP repayment has eliminated existential risk for Synovus. The impending substantial increase in tangible book value puts SNV well on its way towards $3/share by the end of 2013. Continued economic recovery or an acquisition by a larger regional bank or financial institution could drive the price to $4/share.