Sun Bancorp (SNBC) rallied in early July on news of a 100 million equity investment by Wilbur Ross, the Brown Family and others, spiking from the 3.50 area to as high as 5.47. It has since given some of that back, and at a recent price of 4.82 it's worth considering as a follow the smart money ploy. After looking at this a while, I think it may be more useful to think of it as a turnaround: SNBC has some problems, and management is in the process of taking corrective action which over a period of time should restore shareholder value.
Sun Bancorp, Inc. is a bank holding company headquartered in New Jersey. Its primary subsidiary, Sun National Bank, serves customers through 71 locations in the state. The bank's lending activities are focused on commercial and industrial lending within its geographic footprint.
From the 10-Q:
On April 15, 2010, the Bank entered into an Agreement with the OCC which contained requirements to develop and implement a profitability and capital plan which will provide for the maintenance of adequate capital to support the Bank’s risk profile in the current economic environment. The capital plan should also contain a dividend policy allowing dividends only if the Bank is in compliance with the capital plan, and obtains prior approval from the OCC. During the second quarter, the Company delivered its profit and capital plans to the OCC.
The Bank also agreed to: (a) implement a program to protect the Bank’s interest in criticized or classified assets, (b) review and revise the Bank’s loan review program; (c) implement a program for the maintenance of an adequate allowance for loan losses; and (d) revise the Bank’s credit administration policies. During the second quarter the Company revised and implemented changes to policies and procedures pursuant to the Agreement. As noted earlier in this section, the Bank also agreed that its brokered deposits will not exceed 3.5% of its total liabilities unless approved by the OCC. Management does not expect this restriction will limit its access to liquidity as the Bank does not rely on brokered deposits as a major source of funding. At June 30, 2010, the Bank’s brokered deposits represented 3.1% of its total liabilities.
The Bank is also subject to individual minimum capital ratios established by the OCC for the Bank requiring the Bank to continue to maintain a Leverage ratio at least equal to 8.50% of adjusted total assets, to continue to maintain a Tier 1 Capital ratio at least equal to 9.50% of risk-weighted assets and to achieve, by June 30, 2010, and thereafter maintain, a Total Capital ratio at least equal to 11.50% of risk-weighted assets. At June 30, 2010, the Bank did not meet any of the three capital ratios established by the OCC as our Tier 1 Leverage ratio was 8.22%, our Tier 1 Capital ratio was 9.37%, and our Total Capital ratio was 10.64%. See Note 15 for discussion on the Securities Purchase Agreements announced on July 7, 2010 which are expected to assist the Company in its achieving its individual minimum capital ratios.
Management is committed to taking all of the necessary measures to ensure the Bank becomes fully compliant with the requirements of the Agreement.
From the press release:
Sun Bancorp, Inc. (Nasdaq: SNBC) today announced the signing of definitive investment agreements with private equity funds affiliated with WL Ross & Co. LLC , the Bank’s founding Brown Family shareholders, and others, to invest $100 million in the aggregate in shares of the Company’s common stock and newly authorized preferred stock that is mandatorily convertible into common stock upon the receipt of shareholder approval, all as part of the Company’s strategic growth plan. The shares to be purchased by WL Ross will represent 24.9% of the Company’s outstanding common stock, pro forma for the closing and assuming the conversion of the convertible preferred stock. The investment was made at $4.00 per share.
Upon completion of the capital raising transactions, the Company’s total risk-based capital ratio is projected to be at or above 14%, Tier 1 risk-based capital at or above 13% and leverage ratio at or above 11.75%, all levels which are significantly above the general standards to be considered well-capitalized, and which exceed the terms of the minimum capital requirements imposed by the Office of the Comptroller of the Currency previously announced in April.
The Smart Money
Wilbur Ross appears frequently on business TV, with an area of expertise in financials and distress investing. Although he is often characterized as a vulture, he considers himself a turnaround or phoenix investor and describes himself as such when interviewed.
While it is tempting to portray Ross as a vulture, lazily circling his dying prey, and to bring other investors (myself included) into the narrative as jackals or hyenas, following his lead to feast on carrion, the metaphor if embellished might get in the way of intelligent investment thinking.
The point is, Ross has demonstrated an ability to get involved in turnaround situations, with substantial sums of his own money at stake, and emerge with both a profit and a viable company. The analytical task here is to develop a plausible price target that will be met if he is successful, and then weigh the probability of success and the time required to complete the task in order to arrive at an investment decision.
How Serious Are the Problems?
Noting Ross' involvement, the following summarizes my impression after reviewing the most recent 10-K and 10-Q.
SNBC focuses on commercial and industrial lending, and has generally stayed within its geographic footprint in New Jersey, avoiding undue concentrations in any one industry. They are a preferred lender with the SBA and have the right to make loans without prior SBA approval. They do have a substantial amount of residential and commercial construction business, secured by the land on which the structures are to be erected. They use professionals to monitor construction as they advance funds. Not surprisingly, the economic downturn has put pressure on their customers and has resulted in increased loss provisions.
Net interest accounted for 85% of revenue in 2009 and margin has increased to 3.62% as of 6/30/2010, compared to 3.01% as of 6/30/2009, driven primarily by lower interest paid on deposits.
Possibly they were too easy to do business with during the boom times, and to judge by the OCC agreement if the economy deteriorates further their loan portfolio would not respond well to the added stress. Hence the capital requirements. However, with adequate capital, capable management has the resources to manage through and implement their plan.
Doing the math on the July announcement and the 2Q 2010 10-Q, I arrive at a tangible book value per share of 6.52 after the deal is complete. Applying a multiple of 1.5, consistent with a profitable regional bank in a stable economic environment, I arrive at a target of 9.78, round to 10. From a recent price under 5, it's a doubler if the situation develops favorably. Allowing 4 years, time enough for the commercial lending difficulties to ameliorate under careful management in a slowly growing economy, that would return 19% annualized, not too shabby.
The risk here is acceptable as against the rewards if successful. Ross is experienced in this type of situation, and presumably did his homework before putting his own and client money on the line. He will have board representation. Tier 1 capital, after the deal, will be well above the amounts required to be well capitalized.
A capital and profitability plan was prepared and submitted to the OCC. Having been forced to raise capital at the expense of some dilution, management is well motivated to make it work.
A Philosophical Digression
We hear much talk that the banks aren't lending. Stuffed to the gills with newly printed money, bailed out on the backs of taxpayers who will suffer the consequences for generations, they sit on the funds, invest it in Treasuries, or divert it into a wretched excess of speculation and gambling, to include CDS and other derivatives. Or they lend it to hedge funds, at trivial rates of interest, for use in leveraged arbitrage on some systemically sensitive area of the global economy.
In this case, we have a regional bank that focuses on commercial and industrial loans, reaching businesses too small to sell bonds into today's voracious market. The type of lending that they do is precisely the type of lending that is needed to help restore the economy and strengthen these smaller businesses so they can grow and hire.
The funds to support this activity are not coming from the taxpayer. They are coming from private investors - in this case Ross, Siguler Guff & Co., the Brown family, and others. The expected returns are not 2.7%, like 10 year Treasuries; they are in double digits, maybe in 4 or 5 years, although you get some risk and volatility with that. Patience is required.
That is how capitalism is supposed to work. It was done without Federal guarantees, newly printed money, or subsidies. It's a sign of health. An investor puts up his money and takes his chances, as always, but if this doesn't work out, at least you don't have the sick feeling of having been cheated in a second rate casino.
The closings have not yet taken place. After watching the shares give back some of their gains after the announcement, it is tempting to look for an entry point closer to the smart money price of 4. Smaller and less liquid stocks are sometimes volatile, particularly in weak markets.
I have taken up a starter position and plan to monitor developments, verify that the closing occurs as planned, and thereafter track the earnings announcements and press releases to follow progress on restoring operations to a healthy and profitable basis.
Additional shares can be bought as better prices become available and/or as various milestones are met to demonstrate the restoration of value.
Disclosure: Author is long SNBC