Ottawa Savings Bancorp - Second-Step Conversion On The Horizon

| About: Ottawa Savings (OTTW)

Summary

The company recently announced a second-step conversion.

Post-conversion, the bank will be trading significantly under TBV and have a massive amount of capital to put to work.

Management has stated that 50% of the proceeds from the conversion will be used on repurchases.

Mutual conversions have historically outperformed the market.

Upside of 100-120% in three years.

Want to make some quick easy dough? Umm yeah, who doesn't'…is that rhetorical?

I always shake my head when I get sent emails from shady newsletters telling me this is the opportunity of a lifetime. YOU NEED TO BUY NOW BEFORE THIS 'ONCE IN A LIFETIME' OPPORTUNITY DISAPPEARS! I wish investing was that easy-find the shadiest newsletter, buy everything they recommend and retire on an island before you hit thirty. Sad to say, successful investing takes an immeasurable amount of dedication, research and time.

There are some avenues in investing where you can make, more or less, 'predictable' returns. Want to know how? Well that will cost you...just kidding, go to your local Amazon and pick up Margin of Safety or You Can Be A Stock Market Genius. Both of these books allude to ways investors have and can make decent returns in a market.

One of the more unique ways to make money-which a lot of investors tend to overlook-is through second-step conversions. I will let The Manual Of Ideas explain a second-step conversion.

"Meanwhile, in a second-step thrift conversion, an institution that is partly owned by a mutual holding company (NYSEARCA:MHC) typically completes a transition to full public ownership by offering MHC-owned shares to investors. Ideally, the vast majority of the stock of a publically traded thrift is held by an MHC. While those shares are considered to be outstanding, the economics belong entirely to the non-MHC shareholders. The analogy would be treasury stock held by a corporation that had completed a share repurchase. The MHC-related peculiarity causes many investors to overlook thrift conversions, as the relevant institutions may not appear to be particularly cheap at first glance."

Ottawa Savings Bancorp (OTCPK:OTTW) announced on June 3rd, that the board of directors has unanimously adopted a 'Plan of Conversion and Reorganization' via second-step conversion. Moreover, the MHC will sell the majority ownership it owns in the company to the public.

Before we dig into the second-step details, it will be beneficial to do a brief overview of Ottawa Savings Bancorp.

Ottawa Savings Bancorp was founded in 1871 and is headquartered in Ottawa, Illinois. Today the bank serves the areas of Ottawa, Marseilles, Morris, LaSalle, Grundy and Joliet. The bank has $216,565,000 in assets, $144,843,000 in loans and a total risk based capital ratio of 21.63%.

Back in 2005, Ottawa did an initial conversion when they issued 1,223,701 shares of common stock to Ottawa Savings Bancorp and 1,001,210 to the public. With the initial conversion underway, the business model henceforth has been on the originating one-to four-family mortgage loans, marketing core deposits, continuing conservative underwriting practices and expanding into new market areas.

The company has met all of those former goals, with a conservative loan book-over 60% of loan are 1-4 family mortgages. In addition, the loan book has stayed conservative, in good and bad times-in 2008-2010, noncurrent loans to loans hit a high of only 4.04%.

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Finally, the current efficiency ratio, NIM, ROE and ROA are 74.81%, 3.67%, 3.52% and 0.50%. Based upon the former performance and profitability metrics, it would seem as if the bank is not worth an investors time-especially considering the P/TBV of ~1.16x. However, opportunity lies within the recently announced second-step convert.

At first glance, it appears as if Ottawa has a TBV of $29,514,000 and a market cap of $34,440,063. With half converted MHC's, the market cap is taking into consideration the full amount of shares outstanding, even though 69.10% or 1,999,845 of the shares are held by the MHC. However, these shares are not truly outstanding and are in a weird MHC structure-which have a high potential of raising the bank a significant amount of non-dilutive money.

Based upon the company's recently filed S-1 the company is anticipating to raise between $16-22 million post-conversion sometime in 3Q16.

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At this point, readers should realize that the offering is non-dilutive, meaning existing shareholders will receive shares of common stock with an exchange ratio intended to preserve the current aggregate ownership in Ottawa Bancorp as they have in Ottawa Savings Bancorp. This means that the bank is effectively going to be able to raise $16-22 million, with zero dilutive effects. Moreover, there will be an excess amount of capital the company will be able to put to work.

What is interesting is the company is already overcapitalized to begin with. Furthermore, management stated that 50% of the proceeds raised will be used to repurchase shares via employee stock ownership plan. Not only will the bank have an excessive amount of capital, but the convert will give the bank more equity, thereby lowering the effective book value.

Thus, investors buying Ottawa at the current price are effectively buying the bank at 66-75% TBV, instead of the 116% represented. With the board of directors approving the convert, the much added benefits of converting and the S-1 filed, there is a high chance the convert will go through, giving investors a very unique situation to capitalize upon.

Let me ask you this; can you find me a bank trading around 66% TBV that is profitable, not burdened by dilutive debt and is significantly overcapitalized? Didn't think so. This is a unique situation allowing attentive investors to buy into a properly run bank, with intents of returning value back to shareholders via repurchases. Furthermore, I wouldn't be surprised to see the bank issuing a dividend in the near-term-half converted MHC's are constrained by regulations for issuing dividends. Finally, there may be an acquisition or de novo openings post-conversion given the excessive amount of capital.

Post-conversion, I find it very unlikely for the company to sell under TBV for long. The bank will be purchasing shares in the open market, which should help close the TBV gap and there will be much capital to be put to work. Finally, three years after converting, MHC's are allowed to be bought out.

Currently banks are being bought in the range of 1.4-1.5x TBV. Even if the bank is not bought out three years' post-conversion, trading at 1.4-1.5x TBV is likely given the potential capital position, a repurchase program and MHC's as a whole outperforming the board market. Thus, if Ottawa is acquired at 1.5x, the bank has a 100-127% upside or an annualized gain-in three years-of 26-31%.

The biggest risk is if management spends the money post-conversion unwisely. If they do expensive acquisitions, shareholder capital may be wasted. The company may also move into more aggressive lending areas such as C&I. This will pump up the NIM in the short-run, however, if management isn't conservative in regards to lending they may take unprecedented risks. Finally, any unwanted interest rate movements or burdensome regulations will hinder the company's bottom line.

Mutual conversions are the net-nets of the financial world. In fact, they are net-nets with a special situation attached. Once these banks are fully public the CEO's typically find ways to improve the bank through repurchases, dividends, more aggressive loans and acquisitions. I guess the public spotlight gives management the incentive to perform.

Ottawa is planning to fully convert sometime in Q3. After the conversion the bank will be selling significantly below TBV and have a massive amount of capital to put to work. With the undervaluation and vast amount of potential capital, the downside is well protected. Finally, given the history of mutual conversions, there real potential for market beating returns.

Disclosure: I am/we are long OTTW.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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