This week I took a page (or a chapter) from Seth Klarman's excellent book, Margin of Safety, and evaluated a number of recently de-mutualized savings and loan banks. In analyzing these banks my focus was on discount to tangible asset value, profitable operation, alignment of insider interests, and sufficient size to attract institutional buyers. A dozen or so dry annual reports and at least as many 10-Qs later and I stumbled bleary eyed upon Poage Bankshares (PBSK), a Kentucky community bank headquartered in Ashland. Satisfied the numbers were interesting enough to merit the sleepy morning, I promptly swilled another cup of coffee and dug into the story.
Business: Poage (PBSK from here forward… because I still don't know how to pronounce Poage) is a plain vanilla retail bank. It collects deposits, makes loans, and collects the interest rate spread. As with all such banks, credit risk and interest rate risk are key points which management is paid to - well - manage. PBSK has 6 offices in the greater Ashland, Kentucky area. Ashland is approximately 120 miles east of Lexington and is located in an area that lags the national average in employment and per capita income rates. Basically, there's nothing terribly interesting about the fundamental business.
Capitalization/Performance: Is the bank well capitalized? Yes. Tier-1 Capital to Risk Weighted Asset ratio of 29+% due to the cash raised in the demutualization. Return on Average Assets (ROAA) has ranged between 0.5% and 0.8% in the trailing 3 years. Net Interest Margin stood at 3.08% at the end of December 2011. The bank's efficiency ratio stood at approximately 73% as of the December 2011 year end. While I do not have current data on the industry average, this efficiency ratio performance was almost exactly in line with the mid-year 2010 small bank average efficiency ratio. On the whole, this is a fairly average business in very good financial condition.
Valuation: Is it cheap? Yes. With tangible book value per share of $17.50+, the recent price of $11.30 looks attractive at a Price/Tangible Book of less than 0.65. Gross cash (and equivalents) stands at 118mm+ or approximately 37% of total assets. Expected bad loans would have to be catastrophic in nature and volume in order to justify a share price of $11.30. The bank's filing for calendar Q4 2011 indicated Earnings per Share of .20. My best guess for 2012 EPS is approximately $1.10. Frankly, this is a ballpark guesstimate based on applying 2010 profitability levels to an asset base of 425 million (which represents an expansion of approximately 1/3 from current levels - assuming management uses excess cash to grow the business). This estimate does not factor in the advantages of scale in regards to fixed costs/improved profitability per unit of assets. Further, estimated expansion would represent only the near term possibility for the business. The bank's balance sheet would allow for significantly more leverage. However, the bank is a bargain based on its current business and requires no growth to justify an investment.
Management: Will management behave? Management participated in the second half 2011 demutualization in a meaningful manner. In addition, insiders in aggregate own 21+% of the business. Management is experienced, but I cannot attest to its skill given the limited data available on past performance. Its balance sheet policy does appear conservative though, based on historical data included in the 2011 10-K. The risk remains, however, that management will allocate the bank's surplus cash poorly.
Risks: As with other banks, interest rate and credit risk are at the forefront. The bank has begun focusing on adjustable rate loans in place of fixed rate in order to prepare for coming rate increases. The latter risk seems to be mitigated somewhat by an upturn in the economy and declining unemployment, as well as the multi-year shakeout of borderline solvent debtors. Certainly both of these risks remain relevant, but current non-performing loan rates are a reasonable - 2.8mm on 181.6mm in loans outstanding - or 1.5%.
Catalysts: There are a number of potential catalysts for the more accurate pricing of PBSK equity. As the bank is relatively small (recent market cap of 35mm USD) and was a demutualization, not an IPO, the equity began trading without the broad attention of the professional investor community. The bank has also only recently published its first annual report and quarterly financials as a publicly traded company - it will now begin to populate databases commonly used by investors. A handful of professionals have already begun taking long positions in PBSK - Firefly Capital among them - a fund which has an impressive record and is a member of the Greenlight Capital Masters Fund.
Bottom Line: While banks are not my area of specialty, I believe PBSK offers compelling value at recent prices and based on the current business. An investor can purchase today at 65 cents on the dollar a profitable operating business - and pay nothing for the actual operations. As a bonus - excess cash available will offer management opportunities to create additional value through smart acquisitions and/or organic growth. Further, the effects of the demutualization have offered what I believe will prove a temporary opportunity to purchase a share of the business at depressed prices. Using a 5% tangible book value growth rate and assuming the bank should trade at 1x tangible book value over a three year horizon - this investment would produce a Compound Annual Return of 21%. My expectation is that this inefficiency will be remedied more quickly than the model timeframe would suggest.
Disclosure: I am long PBSK.