There are a lot of banks in the United States trading well below tangible book value. Often, this is for a good reason. Sometimes the quality of the bank's assets is poor (i.e. it has many non-performing loans or a high level of other real estate owned), sometimes the bank just isn't earning much money (i.e. its return on equity is poor), and sometimes there are other factors at play (e.g. the bank is doing something that its regulator disapproves of, such as tax refund loans, or financial products that take advantage of the poor). Sometimes, however, after five years of hard times for small bank stocks, good small banks are cheap for no good reason at all. We own 22 such banks in our portfolio, and the very largest of these positions may also be the cheapest: Bank of Utica.
Bank of Utica (BKUT.OB), with one location in Utica, New York, is a very efficient bank with an $87 million market capitalization. The company has two classes of stock, BKUT.OB (voting) and BKUTK.OB (non-voting); both classes have equal economic rights, including dividends.
Over the last three years, the bank has averaged a 10.41% return on tangible common equity, while posting an even more impressive 1.33% average return on average assets.
The bank's business model is to take local deposits, and to largely invest those deposits in securities, rather than making loans. Because of this business model, the bank is extremely efficient (average of 24.41% efficiency ratio from 2009-2011). The company's securities portfolio is mostly in debt securities, including a large position in senior debt of many of the country's 30 largest banks. The company is not currently taking much interest rate risk with this portfolio, as the vast majority of it has a maturity within 3 years.
Because the company makes few loans, it doesn't have many loans that can go bad. In fact, its asset quality is great. As of December 31, non-accrual loans plus loans 90 days past due plus OREO equaled only 0.17% of assets.
Over the past 13 years, the bank has grown shareholders equity from less than $43 million to more than $130 million (an annualized increase of 8.9%), in spite of paying out a nice dividend. In fact, the bank has raised its dividend every year since at least 1994. It currently pays a semi-annual dividend of $4.85 per share. There's certainly room to grow the dividend much more, as the bank earned $54.48 per share in the past 12 months.
Sounds like a nice, solid company for the long-run, right? Well, here is where the story gets even more exciting-the company is trading vastly below tangible book value. BKUT.OB last traded for $346.01, and BKUTK.OB, for $347.00. The bank's tangible book value is $520.32 per share. In other words, the stock is at a mere 67% of tangible book, and 6.37 times trailing earnings. This is absurdly cheap.
But wait, there's more. Because most of the bank's securities are classified as "held-to-maturity" rather than "available for sale," the bank's book value does not correctly state the true liquidation value of its assets. Is it hiding losses? No, it's hiding unrealized gains! The bank has $16.6 million worth of unrealized gains (net of losses) in its HTM portfolio. If you adjust for these gains, the bank's true tangible book value is $586.91. In other words, the shares last traded for 59% of adjusted tangible book value. Unreal!
I believe this bank will earn about $50 per share in the next twelve months, as net interest margin compresses slightly. My one-year price target for the shares is $627.
What's the catch? Well, in many ways, there is no catch. The biggest catch is probably that neither of the bank's share classes trade very often, so this is not a name for investors who want to day trade. This is a buy-and-hold sort of stock, that requires patience and limit orders.
The other catch is that the company should be buying back stock hand-over-fist, but they are not. That is a blessing, and a curse. On the one hand, if the company was buying back shares, we'd have never been able to accumulate a position as cheaply as we have, and you wouldn't be able to do so either. On the other hand, the company has, by any standard measure, a tremendous amount of excess capital. The company has tangible common equity equal to a massive 14.81% of assets. If management wanted to, they could use 40% of the company's equity to buy back shares, and the bank would still be better capitalized than most of its peers. Eventually, they'll likely figure this out, and the stock will go much higher. In the meantime, at least you get a 2.8% dividend, and an insanely inexpensive stock in a nicely profitable company.
Additional disclosure: The author does not, as an individual, own any investments other than an interest in a private fund. The author is the managing member of the general partner of a private fund, which is long BKUT.OB and BKUTK.OB, and which may add to or subtract from its positions at any time.