I have found over the years that one of the most successful investments that one can make is to put a little money in a privately held community bank at its inception. A common strategy taken during the start up of a community bank is for a group of local investors to acquirer a state bank charter from a small rural bank and then to move that charter to a larger urban area within the same state. Another strategy used to create a community bank is for a group of investors to apply for a de nova state or national charter, while this may allow for clean start it is usually more expensive. Either strategy assures a large return on investment for the original investors. Community Banks are generally much safer then their larger peers as management is usually more conservative in its lending methodology and does not take positions in opaque financial securities or instruments.
Typically, the life span of a community bank follows two paths. Both paths start with the bank growing exponentially as it successfully uses the connections and deposits provided by its original investors to fund high return commercial loans. After several years to a decade, the bank will reach $400-500 million in deposits; it is here where the investors will have to make a decision as to whether they wish to remain independent or be acquired by a larger regional bank. In remaining independent, the investors are hoping that the bank’s current management team has what it takes to grow the bank into a competitive but likely smaller regional bank. If they choose to be acquired, they generally see returns of between 200-400% on their original investment and typically receive stock in the acquiring bank. Both paths are extremely profitable but are unfortunately unavailable to the typical retail investor. That is why I find the story of Mercantile Bancorp (MBR) to be particularly interesting.
In an earlier article, which can be found here, I talked about what are some important attributes that investors should look for when looking at regional banks. Many of the criteria that I discussed in that article can be seen in Mercantile Bancorp, as I believe it to be the only example of a community/regional bank hybrid that is publicly traded.
Mercantile Bancorp is a bank holding company out of western Illinois. Along with its main subsidiary, Mercantile Bank out of Quincy, Illinois, the company also has five other wholly owned community bank subsidiaries. They are Marine Bank & Trust out of Carthage, Illinois, Perry State Bank out of Perry, Missouri, Brown County State Bank out of Mt. Sterling, Illinois, Royal Palm Bank out of Naples, Florida and HNB National Bank out of Hannibal, Missouri. These banks are all doing quite well as they have managed to ride the strength of the agricultural economy in the Midwest. The one exception is of course Royal Palm Bank, which has had some trouble recently in the Florida market. Nevertheless, these banks provide the holding company with a diversified geographic footprint that is rare for a bank of its size.
In addition to these holdings, the bank also has a tradition of taking minority and majority stakes in newly established privately held community banks. While the timing of the company taking its stakes varies, they have all for the most part been wildly successful over time. Currently the company has ten such stakes. Below I have listed out the banks in which they have a stake, their percentage ownership and my own estimated value as to what these stakes are worth at one times book value.
- 5% of Integrity Bank out of Jupiter, Florida. Integrity was founded in the first part of this decade and while it has a large number of construction loans, its balance sheet has remained in decent shape. This stake could be worth as much as $750K dollars at one times book value.
- 0.8% of Premier Bank out of Jefferson City, Missouri. Over the last decade Premier was one of the fastest growing privately held banks in the state of Missouri, since 1996 its assets have risen from 25 million to over 1.3 billion. The bank is currently expanding into Illinois and Texas. This stake could be worth as much as 1.2 million dollars at one times book value.
- 5% of Premier Community Bank out of Crestview, Florida. This Florida bank is doing surprisingly well; this can be attributed to its location in the panhandle region, which is seeing a large influx of retirees who do not default on their mortgages. The loan quality at this bank is impeccable. Mercantile Bancorp’s stake could be worth as much as 1 million dollars at one times book value.
- 4.1% of Paragon National Bank out of Memphis, Tennessee. Paragon arose out of the ashes following the purchases of Union Planters, National Commerce and Trust One by larger regional banks. It has grown rapidly since it’s founding driven by a strong commercial loan base and a great management team. This stake could be worth as much 1.3 million dollars at one times book value.
- 0.1% of Integrity Bank (ITYC) out of Alpharetta, Georgia. This investment has been a disaster; fortunately, it is the smallest holding in the company’s bank portfolio with a value of 60K dollars at one times book value.
- 1.3% of Enterprise Financial (EFSC) out of St. Louis. Enterprise is in my opinion the best small regional bank in existence. Its loan portfolio is flawless; management is superb and they are uniquely aware of the opportunity that they have to create a large amounts of shareholder value. Mercantile came into possession of this stake through its ownership interest in a bank by the name of Northstar, which was acquired by Enterprise in an effort to get into the Kansas City market. This stake is worth as much as 2.25 million dollars at one times book value. On a side note, Enterprise’s stock has declined recently in part as a result of the expiration of the shareholder lockup agreement with the former Northstar shareholders.
- 4.4% of Solera National Bank (SLRK) out of Denver. Solera is a unique story, it is one of the few banks in the Denver area that caters almost solely to the Latino marketplace. As a result, it has the ability to show tremendous growth in the years ahead. While the bank itself is currently in some trouble, the holding company is quite strong. This is the result of the holding company’s recent IPO, in the next several quarter I would not be surprised to see the holding company contribute more capital to the bank. Mercantile Bancorp’s stake is currently worth as much as 750K dollars at one times book value.
- 5.0% of Bank of Manhattan (MNHN) out of Los Angeles. While the bank’s location should be of a concern, it is important to note that this is a de nova bank that was founded in mid August of 2007. As a result, they have no loan issues of note. In fact, they are growing exponentially due to their competitors’ inability to lend to high quality customers because of the credit crunch. I believe that this holding has the real potential to be a huge winner for the company, given some time. This stake is worth as much as 1 million dollars at one times book value.
- 5% of Brookhaven Bank out of Atlanta. While Atlanta’s banks are a mess because of their large residential construction exposure, Brookhaven is too new to be in any significant trouble. I would imagine that its story is going to shape up much like the Bank of Manhattan, which I mentioned above in the previous bullet. The company’s stake is worth as much as 1.1 million dollars at one times book value.
- 54.6% of Heartland Bank out of Leawood, Kansas. Heartland is Mercantile’s loan majority owned bank and likely one of its best prospects for growth in the future. Heartland is run by a local banking family with a long history with North America Savings Bank (NASB) as a result their ties and connections to the community will help to drive tremendous growth down the road, even if they are struggling with certain issues right now. The Kansas City market is extremely competitive and as a result, breeds well run banks. Another local bank, Metcalf Bank, was taken out at over three times book value. This purchase goes to show you the multiple at which prime community banks can be purchased. Mercantile Bancorp’s stake in Heartland is worth as much as 9.5 million dollars at one times book value.
These stakes have a total book value of nearly 19 million dollars. While this may not seem like much in relation to the company’s total market capitalization of nearly 140 million dollars it is important to remember that the 10 stakes that I laid out above are all likely worth 3 to 4 times the current book value down the road. In five years the value of its minority and majority subsidiaries is likely to be somewhere between 60 and 80 million dollars. In order to see these returns, the only thing that Mercantile must do is ride these investments through the current trouble in the banking industry. There is always a regional bank willing to pay top dollar for a niche community bank located in an area where the regional currently does not have a presence. It is only a matter of waiting for them to come a long. If Heartland Bank and the Bank of Manhattan pan out in the way I think they well it is very possible that the total bank portfolio well be worth in excess of 100 million dollars.
The company’s six core wholly owned subsidiaries are all likely worth 2 to 2.5 times book value as well, once the cycle turns. This gives these banks a potential value of between 210 and 270 million dollars. Greater returns are possible if management were to follow a Hawthorn Bancorp (HWBK) strategy and merge all its different wholly owned subsidies under one operational structure, as the synergies would likely be tremendous. Even if they keep the banks separated they should all do fine as a result of the strength in America's agricultural areas. It should be clear by now that Mercantile Bancorp offers a safe way to play the return of multiple expansion in the community bank subsection of the banking industry. I believe that it is possible that Mercantile could be worth as much as 350 million dollars or 2.5 times its current price within the next five years.