Talmer Banc's Future Looks Quite A Bit Brighter

| About: Talmer Bancorp, (TLMR)
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TLMR's book of stressed assets performed well in Q2 and has put the company in a position to realize gains if the assets can be sold.

TLMR saw a significant swing in value for its securities held for sale portfolio - I believe it should and been selling the assets away.

TLMR has executed several transactions since its IPO that should contribute to stability of the bottom line and bottom line growth.

It's been a long time since I've been as confused about a stock and company as I am about Talmer Bancorp, Inc. (NASDAQ:TLMR). I mean, I understand the industry in which TLMR operates, I understand the model with which TLMR has deployed, and I understand that the company is still in the development stage of maturation but it seems like TLMR is changing its growth strategies with the winds. Fortunately for TLMR, I think that the stock is in a short-term position to buy based on several factors that we will discuss. This continuing coverage article will break down TLMR's second quarter, will discuss its ever-evolving state of operations, and recommend a buy of the stock based on short-term tailwinds.

A Brief Summary

Since recommending a 'wait and see' approach to the stock in mid-June when the shares were trading at $14.27, the stock has traded in a continued tight range (it was at the time of the initiation article as well) and has remained flat the last few months, closing most recently at $14.09.

My initial recommendation to stay on the sidelines was largely based on the fact that the TLMR model was unproven for the region it operates in - the Greater Michigan area - and for the company itself. Knowing that TLMR built almost its entire asset base from failed banks being auctioned off by the FDIC I wanted to wait to make sure the assets themselves, which are valued by the buyer using different levels of modeling techniques that range in the levels of assumptions made, were in reality close to the assumptions used to value them. In more simple terms, I wanted to make sure the discount product I bought wasn't about to go on bigger discount.


Since the IPO, the assets TLMR put together have done well and actually have done better than I expected. Take a look at some of the credit quality improvements to the underlying assets that have taken place recently:

Always remember that TLMR purchased these assets knowing they were or had serious chances of becoming impaired. Even the "uncovered assets", or assets that TLMR wasn't given loss guarantees (guarantees for coverages and sharing of losses with the FDIC as an incentive for purchasing stressed and/or impaired assets) for have done well to improve in quality.

The image above illustrates that in the last six months the following credit improvements have taken place:

Commercial and Industrial Loans, Commercial Real Estate Loans, and Real Estate Construction Loans:

  • "Pass" Total Loan Growth : 28%
  • "Special Mention" Total Loan Growth: 64%
  • "Substandard" Total Loan Growth: (3%)
  • "Doubtful" Total Loan Growth: (8%)

Consumer Residential Real Estate and Consumer Loans:

  • "Performing" Loan Growth :25%
  • "Non-Performing" Loan Growth: (6%)

TLMR got the improvements it needed where it needed them to justify a higher share price. If we were just judging the valuation from IPO to the valuation currently based on loan credit quality the stock would be undervalued. Credit quality increasing overall is a good thing, a very good thing considering the majority of net income to far at TLMR has come by way of bargain purchase gains it realized on the "value" of these loans. The loans actually showing to have value is big. This is bullish TLMR.

Now, speaking of the valuation of the underlying assets and why the credit quality improving is especially big for TLMR and will continue to be for the next few quarters, it's probably useful to explain exactly how TLMR graded these assets in the first place. This information wasn't public as of the IPO - at least to my knowledge - so it's useful to review what percentage of the assets were evaluated using significant assumptions, versus how much of the composition was evaluated using observable inputs. This graphic doesn't tell us everything we need to know to perfectly value the company but it does give us a look into how TLMR grades assets in aggregate. The graphic below strictly shows assets held for sale, both securities and loans, and how TLMR based its valuation:

This graphic does a good job at showing primarily the securities available for sale but also shows us a small portion of loans and how they were valued as well (mostly residential). Regardless, the information on how TLMR evaluates its assumed and since added securities available for sale is important because we'll soon find out exactly how much this channel of assets can move the income statement.

First, let's focus on the loans we talked about above. You can see that of the small amount of loans held for sale, ~$205 million, and for that matter securities held for sale are categorized as being valued using a level 2 input methodology. What this means for those unfamiliar is:

Valuation is based upon quoted prices for identical or similar instruments in markets that are not active; quoted prices for similar instruments in active markets; or model-based valuation techniques for which all significant assumptions are observable or can be corroborated by observable market data. (SOURCE: TLMR 10-Q)

Essentially, what the company is doing is making its best judgment for the valuation of the asset based on some really correlative data. I don't really have an issue with this as for the most part this is standard procedure in banking. You can also see from the graphic that a small portion of the assets, about ~$93 million or ~10%, is valued using level 3 input methodology. This is slightly more assumption-based and requires modeling using unobservable inputs, making it more risky and harder to value in thinner markets, but based on the overall size to the assets available for sale and to the overall assets at the company I again am not concerned. The important concept we can take from this graphic is that it hints towards how TLMR values assets that can't be valued using level 1 inputs. That matters because the large majority of the assets on the books had to be valued to derive a purchase price in receiverships.

Performance of Assets - Monetization

Now that we know how TLMR runs its operation from the inside out we can take a look at actual asset performance within the quarter. We'll start with loans:

Loans performed beautifully during Q2 and this is also bullish TLMR. Starting from the top of the graphic and moving lower we can see that the composition of assets is slowly shifting towards more heavily weighted the "uncovered" variety from the "uncovered" variety. TLMR's books were never heavily or majority weighted to "covered" but they are becoming more and more weighted towards "uncovered". In the first six months of 2014 the total amount of "covered" loans fell ~13% and the total amount of "uncovered" loans grew ~33%. That is substantial risking off ("uncovered" loans were currently impaired or stressed or had extremely high chances of becoming impaired or stressed in FDIC receivership) for TLMR as it was able to underwrite all of the "uncovered" loans or acquire them in non-impaired, non-stressed scenarios. Total loan growth in aggregate was 25% for the six months ended 6/30/2014. It should be noted that the loan growth and all figures derived in this article so far are inclusive of all assets acquired in FDIC receivership.

Looking at the bottom portion of the graphic we can see that for the six months ending 6/30/2014 that the actual dollar amount of impaired loans coming from the "uncovered" pool of assets is roughly equal to the dollar amount of impaired loans coming from the "covered" pool. This speaks to the credit quality of the "uncovered" pool and further it speaks to the performance of the "uncovered" pool because the "uncovered" pool represents 88% of the total loans on the books. In total, TLMR has ~$3.8 billion in loans. Of that ~$3.8 billion, ~1% of loans impaired are from the "uncovered" pool and ~1% of loans impaired are from the "covered pool". This obviously means a significantly higher percentage of loans from the "covered" pool are impaired when looking at the total size of the covered pool but this is largely to be expected. Overall, loan performance was strong and looks to continue to be strong based on the first six months as a public company. It should be noted that this graphic does not display troubled loans or loans in which concessions will need to be made to avoid an impairment.

Finally, and this was huge for the income statement at TLMR, the securities available for sale saw a much needed valuation improvement during the first two quarters:

I don't think this graphic needs much explanation but from the bottom to the top TLMR increases in unrealized gains and total fair value during from the beginning of the year to 6/30/2014. These unrealized gains helped contribute to other comprehensive income and close the gap that would have existed Y/Y from a net income standpoint.

The Financials

Again, it's worth mentioning that the majority of the net income gains to date at TLMR have come via the bargain purchase gains it has been able to realize after acquiring assets from the FDIC. This one-time type of activity will make for lumpy net income statements until the full year is accounted for and TLMR is able to experience 4 consecutive quarters without those large numbers skewing its bottom line comparisons. That being said, TLMR did notice a ~$30 million decrease in bargain purchase gains on the six month comparison that is reflected at the bottom line. Because of this net income fell from ~$75 million to ~$57 million. That said, and this makes what I'm about to write all the more impressive, TLMR actually grew the net income line when factoring in Other Comprehensive Income which encapsulates the gains from securities held for sale. When looking at the Statement of Comprehensive Income we can see that net income for the six months grew from ~$66 million to ~$67 million - no small feat considering the above mentioned $30 million drop off in one-time items.

What makes this graphic even more important than showing the impressive net income growth? It underscores the unique position that TLMR is in currently and the entire reason I wrote this article.

Where's the Trade?

So, thus far we've come to following conclusions:

  1. TLMR has a very risky book of assets that are currently performing well and are currently being valued at their highest levels since inception.
  2. TLMR has a fairly large book of securities that saw substantial swings from negative valuations to positive.
  3. TLMR's assets, both loans and securities, that we've discussed so far are heavily dependent on macro-economic prosperity (keeping borderline stressed borrowers above water) and on the ten year treasury rate (benchmark for interest rates).

What I believe is that TLMR is smart enough to realize the unique situation it is in and that it will be selling assets into the high tide than has come in. TLMR has to realize that its securities portfolio, which was smoked during Q1 because of rising interest rates, is a liability long-term and that it needs to start looking for exit strategies to risk off. The fact that the securities book valuation swung ~$30 million in six months should be alarming to management. This fact should be especially alarming when they also consider that the company's growth strategy to date, growth by acquisition of FDIC receivership assets, is no long an option. It needs to find ways to generate consistent income without huge swings. Investors do not like huge swings in net income - especially when they are tethered to a ticking time bomb that is tethered to rising interest rates.

TLMR also, I believe, is smart enough to sell non-core market assets and assets that it believes have been or will become in the future at least temporarily impaired to willing buyers while there are buyers. I think it's time for TLMR to begin risking off the covered loans (yes, they are covered but only for so long and only for so much) into the frothy securitization chains that have built momentum once again and to other yield starved mechanisms. It's time to TLMR to get serious about its business.

There is evidence that TLMR is doing this:






JULY 2014




AUGUST 2014 - CLOSING Q4/14 OR Q1/15



~$13.4 MILLION






These transactions are encouraging to say the least and the sale of some of the branches for cash gains should go a long way into decreasing the overall risk portfolio of the company. I have to believe that TLMR, using the above chart and a belief that TLMR management isn't completely incompetent, has been selling away securities at the current valuations and is at least in talks to sell any other assets that meet the above description.

That's my bull thesis here for buying shares at least into next earnings. The selling away and risking off isn't the entire bull thesis because I obviously feel like the assets themselves performed well and I am impressed that TLMR grew net income (factoring in OCI) in a Q and a 1H that saw such a reduction in bargain purchase gains.

Am I perma bulled up TLMR? No. Absolutely not. Am I encouraged by the recent developments? Yes. I don't recommend anybody get deep TLMR and feel like there are plenty of outside opportunities that offer at least an equal reward for risk but the upside to next quarter's numbers is attractive here based on the fact that the shares haven't moved an inch since the decent quarter was reported and the company has net income staring it in the face if it wants to cut bait on some assets.

In summary, TLMR at the very least is a more interesting story now than it was at IPO and has shown that it at least has the potential to hang around - and that's not the worst way to live if you're a new bank.

I recommend a soft buy for anybody wanting to take a chance on an earnings play that is currently undervalued based on its most recent quarterly performance. Don't go off the deep-end but TLMR isn't an avoid any longer.

I look forward to providing continuing coverage. Good luck to all.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.