Finding Value at Wolverine Bancorp

| About: Wolverine Bancorp (WBKC)
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As a headline in Grant's Interest Rate Observer recently stated,

"The Thrifts are Coming! The Thrifts are Coming!"(1)

Wolverine Bancorp (NASDAQ:WBKC) is a federally chartered savings bank located in the "middle of the mitten" Midland, Michigan. Wolverine, formerly just a plain old bank located in "The City of Beautiful Churches", is now amongst the likes of GOOG and AAPL, having IPO'd on the NASDAQ back on January 20, 2011 by selling 2,507,500 shares of its common stock at $10 per share in a subscription and community offering. That included 200,600 shares sold to the Wolverine Bank employee stock ownership plan.

The bank has three locations in Midland and one in Frankenmuth, which by the way, is also home to the "World's Largest Christmas Store". Wolverine serves nearly 7,000 customers, which is almost 20% of the population of Midland and Frankenmuth combined. Wolverine's return on equity can't hold a candle to the numbers put up by Wamu in its heyday. However, Wolverine sports fairly low levels of non-performing loans, has managed to weather the financial crisis, and is way overcapitalized. Perhaps these are some of the reasons why unlike many others in the space, Wolverine is in its 78th year of business, having received its charter in 1933, shortly after Franklin D. Roosevelt took office.

Wolverine currently trades for $14.11 per share giving it a market cap of $35.37m. Tangible book value is $62.3m giving it a price to tangible book ratio of around 56.7%.

Non-performing loans stand at 3.9%, with tangible equity to assets of 16%. Around 50% of their loan portfolio is comprised of commercial real estate loans, including multifamily loans and land loans. 33% of the loan book is comprised of one to four family residential mortgage loans. Wolverine also invests in mainly U.S. government and agency debt, and has traditionally avoided municipal obligations.

Other than obtaining the ability to write off their next visit to "The Top of the Rock" on their next NYC visit as a 'business expense', why would Wolverine management decide to take the company public? It's not like they needed the capital. A short overview on what is happening to small banks is warranted. Pay attention. This is where things get interesting.

The OTS and the OCC

Sometime this summer, the Office of Thrift Supervision (OTS), which has served as the regulator of federally chartered thrifts like Wolverine for over 20 years, will disappear. We have seen this movie before. Established by Bush Sr. in the wake of the Savings and Loan Crisis, the OTS chugged along until the most recent financial crisis, becoming another victim of poor management, or maybe just circumstance, as institutions such as Indy Mac keeled over and died. Dodd, Frank, Obama and a few other financial geniuses went on to decide that the Federal Office of the Comptroller of the Currency (OCC) shall assume regulatory oversight for banks currently under the umbrella of the OTS.

As mentioned in Grant's Interest Rate Observer (Oct 29, 2010 issue) (1) with respect to thrifts' reasons for converting to stock ownership now...

Better the sleepy devil you know than the possibly energetic devil you don't, the converting thrift managements seem to be reasoning. So they are seizing the opportunity of regulatory realignment to convert to stock ownership under the rules before they change, or may change...

What does this mean for banks like Wolverine?

Like Wal-Mart (NYSE:WMT) shoppers on Black Friday, dozens of thrifts are lining up at the gates to go public before the OTS/OCC rule changes go into effect. Unlike a Facebook IPO or a Green Mountain Coffee Roasters (NASDAQ:GMCR) secondary, there will be no roadshow, no slide deck, and no keynote speech or 'swag-bag' at the next UBS Conference at the Grand Hyatt for these companies. And for good reason. Many of these newly public banks are simply too small for large investors to care about and will suffer from illiquidity shortly after the offering.

Need some more reasons that nobody cares?

Depositors, who are offered a first crack at shares, are not the rabid buyers of new issues that they used to be. Pre-crisis, however, many offerings enjoyed oversubscription by deposit holders. Nowadays it is hard to get the average depositor interested in anything other than the safety of his deposit. In Wolverine's case, The Midland Daily News (4) reported after the offering that:

bank officials wanted to offer the stock to local depositors and employee plans first and had said they might increase the number of shares to as many as 3.9 million depending on demand for the shares or changes in the market for financial institution stocks. That increase, [no surprise], did not happen.

Another positive...

In almost every single one of these new issuances, management is a significant buyer of stock in the offering, alongside investors. In Wolverine's case, management personally bought just over 4% of the offering. This is not akin to Steve Ballmer picking up a few shares of MSFT stock. Wolverine's Chief Operating Officer, Rick Rosinski, who earned $125k in total comp in 2009, purchased $50,000 of Wolverine stock. CEO David Dunn, who took home $277k in 2009 comp, bought $300k worth of stock in the offering.

Not only are thrift management teams buying in at the offering price, they generally receive stock options that strike at the offering price as well. This gives management a strong incentive to have cleaned up the loan book prior to the offering. Remember, banks have had 3 years to work through their problem loans following the crisis. Out of the gate, management is also incentivized to maximize earnings through expense reduction, e.g. improvement in the Efficiency Ratio (operating expenses as a percentage of revenues).

Time for another quote (3):

Reading the excellent article today by John Reese on the Peter Lynch strategy reminds me of something I learned by studying Lynch's incredible performance over his years at the head of Magellan. We dissected his returns after he retired and poured through years of annual reports and commentaries. What we found that was although he talked a lot about growth stocks and PEG ratios it looked to us like all of his outperformance could be traced to his vast ownership of thrifts. He was especially astute in having deposits in virtually every mutual thrift in the country so he could participate in conversion IPO offerings.

~Tim Melvin, noted deep value investor and financial author~

Wolverine, like many thrifts that fit this mold, is overcapitalized. This will give them the ability to withstand a soft or even declining real estate market. It's hard to lose money investing in a financial institution sporting a double digit tangible equity to assets ratio. Substantially all of Wolverine's loans have been collateralized by real estate, with one- to four-family residential mortgage loans including home equity loans and lines of credit, commercial real estate loans including multifamily loans and land loans and construction loans, making up 95% of the total loan portfolio. Bank management has stated that they will continue to emphasize real estate lending following the IPO.

Wolverine stayed away from the toxic stuff (e.g. subprime, Alt-A, negative amortization loans, out-of-market loans, etc.). Option ARMS were avoided as well.

Here are some of their key historical financials:







Tot Assets














Loans Receivable














FHLB Advances







Tot Equity





















Efficiency Ratio*







Non Perf /Tot Assets*







* '2010 data is for the 6 mo ended June 30 2010

Efficiency Ratio is non-int exp / (net int income + non int income)

Tot equity not inclusive of the IPO (Jan 2011) proceeds

The more recent numbers above require some explanation - note that the net loss during the 2010 period resulted primarily from a $4.0 million provision for loan losses charge taken during the period and a one-time charge of $2.9 million taken in connection with the freezing and funding of the multi-employer defined benefit pension plan. This goes back to 'cleaning it up' before becoming public.

More on the loan book, if you are still interested:

As of June 30, 2010:

Commercial Real Estate, Multifamily and Land Loans: $84.4 million, or 33.5% of the loan portfolio, consisted of commercial real estate loans, $34.6 million, or 13.7% of the loan portfolio, consisted of multifamily loans, and $15.6 million, or 6.2% of the total loan portfolio, consisted of land loans. Of the $84.4 million of commercial real estate loans, $24.5 million was secured by non-owner occupied one- to four-family rental properties.

One-to Four-Family Residential Mortgage Loans: $83.6m or 33.2% (of the portfolio)

Construction Loans: $10.7m or 4.2% (of the portfolio)

Home Equity Loans: $8.8m or 3.5% (of the portfolio)

Commercial Non Mortgage Loans: $10.5m or 4.2% (of the portfolio)

We always like to look at the biggest loan that a bank has made. For what it's worth, as of June 30, 2010, Wolverine's largest commercial real estate loan had an outstanding balance of $4.3 million, was secured by commercial/industrial properties and condominiums, and was performing in accordance with its terms.

As you can see, while its ROA and ROE are nothing to get excited about (and ROE is going to look even worse now that the "E" portion is even higher), not a lot has to go right for Wolverine to be able to protect its capital, grow modestly, and eventually buy back its own shares if it cannot find better places to deploy funds. As the excesses of the housing bubble are worked off, a more normalized lending environment can develop, and the banks that are left standing will be sure to benefit.

Quote time:

What we're seeing now is almost too good to be true. Clean, overcapitalized thrifts, with less competition than they've faced in years, are coming public at less than one-half of their value to private buyers. And they seem to be coming en masse.

(Also from Grant's Interest Rate Observer: Oct 29, 2010 issue)

The quote above was from noted bank activist Joseph Stilwell, who also appeared in Barron's late last year to discuss the same topic.

From Barron's Dec 18, 2010 (2):

Discounts of today's magnitude could represent a once-in-a-lifetime investment opportunity... The supply of new bank stock is enormous... But demand for thrift shares has withered. Depositors have little interest in the shares, while many institutional investors don't have the funds to participate.

Stilwell has spent the last 18 years investing in banks, and has a notable track record of activism in the space. The most cursory look at his public record (along with some media clippings) shows that his m.o. tends to be the same in each of these investments.

Stilwell buys reportable stakes in newly public or converted banks that are trading at a substantial discount to tangible book value.

He then encourages management to buy back shares, return capital to shareholders through increased dividends, and prudently grow the business, ie, building new branches just for the sake of 'getting bigger' or buying a competitor with the IPO cash would be out of the question.

While not a prerequisite for investment, it does help to be alongside Stilwell as a shareholder. His reputation is common knowledge in most of the boardrooms of these small banks, and he will be "watching the store" to make sure that capital is not squandered. Stilwell filed his 13-D on Wolverine on Feb 7, 2011.

A wave of consolidation is coming.

America's 8,000-odd banks make it one of the most overbanked places in the world. The next 3-5 years should spark a wave of consolidation. Even if Wolverine were to remain independent after its 3 year moratorium, a modest return on equity, coupled with buybacks and dividends and a conservative valuation more reflective of intrinsic value should produce an excellent risk adjusted return.

The fact is that a small, sleepy thrift can't really earn more than 7-8% on equity, even with the prodding of an activist. It should however, be able to earn 4-5% (as Wolverine did pre-crisis), and management has every incentive to get it there if they want their options to be worth anything.

Here is a simple 5 year illustration of an investment in Wolverine using a 5% ROE on average over the next 5 years. (The illustration ignores dividends and buybacks).

Cost: $0.54 (as a percentage of tangible book value - ok, it's now $0.57 since the stock moved, but you will get the idea.)

Average ROE: 5.00%

Starting Book Value: $1.00

Ending book value:

Year One: $1.05

Year Two: $1.10

Year Three: $1.16

Year Four: $1.21

Year Five: $1.28

Target Sale Price: 1.2x Book in Year 5

Sale Price = $1.53

Return = $0.99 ($1.53 - $0.54)

IRR ~ 23%

Keep in mind the average P/TBV exit multiple is historically much higher than the 1.2x that we use above. A Jan 24, 2011 study by Stern Agee that tracked all standard and second step conversions from 1982 through the present day found that 60% of the 504 converted banks they tracked were sold at an average deal price that was 164% of TBV. We will be conservative and stick to the lower figure. If we get 1.64x we promise to mail Stern a fruit basket.

One last point on all of this. Though not central to our thesis on small banks, the financial industry is always a hot button topic, and it does help to be on the right side of the political equation.

As Stilwell says in Grant's...(yes, the same issue):

These [small banks] are politically favored entities right now. People hate Wall Street. People hate Bank of America. Nobody hates First Federal Savings & Loan of Wichita."

Now that is something we can all agree on. After all, how many Chase branches can be found in the same town as "The World's Largest Christmas Store"?

(1) (Grant's Interest Rate Observer Vol 28, No 21, Oct 29 2010 | Two Wall Street New York NY 10005 | | Access by subscription only)
(2) (Barron's Dec 20, 2010 Issue | | Dow Jones Reprints |
| Access by subscription only)
(3) ("Lynch's Returns" by Tim Melvin posted March 15, 2011 | RealMoney is owned by 14 Wall St 15th Fl New York NY 10005
| | Access by subscription only)
(4) Cheryl Wade for the
Midland Daily News, Thursday, January 20, 2011

Disclosure: The author of this article holds shares of Wolverine Bancorp.