Why Premara Financial Is The Most Undiscovered Gem In The Banking Sector

Premara Financial, Inc

TICKER: PARA - OTC	EPS 2013E: $0.74	SHARES OUTS.: 1,692,190
PRICE: $4.60 USD	Forward P/E: 6.49x	9Mo PRE-TAX NOI: $650M
MARKET CAP: $7.78MM	Price / TANG. BV: 0.47	ASSETS: $ 240.1 MM

Potential upside based on

Regional Peers: 117% Tangible Book: 111% Earnings: 163%

Investment Thesis

How would you like to buy a company with sound management, a quality balance sheet, and earnings growing at an estimated 35%? What if you could purchase the company at only 6.5x next year's estimated earnings? To earn these prospects one would only need to sacrifice liquidity and time in exchange for following the timeless principles which allow prudent investors to buy, hold, and take advantage of incredible managers.

Premara Financial Inc. is an opportunity to buy into an exceptional, high quality regional bank that has been oversold due to unwarranted selling by a retail investor base. Due to the market capitalization and illiquidity of the situation this investment is best fit for individual accounts.

• Premara Financial is a healthy, profitable, and growing bank that has been thrown out with the bath water of its undisciplined regional peers
• A weak economy, investment financing, and a retail investor base have unjustly exacerbated selling in Premara Financial to a record disconnect to its intrinsic value
• Thanks to a well-timed launch, Premara Financial is in a position to grow and make quality loans at a time when many regional banks are struggling for survival
• Premara Financial has rejected brick and mortar banking in favor of technology and non-traditional sources of income. This has allowed them to profitably operate, as well as create a scalable and perpetual platform.
• At their core, Premara's management and employees believe in a clear brand that speaks to old fashioned customer service

History

Premara Financial, Inc is a recently formed holding company that was created to own and grow what is known as Carolina Premier Bank. John Kreighbaum is the bank's founder and CEO, having come from a lifetime of banking experience in Texas and Ohio. John's niche has been to develop regional banks in up-and-coming areas just outside of more prominent city boundaries. Such was John's hope in 2005 when he began raising funds to form a new bank in Ballantyne; an affluent suburb of Charlotte, NC.

Management

Premara Financial is steered by its founder and CEO, John Kreighbaum. I have had the fortunate opportunity to meet John on numerous occasions and he is a true gentleman. John embodies an individual of hard work ethic, passion, a Dale Carnegie demeanor, and a drive to achieve one's dreams. In addition to his role as CEO of Premara Financial, John is also on the board of directors for the Charlotte branch of the Federal Reserve Bank of Richmond.

Since it is unfitting for an investor to rely solely on my word, I have attached several news articles about John:

http://www.charlotteobserver.com/2010/08/22/1635480/back-porch-banking-is-his-way.html#storylink=misearch

http://www.charlotteobserver.com/2011/03/06/2111940/smaller-bank-has-grand-plans.html#storylink=misearch

Prior to founding Premara Financial, John Kreighbaum ran CoBancorp, a regional bank in Ohio. In May of 1998 John sold the bank to FirstMerit Corporation for 2.8x book value and 21x earnings. At the time the bank had $665MM in assets. It is John's goal to achieve another high-premium sale. Therefore there is a tangible end-game for those willing to have patience.

Sellers, Financing, and Stock Discount

The key to understanding Premara Financial's current stock begins with the macro environment and the financial crisis of 2008. As noted in the bank's history, John began fundraising for the bank in late 2005 and launched as a denovo bank under a limited charter in 2007. As a result of the timing of the bank's launch, it had the fortunate circumstance to avoid lending in the blow off top.

What has proven as a favorable fortune to the bank's loan book has proven an obstacle for its stock price. 95% of the current non-management investors in the bank are retail investors. Many of them invested a few hundred thousand dollars in 2006 & 2007 when the economy was strong. As the economy floundered many individuals soon found themselves deleveraging and starved for cash. These investors called their brokers and had them sell their shares at the prevailing price. I have been to the bank's annual meetings and can confirm that many of its current shareholders believe that the stock's price represent the intrinsic value of the bank. The majority fail to realize that over the past few years the bank has grown assets at a tremendous pace, maintained a sound portfolio, and moved into profitability.

The stock's retail selling has been exacerbated by the addition of boom-time credit and easy money. Prior to the recession, NC banking laws favored an environment where small start-up banks garnered huge returns in just a few years. As a result, IPO loans secured by Premara's shares were underwritten by other regional banks. Ridiculous as it seems, many times the financing of these shares were 100% of cost. Now that notes are coming due, original investors are having to sell or walk away from their shares - regardless of the disconnect the prevailing price might have with the bank's TBV or intrinsic value. I believe we are seeing this now as a seller poorly executed the sale of his shares over the past 4 months, and placing the stock at a valuation that is once again, too cheap to ignore. I believe anyone willing to take the other side of his sale will be rewarded handsomely with time.

Inside Ownership

Based on recent proxy statements, directors currently hold 9.8% of the total beneficial ownership, while executives are estimated to hold an additional 6.1%. The bank's largest shareholder has been a passive and lifelong shareholder with a 7.68% stake, while we currently account for an estimated 4.98% of outstanding shares. All told, I believe there is an easily countable long-term shareholder base of patient money representing over 28.5% of the outstanding shares. With nearly all of the original board member's stock having been purchased at the original investor price of $11/share, they are well incentivized to make sure that any future transaction garners a favorable price. It is worth noting that all of those involved are looking for an eventual exit and return on their capital, and it is John's job to see this achieved. In summary, there is a lot of financial incentive and obligation for management to execute.

If there is a negative worth noting it is that John Kreighbaum is rarely concerned with the company's stock price. John operates his business from the mindset of a private owner and his care is about building the bank while making sure it sustains the principals that are the building blocks of its culture. While this can be a negative to a current shareholder of the bank, it will prove extremely rewarding to investors favoring patience. It is my belief that great organizations are often a reflection of their culture and 'owner' managers.

Bank Quality & Growth

John's goal is to grow the bank to grow the bank to over $1 billion in assets. Whether he does this via organic growth or acquisition remains to be seen but he has come on the record that he has little interest in buying a troubled bank. Rather, management hopes to explore healthy banks or grow assets via non-traditional routes that will allow the bank to grow deposits without compromising costs. Should the bank decide to move forward with acquisitions, then the current macro environment will allow Premara to purchase healthy banks at a significant discount to historical valuations (Average price/TBV since 1994 is 1.7x for the SNL bank & thrift index).

Premara financial currently has 5 branches; having recently expanded from 2 locations as recently as the past 6 months. During this time Premara has grown its assets by 28% CAGR from inception while maintaining a conservative equity / asset ratio of around 10x leverage over the past 3 years.

 

 

YEAR	2008	2009	2010	2011	20121
ASSETS	$58.1MM	$107.4MM	$157.6MM	$193.2MM	$240.1MM
TANG. BOOK2	$9.04	$8.07	$8.12	$9.15	$9.74
EQUITY/ASSETS	.26	.13	.09	.11	.09
Pre-Tax NOI	($2.1MM)	($1.6MM)	($1.9MM)	$1.16MM	$1.05MM3

A 2011 study of all (22) North Carolina and South Carolina regional banks, three to six years old and with total assets >$100MM in Assets ranked Premara Financial #2 in earnings and ROA, #1 in NIM, #1 in interest, and #3 in $/employee. 2 year average ROA comes in at 43bps and John believes it is reasonable to achieve 75bps in the next year or two. Unlike many of the big bank bulls, John believes the golden 100bps ROA is going to be difficult to achieve in the current environment unless banks find a way to minimize regulatory and brick and mortar costs. Its Texas Ratio comes in at 24.11 vs. 27.90 for its peers, while non-performing assets stand at 1.49 vs 2.57 of its peers.

As part of our investment in the bank we have engaged in extensive scuttlebutt with the bank. This includes multiple conversations with all members of the staff ranking from the personal bankers, transaction tellers, back office administration, the CFO, and the CEO. In addition we have opened multiple accounts with the bank, as well as gained a firsthand experience of the application and underwriting process. In such circumstances we can confirm that the bank has gone out of its way to understand the qualitative factors of the loans. It has been especially reassuring that we have seen them both accept strong loans and reject poor ones.

In 2010, Premara Financial was awarded an "outstanding" rating by FDIC, a designation awarded to only 10% of the nation's 10,000 financial institutions. Since inception loan loss reserves have remained steady at less than 2% of outstanding loans. This comes after all of the bank's real estate assets received an updated appraisal and factored a valuation shock of 30%. Throughout the recession and into Q4 2012 the bank has managed only 2 REO assets; one of which was ultimately sold for the price of its note. As it currently stands only one property remains and it is carried at $515K. We are familiar with the asset and believe it will be moved without significant impairment.

Culture & Technology

Two characteristics combine to make Premara Financial unique. The first is Premara's culture. A walk into the bank is always greeted by a warm and personal touch where the client relationship is valued above all else. Staff members go out of their way to personally introduce themselves and satisfy needs. This 'old bank' mentality is extended throughout the bank's culture where bankers go out of their way to understand the business or mortgage loan, both qualitatively and quantitatively.

Second, Premara Financial has used experience to build a bank centered on technology. Two years ago John Kreighbaum communicated that branch building would become a burden on the industry. By outsourcing many of its electronic operations and creating a paperless infrastructure, Premara has been able to grow its bank without significant increases to payroll and rent. In a recent letter John commented on the secular shift away from brick and mortar banking:

"Last year, for the first time in memory, customer visits to banks and branches actually went down… technology has leveled the playing field and we can compete on equal footing with the big banks…these branch networks are a huge overhead expense that is a drain on banks' profits. Now, the people who run big banks are not dumb and see what is happening. Many banks are already closing branches and consolidating locations. But it is going to take years to 'right size' the branch networks. Meanwhile, banks are carrying the expense in a time of slim margins due to low interest rates."

In addition to its 21st century infrastructure the bank has developed a process to electronically record and interact with all of a client's accounts and potential products. By disseminating the need for product billfolds and advertisements the bank hopes to license its proprietary technology (Omistrater ™) to thousands of other banks throughout the country.

In a world of big banks, dodo bankers, and financial product alchemy, Premara Financial has made a point to differentiate itself from the crowd. In doing so it has built relationships and created a brand that will allow it to win business over its big bank peers.

Expansion and Alternative Revenue Drivers

Over the past 6 months Premara Financial has expanded from 2 branches to 5. First was the assumption of two SC branches from Palmetto Bank. While there is nothing fancy about this acquisition, the bank's are in a niche environment with relatively little competition, and the branches should be accretive to earnings beginning in 2013.

http://www.bizjournals.com/charlotte/blog/bank_notes/2012/01/carolina-premier-bank-buys-rock-hill.html?page=all

More recently, Premara Financial has partnered with the Urban League of the Central Carolinas to provide a banking center inside its headquarters. What is interesting about this branch was the simplicity of scale. The interior and build out was pre-fabricated, brought in by truck, and employed with a relatively small labor cost. With this comes added visibility with the community and new relationships. While I am unsure on the future profitability of the branch, I believe it will be a telling experiment to the future scalability of similar kiosks with additional trade groups.

http://www.bizjournals.com/charlotte/print-edition/2011/12/02/carolina-premier-will-open-uptown-with.html

Finally, John has begun expansion into the Washington D.C. market. The bank currently has two time employees operating out of leased space and they are searching for additional locations. This is important for two reasons. 1) The loan demand and quality of loans in Washington D.C. is second to none 2) Wall Street understands the quality of D.C. banks, which I believe will act as a catalyst as Premara expands into the market.

http://www.bizjournals.com/washington/print-edition/2011/10/14/north-carolinas-carolina-premier-bank.html

Walk into Premara's branches and it becomes apparent that it has a lot to offer for such a small bank; merchant processing, IT services, wealth management, traditional banking. While all these services are expensive given its size, they offer tremendous operating leverage as Premara continues its expansion. Furthermore, in an economy subject to low-growth and fits of uncertainty, I believe John's focus to build multiple sources of income will prove beneficial. In time, these characteristics should allow this special bank to trade at a premium to its more traditional peer group.

SLBF Funding & Peer Group

In 2011 Premara Financial received $6.23MM in Tier 1 Capital via the Small Business Lending Fund (SBLF). The SBLF was created by the treasury in order to spur small business lending throughout the country. Of 933 applications, 332 institutions were approved to be of sound quality and worthy of funds. Premara Financial was one of nine banks with a North Carolina location, and one of two banks in Charlotte. Due to the Treasury's overview and application process regarding the selectivity of qualified banks, Premara can be compared to other Southeast banks that are recipients of the fund.

Peer Group of Listed Banks Receiving SLBF Funds in NC:

Bank Name	Ticker	Market Cap	MktCap to Assets	Book Value
Citizens South Banking Corp	CSBC4	80.54MM	.076	1.12
First Bancorp	FBNC	214MM	.064	0.76
Towne Bank	TOWN	469MM	.108	1.19
AVERAGE	n/a	186MM	.0826	1.02
Premara Financial	PARA	8.78MM	.032	.47
UPSIDE TO AVERAGE	n/a	n/a	158%	117%

Potential Catalysts

We currently foresee 3 catalysts to unlocking Premara Financial's value. First, would be an increase in awareness and information concerning Premara Financial. This year we have arguably witnessed a bottom in the housing market. Accordingly, we have seen financials outperform the general market, with the XLF rallying over 23%. During this time Premara Financial has grown and increased in profitability and operating leverage - yet the stock is unchanged YoY due to its uninformed retail sellers. I believe this gap will close as1) Premara continues to execute and grow earnings 2) begins to make its financial information readily available.

Right now the company's website does not list its financial data. I believe this lack of information is one of the reasons behind disconnect between the bank's stock price and its intrinsic value. However, the addition of such information will ultimately serve as a catalyst as institutional money seeks out businesses trading at such a large discount. As the second largest shareholder of the bank, we have recently suggested this information be added to the website and made readily available.

The second catalyst would be an increase in M&A activity. As demonstrated by the recent comp in Citizens South Banking Corp, the thirst for healthy institutions to grow may allow regional banks to achieve potential premiums of 0.8x to 1.2x TBV in even a slow environment. Ironically, the increase in regulation that may prove a hindrance to current banking economics may provide a catalyst for future acquisition activity.

The final catalyst would be an event directly involving Premara Financial. In April of 2011 the bank, formerly Carolina Premier Bank, formed itself into a holding company in order to open up all options of growth. While we will not speculate as to any future activity regarding the bank its clear it has many attractive qualities that make it unique versus its peers. With management owning such a large % of the bank (at a higher cost basis), and many of them nearing an age of retirement, I believe they will ultimately seek an exit. This might come via an outright sale of the bank, or an equity raise where the new shareholders seek covenants calling for a market listing or liquidity increase. With the second option having been available to John for the past 18 months (but yet not acted upon), I am confident that he will only take the action if 1) he can effectively use the resources to take advantage of a attractive opportunity 2) He does so at a price that recognizes the value of the bank (above peer TBV). Any pickup in the stock's volume should at a minimum, allow it to trade alongside the average TBV of its weaker peers.

IRRs - Book Value Approach

Based on current TBV of 0.47 and stock price of $4.60 / Share. Assumes no growth in TBV

	Southeast Peer Group5	SLBF Peer Group	Recent Comps
Comparable TBV	.75	1.02	1.12
Comparable $ / Share	$7.31	$9.93	10.90
Upside Return (0.47 TBV)	59%	117%	136%
2yr CAGR	26%	47%	54%
3yr CAGR	17%	29%	33%

ROI- Earnings Approach

Based on the current share price of $4.60/share, 1.69M shares outstanding, and John's estimate of a ROA of 75bps. Average ROA has maintained in the mid 40 bps.

	LOW	MID	HIGH
Current Assets	$240MM	$240MM	$240MM
3 YR CAGR	10%	15%	20%
2015E Assets	$320MM	$365MM	$415MM
ROA	0.60%	0.70%	0.75%
Net Income	$1.92MM	$2.55MM	$3.11MM
2015E EPS	$1.13/s	$1.51/s	$1.83/s
Multiple	8x	8x	8x
2015E Price	$9.04	$12.08	$14.64
Upside	96%	163%	218%
3YR CAGR	25%	38%	47%

Conclusion

Premara Financial is a sound bank with an experienced and well seasoned team. A healthy loan portfolio and low overhead has allowed the bank to achieve profitability in the face of a poor lending environment and costly regulation. With share price to tangible book value trading at such a large discount, the margin of safety is sizeable. With limited downside risk a prudent investor only requires patience.

1 Estimated based on annualized 9-month numbers

2 Common Equity - Does not account for preferred equity

3 Accounts for acquisition of SC branches

4 SOLD - Q4 2012 for $7 per share cash. 35% premium

5 NC based banks between 150MM -400MM in assets, Texas Ratio < 30, and stock tradable on pink sheet or exchange

Disclosure: I am long PARA.