The Worst EPS Declines in Bank Land Over the Past 5 Years
Plus, the ones I'd probably never buy no matter how cheap they are ...
The Big Picture: KRX EPS & Multiple Since 2019
Jumping right in, something struck me the other day. Looking at KRX (regional bank index) over the past 5 years, EPS CAGR is basically flat while the industry itself has actually grown TBV/S (Bloomberg is not great at this calculation in general FYI). Quite a bit has happened in the past 5 years, and in particular in the past few for banks. At least from an earnings standpoint the industry saw a massive pandemic led decline in earnings followed by an equally impressive stimulus led rebound only to feel rates up 500 and end up back where it was.
So, what’s driving the share decline has really been some level of multiple compression, one that has actually expanded quite nicely of late. Remember that multiple is a subject measure that attempts to put a “valuation” on a company’s returns in excess of its capital for some duration. Higher multiple should mean the Company is outearning it’s cost of capital and lower multiples should mean the opposite. What you’ve had in banks are swings in what the market is willing to pay for future bank earnings streams with basically flat earnings indexed to 2019. In my opinion the easy money has in fact been made. So, what are you supposed to do? Buy the banks that will outearn the index going forward. Again no one ever accused me of being a rocket scientist.
I don’t have a crystal ball on multiples. If you pressed me, I would say regional bank and all bank multiples in general are more towards “fair” than anything. Recession fears have passed, NIM compression fears are passing, and liquidity stopped gushing out of community banks into T-Bills and chill. 2023 was a gift. 2024 and beyond will be much tougher so you’ll have to pick unique banks to outperform, unless you have some ironclad prediction on the future of the economy or interest rates which Peter Lynch didn’t, so I assume I don’t.
The No from Me Dawg List: 5 Year Worst EPS Declines:
I try to find the banks who are historically good at annually growing Revenue (Net Interest Income + Non-Interest Income), Earnings Per Share, and Tangible Book Value Per Share. Once I see that, I try to uncover who is cheap & who is expensive before digging deeper into the balance sheet. That entails looking at all of the metrics you all care about: NPL, Provisions, NIM, COF, L/D ratio, Asset/Liability make up, and so on. Once that’s done, I do the screen for the management & governance factors: is the CEO comp right, does the bank “care” about shareholders, do I trust the CEO, etc. I’m going to borrow from Charlie Munger here though this time and “invert the problem”. Here is the list of banks that over the past 5 years have done the absolute worst at growing earnings & some commentary where applicable. These opinions are my own and are heavily subjective.
First Foundation (FFWM):
This bank just confuses me. I think that’s as succinctly as I can put it. To start with they have branch/office locations in California (the wealthy areas), Texas, Nevada, Hawaii, and Florida. And while this sounds fun (especially for exec PJ travel) and I understand catering to the wealthy, I have rarely seen this kind of geographic spread work for a small bank. They also tout a wealth department with AUM/AUA at $6.6b, which is admirable but small all things considered. I know zero about their platform, but in the RIA shuffle going on right now I don’t know what their differentiator is above and beyond a Raymond James type (great platform) or a PE buyout (higher payout). Their M&A move into Florida hurt EPS but then so did rates up and seemingly very little balance sheet management. Their NIM is in the low 1s and their COF in the mid to high 6s. Their L/D ratio is pretty bad too although to be fair their California Multi Fam loans have been performing really well. All in all, it all just feels confusing or maybe distracted. Like they’re trying to do a lot of things all at once, and maybe none of them great. Like Bruce Lee said, “I fear not the man that has practiced 1000 kicks, but rather the man that has practiced one kick 1000 times”. Oh, and I recently found out their COO spends at least some of his time with a YouTube channel and talks about his T levels on X while promoting some supplement company.
What They Need Badly: Rates down on the short end and a benign credit environment.
Unsolicited Advice: Respect the balance sheet management function of the banking game. Someone should have been hedging the balance sheet for rates up given the inherent sensitivity of the deposit base. Do less, better.
Financial Institutions (FISI):
The pride of Western, NY. This one surprised me to be honest. More so because I forget about them when I think about small/mid cap banks. They’re kind of buried in a low growth area and have not historically performed well on any of the metrics that historically matter to me. I don’t know if I’d blame it on the geographic location but that certainly can’t help EPS & Revenue growth when you’re in rural and small market areas in Central & Western NY. They probably over invested in long MBS during the low rate 2020/2021 times and so are hung with a lot of low yielding assets that can’t be unwound. They also have a lot of indirect auto which has performed well historically but is at best a book value business without much franchise value. Those two things mean they probably have a lower amount of credit risk than most regional type banks. For me though, it just always seems like something bad happens to them. And I don’t want to say “unlucky” but this recent check kiting scheme they’re dealing with is another example. So, here’s my bull case, rates go down and they lean into and find a way to win Micron business. For those of you that are asleep this is going to make winners in NY above and beyond what people are expecting. They’ve also been beat up a bit worse than I’d expect given their EPS relative to KRX.
Where I’d Focus: Do everything in your power to win some of this CHIPS ACT business. Divest “non-core” businesses like Indirect Auto & focus on giving back excess capital to shareholders. Increase value of stock & try to do M&A before you are just another low growth, low multiple sale target.
Key Competitors that will also cash in on the CHIPS ACT: NBT, CBU, CHMG, EVBN, TMPF (Ithaca is Gorges).
Triumph Financial (TFIN):
Some of my bank friends have written on TFIN more eloquently and intelligently than I ever could so I’ll keep this one simple. It’s kind of a love it or hate it type situation with the bank. And by bank I really mean depository looking to dominate the trucking industry. My enduring question for them is what if the trucking industry stays mired in this kind of muck and mire that it’s in for a long time. Or what if it gets worst? And not for nothing it doesn’t seem like insiders are terribly convicted at this valuation either. Worth noting, their earnings growth is lagging KRX while their stock price is most certainly not.
Their Success or Failure in a Word: Trucking
Tough Question for Management: Help me understand, how should we believe you on Triumph Pay EBITDA projections and all of the money you’re funneling into it when you haven’t hit projections yet?
Washington Federal (WAFD):
The most important thing is this. I personally having met Brent Beardall, would never choose to bet against Brent Beardall. Having played professional sports I have seen enough people like this to know that you don’t bet against them. Period. If you’d like to discuss more what I mean, please hit me up. Their earnings decline was a result of the close of their Luther Burbank deal. They added an $8b balance sheet and closed in record time. What they acquired in Luther was a very liability sensitive balance sheet so if rates were to go down, all of the earn back numbers they put into presentations would be wrong and results would be materially better. What’s more, is that they care about making money, it’s actually front and center in their recent decks that they want to be “highly profitable”, digitally focused, and want to make their customers lives better. And lastly, I’m going to trigger some of my NPS fans, but they care about their customers opinions of them and are approaching USAA level status. Winners win and I think WAFD long term is a winner given their higher EPS run rate going forward and the man driving the ship.
Truth Serum Question for Management: Do you feel like you overpaid for Luther Burbank, even if over the short run?
Key Competition: COLB, BANR, BANC, EWBC
North Dallas Bank (NODB):
I’ve seen some very antagonistic (but truthful?) takes on this bank out there. I always wondered what was up with them. I spent about 15 minutes going through all of their shareholder letters, all of their front facing marketing materials, their website, etc. I can tell you two things. One, they absolutely care about is doing well in their community. That much is obvious, and it’s stamped everywhere, and I am sure their communities are better off because of them. Two, I do not believe they care about shareholders as much. I would not be so rude as to call them a credit union, but you do your own research and tell me what you think. I can’t give capital to someone that doesn’t care about producing returns for me. Kind of simple. In fact, their 2022 letter read like a victory lap in the face of being boat raced by KRX. I won’t say they weren’t aware, but maybe that it’s just not that important for them to produced returns for shareholders. At 70% of TBV it feels like they could be a takeout candidate, but I don’t get “we want to sell” vibes. At least they do have their NDBT tower down 635 from TFINs soon to be old digs.
Unsolicited Advice to Management: Creating value for shareholders matters at least as much as giving back to your community if you are a stock, Company. Shift at least some of your energy towards that.
Valuation Cap: Banks with a great “brand” and poor returns are worth book value. 100% of TBV can be seen as a lid in situations like this & if you sell to a larger bank they are not going to spend as much as you did (energy or dollars) on the community so be mindful.
First Guaranty (FGBI):
I can’t imagine ever buying this stock. And there are some amazing stories about them, but in lieu of a long-winded write-up I’ll share the 1 of 1 shareholder letter where they blamed their performance solely on the Federal Reserve Bank raising rates. They did not say any of it was their fault for not managing the balance sheet correctly. Nor did they give any of their 2021 or 2022 performance credit to the Federal Reserve Bank for lowering rates & doing QE (or to the government for running unprecedented stimulus). To those that are triggering by those embracing the victim mindset, please look away.
Competitors: ISTR, OBK, HFBL
Competitors I’d rather own: HBCP, BFST, RRBI
Flushing Financial (FFIC):
I really wanted to not like them. And then I went through their investor deck and it changed my mind. They kind of screen for all the things you wouldn’t want. Liability sensitive, CRE in the NE and in particular NY, and a thinner margin. But once you dig into the numbers things get better. First of all on the credit side, net charge-offs from 2000-2023 have been really low, I’m talking 4bps relative to 50bps for their peer group. Secondly, non-current loans have also been low at roughly 37bps relative to 130bps for their peer group. And lastly they do low leverage lending touting an average LTV of 36% which is kind of impressive and reminds me of OZK. I hate to give people too much credit, but they are addressing all of their problems head on in investor presentations which tells me that they are: A) thinking proactively, B) seeking investor feedback, and C) incorporating that feedback into strategy and messaging. Couple that with a 55% of TBV valuation and you get to a place where there’s upside just on the reversion to TBV. This is again too small for me to play in but I think they’re worth a look on the long side.
Main Risks: Continued rates up (although they’re hedged somewhat) & deterioration in CRE credit.
Competition: DCOM, VLY, MCB
Who Were the Winners Over in EPS Growth from 2019 to Today?
Would be remiss if I didn’t mention. May write them up another time. Let me know who you like.
Until next time,
Aurelius
PS - Probably will stop going free in the next few posts. If you like this be sure to spread to your friends.