Monthly Archive for December, 2010
I pulled these two tables from the FDIC article I mentioned in the prior post.
Table 3 shows how banks that relied heavily on Trust Preferreds fared had worse financial performance than those banks who did not use them at all.
Table 4 shows how banks that relied heavily on Trust Preferreds failed at higher rates.
The FDIC suggests four reasons why banks that relied on Trust Preferreds were weaker:
- First, reliance on TruPS increased the financial leverage in banking organizations, making them less resilient in the face of adversity.
- Second, heavy users of TruPS appear to have levered the proceeds to make riskier than normal loans, perhaps in response to pressures to meet aggressive return on equity targets.
- Third, when an organization has issued TruPS, the FDIC has more difficulty attracting investors to the institution in a stressed situation while the institution remains open. This increases the likelihood of failure rather than rescue, which increases the FDIC’s costs.
- Finally, when TruPS are issued by one BHC as capital and owned by another bank, the resulting double counting of capital in the banking system creates inter-linkages that magnify the effects of losses.
The winter release of the FDIC’s Supervisory Insights publication has a very interesting article on Trust Preferred Securities:
“Trust Preferred Securities and the Capital Strength of Banking Organizations” looks closely at the role of these hybrid securities during the financial crisis and highlights the fact that the use of TruPS in tier 1 capital enabled large bank holding companies (BHCs), as a group, to operate with substantially less loss-absorbing capital than permitted for insured banks. Evidence also suggests that institutions relying on these instruments took more risks and failed more often than those that did not include TruPS in tier 1 capital. The eventual elimination of TruPS from large BHC tier 1 capital, as mandated by the Collins Amendment and recent agreements by the Basel Committee on Banking Supervision, is expected to help move the U.S. banking industry toward a stronger capital foundation.
Steuben Trust Company (SBHO) is a small bank headquartered in upstate Hornell, New York. SBHO was started in 1902 and now has $354 million in assets and operates thirteen offices with 7 in Allegany County, 1 in Livingston, 1 in Monroe, and 4 in Steuben County. SBHO is one of the few banks in this country that operated with prudence and sound banking practices prior to the financial crisis. 2008 and 2009 were both record earnings years for SBHO with earnings of $3.96 million and $4.1 million.
Slow and Steady
SBHO is an unexciting and small community bank that has done very well over the years despite the considerable economic turmoil. Earnings per share doubled from $1.25 in 2004 to $2.50 in 2009. ROA has improved steadily over the past 8 years from 0.48% to 1.14%. Net interest margin is very good at 4.47%. Also, in June 2009 US Banker ranked the SBHO’s performance #44 among the top 200 community banks with under two billion dollars in assets in the United States based on its 3-year average ROE.
Though it is a tough environment for all banks due to the fact that there is low demand for loans and net interest income is declining for most, SBHO will continue to operate in its steady and stable fashion. Perhaps SBHO will even begin to acquire some other local banks that have been in dire straits these past few years.
Indeed, SBHO acquired Canisteo Savings and Loan, a small mutual thrift, on February 20, 2009. SBHO acquired assets of $6.87 million and liabilities of $6.334 million. Under the terms of the agreement, SBHO paid no consideration related to the net assets acquired from Canisteo.
Unknown and Unfollowed
SBHO is unknown and unfollowed by Wall Street, which is the big reason why I think SBHO shares are mispriced. However, it will be very hard to acquire any meaningful amount of shares given the stock is very thinly-traded. The way to go here is to put in a limit order at an appropriate prices and wait and see!
Risks
The main risk is that of another economic downturn. And even if there is another downturn, given the performance of SBHO during this most recent economic crisis, I feel there is little to worry about.
Valuation
SBHO is trading at an approximate 30% discount at current prices. Assuming average assets and ROA just remain stable at about $355 million and 1.15%, SBHO can earn 2.48 per share. Attach a more deserving multiple of 12 and you have ~ $30 per share as intrinsic value. If SBHO can grow assets just modestly and maintain its ROA, intrinsic value will be greater than $30 per share.
Also, see my spreadsheet of the bank’s historical performance condition ratios.
Summary
In summary, SBHO is a solid bank that is mispriced because it is small and unfollowed. When the economy begins to turn around, SBHO will have a lot of capital it can deploy to earn even greater profits. In the meantime, you can collect a dividend that is yielding greater than 4% at current prices, a high yield for a high quality bank.
On July 28 this year I suggested that GXDX might be a buyout candidate. Lo and behold, there is news that GXDX is putting itself up for sale.
Assuming one had purchased at$17.40 on July 28 and held until selling today at $21, that would be an annualized return of about 163%.
I think it’s most likely QE2 is and will be, as Pragmatic Capitalist says, “the greatest monetary non-event.” I believe its unlikely the Fed will accomplish any of its goals with QE2. If anything positive does happen, it will be in spite of QE2, not as a result of it.
One reason I think QE2 will not help is that there is no demand for loans because people and businesses are still repairing balance sheets and people and businesses still feel very uncertain about the future due to all the new laws and regulations surrounding Obama’s agenda. Below is a visual illustration I created of my point (click for larger image).
The data is indexed to 100 on October 1, 2008, which is when the value of commercial and industrial loans peaked. Here is an explanation of the data:
- The monetary base is highly liquid money that consists of all coins, paper money, and commercial banks’ reserves with the Federal Reserve.
- M1 are funds readily accessible for spending. It consists of: (1) currency outside the U.S. Treasury, Federal Reserve Banks, and the vaults of depository institutions; (2) traveler’s checks of nonbank issuers; (3) demand deposits; and (4) other checkable deposits.
- M2 consists of M1 plus: (1) savings deposits (which include money market deposit accounts); (2) small-denomination time deposits (time deposits in amounts of less than $100,000); and (3) balances in retail money market mutual funds.
So, now an explanation of the chart. The chart simply shows the monetary base increasing at a far greater than the broad money measures of M1 and M2. The monetary base has increased at a greater rate because the Fed has been purchasing huge amounts of assets from the banks, thereby increasing the banks’ reserve accounts, but the banks have not been making more loans. In fact, loans have been decreasing despite all the Fed’s actions.
In my mind, the Fed is quite powerless and my best guess is that they feel its better to do something rather than declare they are impotent. The best and only solution to reviving the economy is through fiscal policy. We need tax cuts and more government spending on items such as education and large projects that will help stimulate demand now and will provide good benefits to our society in the future.
| M1 includes funds that are readily accessible for spending. M1 consists of: (1) currency outside the U.S. Treasury, Federal Reserve Banks, and the vaults of depository institutions; (2) traveler’s checks of nonbank issuers; (3) demand deposits; and (4) other checkable deposits (OCDs), which consist primarily of negotiable order of withdrawal (NOW) accounts at depository institutions and credit union share draft accounts. |
Over at Mises Daily, author Jire Sekar writes about the five year anniversary of the death of M3. This is one of the events I remember very clearly as this was about the time I had started to spend more and more time learning about investing and economics.
Five years ago, in November 2005, the Federal Reserve announced that it would no longer be tracking the aggregate money supply. It issued a terse, cryptic 143-word press release entitled the “Discontinuance of M3.” M3 was the broadest member of the big 4 of monetary aggregates published by the Fed — M0, M1, M2, and M3 that the Fed had compiled monthly since 1959.
John Williams of Shadowstats noted the oddity of the announcement, opining that M3 was probably the most important statistic produced by the Fed and the best leading indicator of economic activity and inflation. The Fed’s lack of interest in the components of M3 can be directly linked to its inability to foresee the 2008 collapse of the financial system.
M3 is basically M2 plus institutional money funds, Eurodollar deposits and repo agreements. Though information on Eurodollar deposits and repo agreements was incomplete and difficult to collect, the author suggests that if the Fed had been tracking this data, they would have seen the cracks starting to form in the financial sector in 2007. Whether the Fed would have done anything is another question.
Nevertheless, my thoughts on the subject remain the same on this subject. I believe more information and transparency is a good thing. As such, I believe it was wrong for the Fed to stop collecting and assembling the M3 data.
Last night Charlie Rose interviewed a group of three about gold: Jim Grant, John Hathaway of Toqueville Asset Management, and Peter Munk, chairman and founder of Barrick Gold. Rose then did a one-on-one with Einhorn on gold and inflation and other topics.
I think its a good show. Jim Grant’s thoughts and opinions are always interesting. I also enjoyed having the perspective of a miner. And it’s always good to listen to Einhorn.
Rose asked Einhorn what he likes about the investing business. Einhorn likes “solving the puzzles.” If Rose asked me the same question, I would have answered differently. I would have said that I enjoy doing something that is very hard, that few people are good at and where I have the opportunity to be one of the best. However, I do agree that there is a “puzzle solving” aspect to being a good investor.
TNT NV, Europe’s second-biggest express-delivery company, announced plans to reverse course and spin off the business while retaining the smaller mail division.
TNT rose 8 percent in Amsterdam trading, the biggest jump in more than two years, after saying current investors will be offered new stock in the express unit next year. The postal operation will retain a 29.9 percent stake until some financial questions are resolved, Hoofddorp, Netherland’s based TNT said in a statement.
Analysts estimated earlier this year that the express unit was worth about 6.25 billion euros ($8.3 billion) following investor speculation that United Parcel Service Inc. or FedEx Corp. may seek to buy the division. TNT, which had a monopoly on letter deliveries in the Netherlands until last year, started an internal separation of the express and postal businesses in April with the aim of selling the latter.
“This is quite an important change of strategy,” Andre Mulder, an analyst at Kepler Capital Markets, said today. “It’s harder to sell the mail unit because of the strikes and influence from the government. You have a bigger chance selling the express division.”
I think this is likely a great opportunity for the inquisitive investor to earn above average and uncorrelated returns. Currently TNT controls 18 percent of express deliveries on the European continent. Acquiring TNT’s express business once it is spun out would be a great way for either FedEx or UPS to solidify a market position. FedEx has a 2% market share while UPS has a 9% market share.
On November 30, 2009, I made my first investment decision with my new retirement portfolio. As of December 1, 2010, my retirement portfolio has gained about 23.86% versus 12.14% for the S&P 500, an outperformance of 11.72 percentage points. The portfolio now has 8 positions in individual securities and a sizeable position in cash. Take that Efficient Market! I’m proud of my efforts and I look forward to continuing to work hard at making excellent investment decisions.
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