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Valuation For Banks With Negative Earnings Negative Book Value


persistentone
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What are some valuation approaches we could use to value a bank with negative book value and negative earnings?  My feeling is that the best approach might be to determine an enterprise value based on customer deposits and back out value of preferred shares and debt.  What do others think?

 

One such bank is FMAR.  They have negative book as a result of the real estate collapse.  They had positive earnings but that has gone negative.  I assume that this is because refinancings accounted for most of those earnings and now those have gone away.  They are raising bank fees and I don't know how much closer that can get them to breakeven.

 

They have about $15M of preferreds coming due at end of year (much of it was bought back below par in the past).  This was amount due as of quite some time ago.  I haven't referred to recent filings.  But the bottom line was that the full par value of what is due immediately didn't look like a bank-busting event.  They ought to be able to clear that hurdle.

 

I guess something like this comes down to do you believe they can hold off on a regulatory action to seize them, then grow to positive earnings as economy heals.  On a normalized earnings basis this is a $6 to $10 stock, and it sells for 80 cents.  But there is a non zero risk here of them blowing up.

 

In any case, I am very interested in understanding what an acquirer might pay for them today, with negative earnings, based on some alternative valuation approach.

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I did quite a bit of research on the small community banks a couple of years ago...

 

I am going to suggest that this is a VERY low quality bank if they have not been able to improve their earnings, book value, and regulatory capital levels.

 

In fact, if they have not does this by now, when are they going to do it?  I am going to suggest that is a NEVER.  The easy money has already been made.

 

As to their accounts having value, most definitely, yes...

 

HOWEVER, put your yourself in the shoes of any acquiring bank.  Why not simply wait & see if the FDIC seizes the bank.  Make no mistake, they are most certainly at risk of seizure if they have negative book value and are losing money.

 

So a sharp acquirer would probably wait to work a deal with the FDIC.  They are most certainly going to get a better price from the FDIC than the shareholders/management of FMAR.

 

Another thought is why to even fool around with such a bank?  There are banks that are SOLIDLY profitable, selling well below book value and paying dividends.  Check out SBFG.

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First off, awesome question!  Here are my thoughts:

 

Banks are regulated, as such a bank (not a holding company) with negative equity is going to end up being liquidated very quickly by the FDIC.  What's important in this investment is to break out the subsidiary bank and the holding company that owns the bank.

 

The bank itself has $45m in equity and lost $387k in the last quarter.  They charged off $1.5m in loans, which if that comes down the subsidiary will be break-even or profitable.  I do have some concern for the bank itself, their net interest income isn't all that high and it isn't covering expenses.  They have a lot of non-interest income that is related to mortgage origination, not that this is bad, just something to keep in mind.

 

The bank doesn't have that much of an equity cushion, if they do continue to generate losses it's possible the regulator could force a sale.

 

What's interesting is this is a case where the subsidiary bank has value, they could be acquired easily, but the holding company doesn't have much at all.

 

You asked how to figure out value, I'd start at the sub and build up.  Look at the take out value.  The first thing I spotted on the subsidiary is they have two branches that are probably losing money.  An acquirer would either boost deposits and turn the branches around or close them and cut those expenses.  I see two other levers of value, the first is their funding cost is high.  Their yield on earning assets is average, but they're on the high side of funding.  The second is their expenses in general, there is probably some fat that needs to be cut.  An acquirer would look at this bank and cut executives (automatic earnings increase) then they'd look at their deposit base.  Almost all of their deposits are interest bearing, and they're in small accounts.  You have 395 accounts with more than $250k in them, and 54,529 accounts with less than $250k, and if you look through that 53k of those accounts have less than $100k. 

 

Their high rates are attracting savers in expensive products.  They could probably drop their rates slightly and not lose that many customers.

 

Take all those pieces together and you can estimate what an acquirer might pay.  The number I've always heard is 11x cost adjusted earnings, or book value.  I would say in FMAR's case if they cut their deposit rate, cut executives and cut their unprofitable branches it's not crazy to think they could swing from a -$387k loss to a million a quarter in profit, couple that with reduced charge offs at 11x and maybe it's somewhere close to book value.

 

So in general let's assume this bank is worth book value.  But the investor isn't investing in the bank, they're investing in the holding company with its own set of liabilities and capital structure.  I didn't see any preferred securities in the company's capital structure, just the common equity.  The holdco has negative equity because the holdco has expenses at the holdco level compounding losses from the bank.  The holdco's actual liability structure is fairly clean.

 

Put these two things together and I can see this thing going for maybe 80% of TBV, so maybe $35-38m, or double the current price.

 

Does this make sense? Thoughts?

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HOWEVER, put your yourself in the shoes of any acquiring bank.  Why not simply wait & see if the FDIC seizes the bank.  Make no mistake, they are most certainly at risk of seizure if they have negative book value and are losing money.

 

So a sharp acquirer would probably wait to work a deal with the FDIC.  They are most certainly going to get a better price from the FDIC than the shareholders/management of FMAR.

 

Another thought is why to even fool around with such a bank?  There are banks that are SOLIDLY profitable, selling well below book value and paying dividends.  Check out SBFG.

 

I agree, but there's a VERY important distinction, the actual bank (the regulated piece the FDIC cares about) is alright, they're on thin ice, but I don't see eminent failure in their future, although if they don't turn around they'll be forced into a sale.

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I agree, but there's a VERY important distinction, the actual bank (the regulated piece the FDIC cares about) is alright, they're on thin ice, but I don't see eminent failure in their future, although if they don't turn around they'll be forced into a sale.

 

Yes, but another point I was trying to make is that a LOT of banks have made a LOT of money these past 2-3 years.  If a bank has even border line competent management, they've made money.

 

if a bank HAS NOT made money, they were either in a catastrophic situation OR had terrible management or both.

 

I suspect that future earnings for banks will be a little more difficult.  The easy money has largely been made.  If a bank was not able to make money in the past couple of years, I don't think they are going to make it in the future.

 

The FDIC may also tighten up on regulatory levels.  They have been especially lenient this past year or two.  That may change.  If it does, I would not want to be in a bank with thin capital levels.

 

When the cycle turns tougher (which I think it is), I definitely do not want to be in weaker banks.

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What are some valuation approaches we could use to value a bank with negative book value and negative earnings?  My feeling is that the best approach might be to determine an enterprise value based on customer deposits and back out value of preferred shares and debt.  What do others think?

 

One such bank is FMAR.  They have negative book as a result of the real estate collapse.  They had positive earnings but that has gone negative.  I assume that this is because refinancings accounted for most of those earnings and now those have gone away.  They are raising bank fees and I don't know how much closer that can get them to breakeven.

 

They have about $15M of preferreds coming due at end of year (much of it was bought back below par in the past).  This was amount due as of quite some time ago.  I haven't referred to recent filings.  But the bottom line was that the full par value of what is due immediately didn't look like a bank-busting event.  They ought to be able to clear that hurdle.

 

I guess something like this comes down to do you believe they can hold off on a regulatory action to seize them, then grow to positive earnings as economy heals.  On a normalized earnings basis this is a $6 to $10 stock, and it sells for 80 cents.  But there is a non zero risk here of them blowing up.

 

In any case, I am very interested in understanding what an acquirer might pay for them today, with negative earnings, based on some alternative valuation approach.

 

You should really go away from these kind of banks. Be aware of regulatory risks!

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What are some valuation approaches we could use to value a bank with negative book value and negative earnings?  My feeling is that the best approach might be to determine an enterprise value based on customer deposits and back out value of preferred shares and debt.  What do others think?

 

One such bank is FMAR.  They have negative book as a result of the real estate collapse.  They had positive earnings but that has gone negative.  I assume that this is because refinancings accounted for most of those earnings and now those have gone away.  They are raising bank fees and I don't know how much closer that can get them to breakeven.

 

They have about $15M of preferreds coming due at end of year (much of it was bought back below par in the past).  This was amount due as of quite some time ago.  I haven't referred to recent filings.  But the bottom line was that the full par value of what is due immediately didn't look like a bank-busting event.  They ought to be able to clear that hurdle.

 

I guess something like this comes down to do you believe they can hold off on a regulatory action to seize them, then grow to positive earnings as economy heals.  On a normalized earnings basis this is a $6 to $10 stock, and it sells for 80 cents.  But there is a non zero risk here of them blowing up.

 

In any case, I am very interested in understanding what an acquirer might pay for them today, with negative earnings, based on some alternative valuation approach.

 

You should really go away from these kind of banks. Be aware of regulatory risks!

 

I think it's very situation dependent, there are MANY great banks that are cheap, so if you're into shooting fish in a barrel those are the ones to buy.  But there are certain industry dynamics that can make a trade like FMAR attractive. 

 

I have heard of one fund manager who looks for average bank subsidiaries and terrible holding companies.  That dynamic alone is a catalyst because the FDIC will prevent upstreaming dividends, which can mean a potential bankruptcy scenario for the holdco, and that means motivated managers.  A sale usually follows.

 

I agree though, don't invest in banks (read the actual bank, not the holdco) that are losing a lot of money and have negative equity, their days are numbered.  The situation is different when the bank is in moderate or healthy shape, but the holdco is not.

 

It's VERY important to distinguish between the bank and the bank holding company.

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What are some valuation approaches we could use to value a bank with negative book value and negative earnings?  My feeling is that the best approach might be to determine an enterprise value based on customer deposits and back out value of preferred shares and debt.  What do others think?

 

One such bank is FMAR.  They have negative book as a result of the real estate collapse.  They had positive earnings but that has gone negative.  I assume that this is because refinancings accounted for most of those earnings and now those have gone away.  They are raising bank fees and I don't know how much closer that can get them to breakeven.

 

They have about $15M of preferreds coming due at end of year (much of it was bought back below par in the past).  This was amount due as of quite some time ago.  I haven't referred to recent filings.  But the bottom line was that the full par value of what is due immediately didn't look like a bank-busting event.  They ought to be able to clear that hurdle.

 

I guess something like this comes down to do you believe they can hold off on a regulatory action to seize them, then grow to positive earnings as economy heals.  On a normalized earnings basis this is a $6 to $10 stock, and it sells for 80 cents.  But there is a non zero risk here of them blowing up.

 

In any case, I am very interested in understanding what an acquirer might pay for them today, with negative earnings, based on some alternative valuation approach.

 

The key part to ask is the bank profitable and then is the holding company profitable. You can value the bank separately from the holding company. 

 

In FMAR's case, the bank is on rocky footing and I would run as fast as I could.  Tier one at 3.55%? Likely a Chapter 11 363 sale with no value for equity holders. At a conference in the past week and the FDIC representative indicated that he expects to see a higher level of 363 sales like Wilbur Ross's Talmer Bancorp's bid for Capitol Bancorp's four charters (http://on.wsj.com/1aIcp3c).  The answer was in response to holding companies who are unable to get dividends from their banks sufficient enough to cover their debts (TRUPS and otherwise).  I would agree.

 

However, there are instances where maybe there is some residual value if the underlying bank is performing in line with its competitors and has the ability to upstream dividends to pay down debt and create value for the holding company. However, it should be doing so not at the expense of future profitability and growth at the bank. Hard to establish and find. Better to bet on Talmer and other buyers in any case as more value is likely created from these situations on the buying side than the selling side in my opinion.

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First off, awesome question!  Here are my thoughts:

 

Banks are regulated, as such a bank (not a holding company) with negative equity is going to end up being liquidated very quickly by the FDIC.  What's important in this investment is to break out the subsidiary bank and the holding company that owns the bank.

 

The bank itself has $45m in equity and lost $387k in the last quarter.  They charged off $1.5m in loans, which if that comes down the subsidiary will be break-even or profitable.  I do have some concern for the bank itself, their net interest income isn't all that high and it isn't covering expenses.  They have a lot of non-interest income that is related to mortgage origination, not that this is bad, just something to keep in mind.

 

The bank doesn't have that much of an equity cushion, if they do continue to generate losses it's possible the regulator could force a sale.

 

What's interesting is this is a case where the subsidiary bank has value, they could be acquired easily, but the holding company doesn't have much at all.

 

You asked how to figure out value, I'd start at the sub and build up.  Look at the take out value.  The first thing I spotted on the subsidiary is they have two branches that are probably losing money.  An acquirer would either boost deposits and turn the branches around or close them and cut those expenses.  I see two other levers of value, the first is their funding cost is high.  Their yield on earning assets is average, but they're on the high side of funding.  The second is their expenses in general, there is probably some fat that needs to be cut.  An acquirer would look at this bank and cut executives (automatic earnings increase) then they'd look at their deposit base.  Almost all of their deposits are interest bearing, and they're in small accounts.  You have 395 accounts with more than $250k in them, and 54,529 accounts with less than $250k, and if you look through that 53k of those accounts have less than $100k. 

 

Their high rates are attracting savers in expensive products.  They could probably drop their rates slightly and not lose that many customers.

 

Take all those pieces together and you can estimate what an acquirer might pay.  The number I've always heard is 11x cost adjusted earnings, or book value.  I would say in FMAR's case if they cut their deposit rate, cut executives and cut their unprofitable branches it's not crazy to think they could swing from a -$387k loss to a million a quarter in profit, couple that with reduced charge offs at 11x and maybe it's somewhere close to book value.

 

So in general let's assume this bank is worth book value.  But the investor isn't investing in the bank, they're investing in the holding company with its own set of liabilities and capital structure.  I didn't see any preferred securities in the company's capital structure, just the common equity.  The holdco has negative equity because the holdco has expenses at the holdco level compounding losses from the bank.  The holdco's actual liability structure is fairly clean.

 

Put these two things together and I can see this thing going for maybe 80% of TBV, so maybe $35-38m, or double the current price.

 

Does this make sense? Thoughts?

 

Regarding what I called "preferreds", look at page 52 of the last 10Q.  Do not confuse the Trust Preferreds that the bank issued for its own capital needs with the Trust Preferreds that they have purchased as investments.

 

"In the past, to further our funding and capital needs, we raised capital by issuing Trust Preferred Securities through statutory trusts (the “Trusts”), which are wholly-owned by First Mariner Bancorp.  The Trusts used the proceeds from the sales of the Trust Preferred Securities, combined with First Mariner Bancorp’s equity investment in these Trusts, to purchase subordinated deferrable interest debentures from First Mariner Bancorp.  The debentures are the sole assets of the Trusts.  Aggregate debentures outstanding as of both June 30, 2013 and December 31, 2012 totaled $52.1 million."

 

"The Trust Preferred Securities are mandatorily redeemable, in whole or in part, upon repayment of their underlying subordinated debentures at their respective maturities or their earlier redemption date at our option.  All redemption dates have passed and we have not opted to redeem any of the junior subordinated interest debentures."

 

"In 2009, we elected to defer interest payments on the debentures.  This deferral is permitted by the terms of the debentures and does not constitute an event of default thereunder.  Interest on the debentures and dividends on the related Trust Preferred Securities continue to accrue and will have to be paid in full prior to the expiration of the deferral period.  The total deferral period may not exceed 20 consecutive quarters and expires with the last quarter of 2013. First Mariner is currently prohibited from paying such interest under the terms of the agreements with the Federal Reserve Bank of Richmond (“FRB”). (See discussion of the agreements below under “Capital Resources”)."

 

"First Mariner Bancorp has fully and unconditionally guaranteed all of the obligations of the Trusts."

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You should really go away from these kind of banks. Be aware of regulatory risks!

 

I didn't make clear in my original post that I am not invested in this currently.  I rode it from 60 cents to $2.90 and sold as soon as earnings went negative around $1.80. 

 

I like banks like this when they can earn their way out of the hole.  And I hate banks like this when earnings go negative.

 

The purpose of the current question was to just get a sense of how to value a bank with negative book and earnings.  Most bank purchases are geared to tangible common equity or tangible book, and I was simply interested in getting a sense of where value would be to an acquirer when those formulas are not available.

 

I wouldn't touch this until earnings go positive, and they may get seized before that happens.

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