First National of Nebraska – FINN

I have long held that a prime hunting ground for value is in very high-priced stocks, especially those that are unlisted or trade in foreign markets. For whatever reason, investor appetite for shares really falls off once the price eclipses $1,000, especially for illiquid stocks. I suspect the wide bid/ask that often accompanies these shares is also a contributor. Those willing and able to purchase these high-priced shares may walk away with a bargain.

A textbook example of this phenomenon is First National of Nebraska, a large and well-run bank that nonetheless trades at a deep discount to the valuations its peers command.

Since this blog focuses on micro-cap stocks, one might assume that I mean “large” in a relative sense, as in a balance sheet of one billion dollars or so. But First National is a truly large bank holding company, with a balance sheet of $19 billion. Fewer than 50 other public US banks are larger. But you’ll never hear about First National of Nebraska’s shares on CNBC, because they have an eye-popping price tag of $7,500. A typical day’s trading volume is in the single digits, so it’s not exactly easy to acquire a huge position.

First National is well-run in the sense that it consistently generates a return on assets in excess of 1.0%, and a return on equity of 10-11%. The company maintains a strong capital position with common equity to total assets of >10%, a much lower leverage ratio than the company employed before the crisis. Speaking of the crisis, First National never had one. Profits suffered in 2008 and 2009, but the bank never recorded an annual loss. The recession was only a temporary setback in the bank’s continued expansion.

First National has 101 branches in seven states. Please excuse the poor image quality of the graphic I borrowed from the company’s annual report I received last week.

Some banks focus on residential mortgages, others on commercial real estate, others on agricultural or development loans. First National of Nebraska has carved out a very profitable niche in credit card lending. Thousands of different businesses and non-profits offer their own branded credit cards to customers and members. First National is the entity actually making these revolving unsecured consumer loans. First National counts Best Western and Ducks Unlimited among its customers, and has a nearly $6 billion portfolio of credit card loans. Credit card loans are riskier than other types of lending, but the bank has large reserves against expected loan losses and has proven itself a responsible lender in the sector. Credit card loans make up 43% of First National’s loan book. Commercial loans, real estate and otherwise, make up 29%. Agricultural loans are 11%, residential real estate 10%, and “other” 7%.

First National has a long history of steady if not spectacular growth. Since 1997, the bank’s balance sheet expanded at an annual rate of 4.3%. Loans grew at the same pace, while deposits expanded at 4.7% annually. Profits grew at a 5.4% rate. Profit growth on a per share basis has been higher recently, growing at 8% since 2012.

Despite its healthy balance sheet, good profitability and attractive niche business, First National of Nebraska trades at a large discount to other banks of similar size and quality. I generated a list of publicly-traded banks with $10-30 billion balance sheets and a five year average return on equity of at least 8%. I may have missed a few peers, but this exercise is to prove a point, not create academic-quality data.

The entire peer group trades at an average price-to-book ratio of 1.8 and a P/E ratio of 19.8. First National’s closest competitors in terms of average historical ROE trade slightly higher, at a P/BV of 1.9 and a P/E of 20.5. Whichever set of banks we look at, First National of Nebraska is far cheaper at just 1.1x book value and a P/E of 10.4.

Perhaps some of this discount is justifiable. First National may carry more risk than other banks in its size range because of its exposure to credit card and agricultural loans. Credit card loans are uncollateralized and agricultural is highly cyclical. And yet, First National of Nebraska remained profitable in the crisis when many traditional residential real estate lenders failed. Or, perhaps the market is concerned that First National may lose some of its credit card relationships. They did lose a large relationship in 2016. Maybe the market doesn’t believe that First National will benefit from rising rates the way its peers will.

However, I believe that nearly all of the valuation discount is due to First National of Nebraska’s lofty share price and minimal trading volume. This presents opportunity for long-term investors who care little about the day to day fluctuations and much about the long-term performance of the underlying business. Naively assuming the bank can earn its long-term return on equity of 11.0%, First National could earn almost $790 per share in 2017, for a forward P/E of 9.6. Of course, who knows what this year holds. A recession could arrive, or expected higher interests rates could fail to materialize. But I am sure that long-term holders of First National of Nebraska will be richly rewarded.

Alluvial Capital Management, LLC holds shares of First National of Nebraska, Inc. Alluvial may buy or sell shares of First National of Nebraska, Inc. at any time. 

Alluvial Capital Management, LLC may buy or sell securities mentioned on this blog for client accounts or for the accounts of principals. For a full accounting of Alluvial’s and Alluvial personnel’s holdings in any securities mentioned, contact Alluvial Capital Management, LLC at info@alluvialcapital.com.

 

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9 Responses to First National of Nebraska – FINN

  1. Robert Ray says:

    You might look at Farmers and Merchants Bank in Long Beach CA too, one of America’s strongest banks, also trading at over $ 7,000 a share..

  2. pavel Kadera says:

    Thanks for the article.

    I wonder why wouldn’t they do a stock split?

    • otcadventures says:

      I just don’t think they’re interested in a higher stock price. They pay reasonable dividends and they buy back stock. It would not benefit long-term shareholders to have a higher share price right now, especially because they do not use their stock as currency.

  3. KJP says:

    What is your long-term expected rate of return on any investment in FINN?

    Assuming I’ve done the math right, if a company earns 11% ROE, reinvests sufficient capital to grow earnings at 4.5% per year, and uses the surplus capital to buy back stock at a 10 p/e, then, over time, you’d expect the stock price to increase 11% per year. (I realize that FINN’s capital allocation doesn’t match my hypothetical, but I was trying to build as simple a model as possible.)

    The returns would, of course, be higher if the business was sold at a higher multiple than the 10 p/e presumed above.

    • otcadventures says:

      Using the Gordon Growth Model and assuming a 25% payout ratio, $187.5/share dividend in 2017, and 11% ROE, I get an expected return of 10.75%. In reality, I think there are multiple levers that could push expected return higher. I think conditions will improve for banking in general, which could drive industry ROEs higher. In the 90s, FINN was earning ROEs in the 20-25% range. Not saying that will happen again any time soon, but an improvement to even 13-14% ROEs would make a big difference. Absent general improvement in banking economics, FINN could still drive up its ROE by employing a slightly more aggressive balance sheet. I don’t think we’ll see a return to 15-20x leverage, but the current assets-to-equity ratio is unusually low, which is constricting ROE. The bank is right to be more conservative following a long period of benign credit losses, but they are carrying substantial excess capital.

  4. Len Rosenthal says:

    As with many banks trading on OTC Markets, the founding family has a controlling stake in the company. so its is their show. You have to be a patient, long-term investor if you want to be in this stock.

    • otcadventures says:

      This is quite true. Nobody should invest in this company expecting a quick return. Long-term appreciation will come from increasing book value and dividends.

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