I have never had great luck finding obvious value in California banks. Nearly without exception, these banks trade at large multiples of earnings and tangible book value. This makes sense. After all, much of the state enjoys a strong economy and good demographic trends. It’s a favorable environment for a bank to call home compared to say, southern Indiana or post-industrial regions of Pennsylvania or Ohio. Still, I do manage to find an interesting Golden State bank now and then. Here are brief looks at two banks, both very successful and trading at undemanding values.
River City Bank (Ticker:RCBC) is the Sacramento area’s largest business-focused bank. The company was founded in 1972 by Jon S. Kelly, a Sacramento broadcasting, telecom, and real estate titan. Mr. Kelly remains the largest shareholder. The bank operates 12 branches in 5 counties and focuses on commercial real estate loans, which make up over 80% of its $1.7 billion loan portfolio. The bank maintains strong capital ratios and has low levels of non-performing assets, leading to a “Superior” rating from Bauer Financial. Like many other business-focused banks, River City Bank enjoys a high proportion of non-interesting-bearing deposits. The bank’s balance sheet exceeds $2 billion with nearly one-quarter of that total invested in government debt securities.
River City’s most impressive accomplishment may be its efficiency. In 2018 and 2017, non-interest expenses were under 40% of net interest income. Without the need for a large branch network in order to service retail accounts, River City can economize on staffing and premises expenses. This has allowed the bank to earn >1% on its assets despite a rather pedestrian net interest margin.
With shares trading in the high $180s, River City Bank has a trailing P/E ratio of just over 10. Tangible book value per share sits at $148 for a price/tangible book ratio of 1.28. Shares trade cheaply because of their extremely low liquidity and the perceived risks of commercial lending compared to traditional lending. River City has a long history of successfully managing these risks, and I expect the bank’s strong balance sheet and high lending standards will help them manage whatever the next down cycle brings.
Headquartered one hundred miles or so west in Santa Rosa is Exchange Bank (Ticker:EXSR). Exchange takes a very different tack, operating as a traditional community bank and lending mainly against single-family houses. Founded in 1890, the bank has had only 8 presidents in its history. Exchange Bank maintains a conservative balance sheet, with tangible equity of $241 million on a $2.5 billion balance sheet. Like River City, Exchange Bank invests heavily in government securities and has a high proportion of non-interest-bearing deposits. Exchange saw its deposits swell last year as customers received insurance settlements from the area’s terrible fires. Deposit levels are now normalizing as homeowners rebuild.
Exchange Bank’s efficiency ratio hovers around 70%. That’s good, even if nowhere near as low as River City’s. However, Exchange also earns a much larger net interest spread, allowing it to generate a healthy return on assets and equity. Exchange Bank also benefits from its profitable trust and investment management group. In October 2018, Exchange purchased First Northern Bank’s trust department.
With shares trading in the mid-$160s, Exchange Bank trades at a trailing P/E ratio of just 7.7. Tangible book value per share sits at $141 for a price/tangible book value ratio of 1.16.
Shares of Exchange are illiquid for a unique reason. Rather than passing shares down to his heirs at his death, Exchange Bank co-founder Frank Doyle established a trust that would own 50.44% of the bank’s shares for the benefit of the community. Today, dividends received by the trust are distributed to the Frank P. Doyle and Polly O’Meara Doyle Scholarship Fund for students attending Santa Rosa Junior College. That works out to $3.8 million annually. What a legacy!
The fact that over half of Exchange Bank’s shares are effectively owned by the community makes a buyout or merger much less likely, which probably contributes to their cheap valuation. That doesn’t mean shares cannot perform well for shareholders. After all, the Hershey Company has a similar ownership structure and shareholders have been quite well-treated over the years.
Both River City and Exchange Bank appear under-valued. River City is the more aggressive of the two and will likely grow its balance sheet and earnings more quickly, but is more sensitive to economic conditions. An environment of falling interest rates and a flat or inverted yield curve will present challenges for both banks.
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Regarding Exchange bank, the statutes of the Doyle foundation don’t just make a takeover of Exchange bank unlikely, they make it virtually impossible. I believe the bank deserves to trade a discount for that reason, The bank is also more interested in dividend than share buybacks for that reason. It’s a well run and well respected Bank (I lived in Santa Rosa for many years). They got into trouble during the Great Recession because they expanded to the Sacramento area with loans to real estate developers, which later defaulted or got into trouble. In their home county, they always did very well.
One other reason for the relatively low valuation might be their long-term track record. Actually, I find the ‘well-run’ descriptor quite generous. This is all from a short look at the numbers, so I am not an expert.
If I take 2006 as a starting point, the bank has compounded tangible NAV per share at ~3.5%. They’ve paid out some modest dividends in the interim, but net creation of value is way below 4% per annum. That is a pretty poor performance – I guess that’s below nominal GDP growth for California in that same timeframe. The analysis looks only marginally better on different timeframes.
Average RoE through the cycle is not that good, which explains most of the poor performance, but it also looks like they raised some money at a very low valuation in 2010, diluting shareholders at the worst possible time. I wonder if the historic significant discount to book might be perfectly justified.
I’m fine w/ buying EXSR outright on a valuation thesis (good ROE, cheap price), but I don’t think the discount to peers ever gets closed due to the ownership structure. EXSR also boasts one of the more enviable deposit franchises in the country.
I’m partial to FNRN as a comparable (great deposit franchise, nice ROE, cheap price) without the ownership overhang that plagues EXSR (although FNRN’s management is fairly open with fact that they don’t ever want to sell).