Bank of Utica is an 86-year old institution doing business in upstate New York. The bank operates only a single branch in downtown Utica, yet its balance sheet holds $912 million in assets and $727 million in deposits against $155 million in equity capital. Bank of Utica is controlled by the Sinnott family through a controlling stake in the bank’s voting shares.
Bank of Utica follows an unusual strategy. Most banks take deposits and originate loans, making their income on the interest rate spread, less loan losses. This process requires a host of loan officers and staff and all the associated salaries, office space, software and compliance costs. It also requires ongoing monitoring and management, plus additional expenses when a portion of the loan book inevitably sours.
Bank of Utica doesn’t bother. The bank takes deposits, then turns around and buys liquid debt securities like treasuries, municipal bonds, mortgage-backed securities, foreign bonds and others. Nearly 70% of these securities have maturities of three years or less, which greatly reduces interest rate risk. The yields on these assets may not be as robust as the yields on loans the bank could originate, but their credit risk is extremely low.
Bank of Utica does originate and run a small book of commercial, personal and real estate loans, but the loan origination business is clearly not the bank’s focus. For example, the bank’s only first position mortgage product is a 15 year fully-conforming loan at 4.95%, fully 1.50% above the national average. Bank of Utica will originate loans, but only opportunistically and on its own terms.
At quarter’s end, Bank of Utica’s net loan book was $47 million. Its securities holdings were $848 million. Interest on these securities accounted for 92% of Bank of Utica’s interest income for the first half of 2013.
Bank of Utica’s credit risk is extremely low due to its conservative investment policies. On top of this, the bank is highly over-capitalized. Bank of Utica’s common equity ratio is 17.04%. This figure includes nearly $20 million in unrealized gains, some of which are likely to disappear if interest rates rise. Excluding unrealized gains entirely, the bank’s common equity ratio is still a strong 15.20%.
Despite its conservative investing and over-capitalized balance sheet, Bank of Utica still manages good returns on assets and equity. For the last four quarters, the bank averaged a 10.00% annualized return on equity, and an average annualized return on assets of 1.60%. A big reason for these solid returns despite minimal leverage is Bank of Utica’s efficiency. With minimal staff and need for infrastructure, the bank’s operating expenses are very, very low. Operating expenses ate up only 25% of the bank’s net interest income over the past year, an almost absurdly low figure. Many banks struggle to keep this figure below 70%.
Bank of Utica’s geographic home is not the nation’s fastest-growing region, but the bank has still managed to grow its deposit base at a modest rate. Over the last five years, deposits grew at an annual rate of 3.9%. Deposits are the “fuel” that allow a bank to invest in additional earning assets and increase the bottom line.
Bank of Utica’s credit quality, capital position and efficiency are all high, but its valuation is not. The bank has two share classes outstanding. BKUT is the voting share class and is majority-owned by the Sinnott family. BKUTK is non-voting. There are 50,000 voting shares and 200,000 non-voting for a total of 250,000. The voting shares trade at a slight premium to the non-voting. I can’t imagine why an investor would pay up for the voting shares with no possibility of exerting influence, so I’ll concentrate on the non-voting shares, which last had a bid price of $420.00.
Bank of Utica has common equity of $621.76 per share, giving the non-voting shares a price to book ratio of just 67.6%. Trailing earnings per share are $63.24 for a trailing P/E of 6.64. These ratios are far too low for a bank of this quality and profitability.
Bank of Utica does not release financial statements on its website. If anyone is wondering where I found them, try here. When it comes to investing in banks, FDIC call reports are your best friend!
1/3 of the bank’s assets are in the domestic “other” category. Any idea what these are?
While there’s no way of knowing for sure, I have heard the bank invests heavily in short-term debt securities of other US banks. Again, that is only what I have read in other articles written about the bank and I have no way of confirming it.
First off, thank you for an amazing blog! I have a question that may seem stupid, but as I’m still learning how to read the financial statements of banks, I would apprechiate clarity on one point. At the FDIC site that is linked in the blog post, when I choose “income & expenses” in the rolldown meny and generate a report, item 20 seems to suggest that the net income for BKUT is $6,5m, which comes out to just under half of the $63 per share figure in your post. At first I figured that these were figures for a six month period, but the column is labeled “year-to-date”. I would be very thankful if someone could point out what I am missing here and where the actual earnings are stated?
Best Regards from Sweden!
Hello, and thanks for the kind words!
You are interpreting the report correctly. The $6.5 million is a year to date figure, for the period from January 1 to June 30, 2013. Six months. That’s why it appears to be roughly half of the trailing net income figure. That is how the FDIC call reports work. They always report income figures cumulatively. Does that answer your question?
Yes! I managed to read year-to-date as “12 months leading up to” if that makes sence. When I added in the last six months from the previous year I came up with the right numbers. Thank you for helping me out!
Sounds interesting. Why no position?
I’ve been trying to learn about investing in banks, but it is so different from investing in industrial companies, and so much scarier, that I have trouble pulling the trigger. My strategy has been to read reports and google everything I don’t understand. How did you get comfortable with them? Did you read some books on the subject?
With industrials there are things that I use to weed stuff out, like too much debt, revenues declining with no reason to expect a recovery, cash flow problems, etc. What are some of the main things you look at that make you pass on a bank?
I like the fact that Bank of Utica doesn’t make loans; I would think it would be harder to get in trouble that way. What do you think is going to happen to them if inflation picks up or interest rates start going up? I am guessing they are smart enough that they have hedged this or gone to shorter maturities.
No position because I have no room in my portfolio. I think Bank of Utica is great, just not as great as some other holdings of mine.
Banks are strange. You’re essentially buying into a leveraged carry trade that you hope will generate a positive spread. It will, as long as management lends prudently and interest rates don’t become inverted for a long period and as long as depositors remain confident in the institution’s soundness.
With banks, I tend to avoid those that are excessively leveraged (with less than perhaps 8% common equity, though there are some solid banks with less than that) and a history of attractive returns on equity and assets. A bank that manages long-term ROE north of 10% without excessive leverage likely has strong management and cost controls or it operates in an attractive geographic or demographic market.
I also look at liability structures. I dislike banks that rely on brokered deposits, which are expensive and a poor source of long-term capital. I also look askance on banks with a lot of term debt.
Basically, my ideal bank operates in a area of only modest economic growth (which discourages management from making crazy loans or empire-building) has a stable and low-cost deposit base, uses only prudent leverage and is shareholder-focused, striving to hit a healthy ROE target and returning excess capital. A lot of small community banks are clearly content with earning only 5-6% on equity every year, and I avoid those.
As for Bank of Utica’s securities portfolio, the assets they buy are primarily short-term. Last I heard, the portfolio duration is under 3. Rising rates would have a moderately negative effect in the short run, but could be positive in the long-run, allowing the bank to earn more on its investments.
One more thing. When it comes to banks, the simpler the better. I want those whose business model is simple: gather deposits, invest deposits in loans and securities, earn a spread, do it again the next day. I get very uneasy once I see complicated derivatives and off-balance sheet financing come into the picture.
Are you concerned with the amount of foreign debt securities?
As long as they don’t have any major problems with securities it is hard to see how they could go belly up.
How do you find the amount of insider ownership?
Deposits have been shrinking ever-so-slightly the past 12-18 months.
Also, maybe they are playing it TOO safe: hence the undervalued stock.
Perhaps. I think the most significant reason for the undervaluation is the very low trading volume and the fact that the bank does not release its results publicly.
I agree with that: low price = no public results, low trading volume. The issue then becomes, when will those conditions ever change? Probably never or at least not for a long, long time. Nevertheless, I’m considering this stock.
In his last letter to shareholders, The president of the bank said that at a “normal” interest rates environment he expact the bank to earn only 7 m a year. If he is correct, the stock isn’t that cheap.
What do you think about it?
Asa, or anyone, where did you find the Letter to Shareholders?
“Nobody should presume that our spectacular net operating income over the last three years, or our profits on specialized investment activities, are a new norm for us. They are not. Most of the investment profits were one-shot …
The operating profits are a product of the current historically low interest rates. …
This environment allowed us to drop the rates we paid on our deposits in 2012 further to levels close to what our competitors pay. In a normal world, because of our lack of convenience of branches (this is why our overhead is so low), we traditionally have to pay more, sometimes substantially more, than our competitors to attract and maintain deposits. Not so right now. …
Many local depositors appear to be so beaten down by worrying about, and disillusioned with, the financial world and what the future will bring, what will the next financial maelstrom be, that they are looking for the safest port in the storm – rates be damned. That’s where we come in. We
have always had a (local) legendary reputation for strength and stability due to our high capital and multi-generational family control, currently being reinforced with much advertising. Believing they can trust us more than other banks, at this time depositors seem to be willing to keep their money with us even though we are not paying any material premium over our competitors. However, it is likely that if (when) a more normal financial world develops, this will end, significantly dropping our net interest income. If we had to pay, say one percent more on our $750 million in deposits, it would decrease our operating income $7.5 million, or $4.5 million after taxes.
The above discusses our cost of funds relative to our competitors. An even more important factor as to why our operating profits won’t continue at our record levels of recent years is what we can earn on our investments. The yield on our investment portfolio has been decreasing as we have inexorably been replacing higher yielding bonds as they mature with lower yielding ones. … If rates hold this low, our yields will continue to drop and we can no longer offset any of that with decreased expenses for deposits … When rates ultimately go up, we may have to pay more for our deposits fairly quickly, but, even though we have been investing quite short for a hold-to-maturity bond portfolio, it would still take us three and a half years to replace 78% of our bond portfolio. …
When rates eventually and inevitably rise, we pray they do so slowly.
The point of the above is no one should be mesmerized by our recent high earnings. I don’t know what they might level out at when that more normal financial world reappears, but if I were to hazard a guess, this is in no way a cast in stone prediction, I might feel that for us a Return-on-Assets of around 0.75% or around $7 million, half of what we earned in 2012, might be a reasonable goal and a most satisfactory return”.
Still think the stock is very cheap?
Do you have a link to the letter to shareholders? I did a Google Search of some of the phrases in the letter, but wasn’t able to find them referenced anywhere.
I got the letter from the bank. You can’t find it on the internet.
Dave, thanks for all the great posts. Is this the bank you alluded to in your December 2012 post regarding future companies to be discussed?
From the FDIC website, in 1995 the Bank had total assets of 342 mil and deposits of 310 mil, for remaining equity of 32 mil to compare with Dave’s numbers above. Assuming Net Operating Income = Earnings, and assuming that the shares have remained stable at 250,000 shares since 1995, here are some numbers for review.
Year Net Income Cumulative
Operating per Share Income
Income (Assume 250k)
1995 3703000 14.81 14.81
1996 4012000 16.05 30.86
1997 4281000 17.12 47.98
1998 4537000 18.15 66.13
1999 5310000 21.24 87.37
2000 5571000 22.28 109.66
2001 6135000 24.54 134.20
2002 11425000 45.70 179.90
2003 11118000 44.47 224.37
2004 12276000 49.10 273.47
2005 7636000 30.54 304.02
2006 4246000 16.98 321.00
2007 5385000 21.54 342.54
2008 9830000 39.32 381.86
2009 12900000 51.60 433.46
2010 12148000 48.59 482.05
2011 12859000 51.44 533.49
2012 12801000 51.20 584.69
6 months 5286000 21.14 605.84
Yes, it’s the same bank. Just took me a long while to getting around to writing about it. Thanks for providing that data. The bank does pay dividends, which accounts for the discrepancy in book value. For 2012, $10.70 per share for the twelve trailing months.
My columns did not stay as I intended.
First column is year
Second column is Net Operating Income for 12 months
Third column is Net Operating Income per share (assuming 250,000 shares outstanding)
Fourth column is cumulative income per share starting in 1995
As book value is currently $621, I have to assume either that there used to be more than 250,000 shares and/or some of this money has been returned as dividends.
Does anyone know shares counts going back in time?
One further point. I see that my figures for Net Operating Income do not take into account annual gains or losses on securities, which affect the actual earnings per share. For that I would need to go to the Call Reports, which I just learned about today. That said, the above figures at least give some insight into the variance and range of the Bank’s earnings from interest income alone.
It looks like the 9/30/13 quarter data is partially up at FDIC.
Maybe someone smarter than me can make sense of it.
Not claiming to be smarter than you, but I’ll take a stab at the figures.
Total interest income is down 10% for the first nine months of 2013 compared to 2012. Not really a surprise as older securities mature and are reinvested at lower yields. On the flip side, interest expense is down 16.6% for the same period as short-term rates remain effectively zero. Net interest income is down 7.8% YTD.
BoU’s balance sheet remains rock solid. The allowance for loan losses is $1.06 million, or 0.1% of assets. Equity-to-total-capital is 17.11%.
EPS for the quarter: $10.02. EPS for the twelve trailing months: $59.94.
Book Value Per Share: $635.44, up from $621.76 last quarter.
Bank of Utica’s earnings without gains on securities would have been lower. Assuming a tax rate of 35%, gains on securities accounted for earnings of $7.93 per share in the twelve trailing months.
BKUTK trades at $417 as I write. Excluding the earnings due to gains on securities, the shares go for 8.0x earnings and 67.1% of book value. Pretty good price for a well-run bank with practically no credit risk.
Has the company ever provided color on the mix of foreign bonds in its portfolio? FYI, I’m long BKUTK.
@Bob: As far as i know FDIC insured Deposits can only be invested in Investment Grade Bonds. This coupled with the short term duration makes the balance sheet very safe. I think the foreign bonds are from major international bluechips in dollar face value( it would be a too high risk if the face value would be in Euro oder Yen etc.).
What i think is more interesting and a maybe catalyst:
What is in the equity portfolio? Of the 180 million dollar in equity-77 million are in equity securities.
So if u buy the stock u get a big stock portfolio for free. The problem is “we don t know what is in it”?
Catalyst could be a 13-F.I think if a portfolio becomes bigger than 100million Dollar institutions have to make their holdings public.
I cannot stop myself from appreciating this great work. Its very inspiring and motivation. Thank you.
Great and nice work. Keep it up team. Thank you.