American Business Bank

Note that American Business Bank (AMBZ) trades OTC and has no SEC filings, but they release quarterly and annual reports on their website. No reason for concern since data can be easily verified with the Call Reports that AMBZ has to file each quarter with the FDIC. Given the size and trading volume, the idea is targeted to the “nimble” investor.

Thesis:

American Business Bank is an “undiscovered” Los Angeles bank that focuses on only one niche: banking middle market companies whose sales are $5M to $150M annually. The narrow focus has served AMBZ really well – since its establishment in Oct 1998, assets have grown from a little over $100 million to over a $1.1 billion today, and annual net income has grown from less than a $1 million to over $10 million. It has consistently achieved a ROAE of 12% to 14% with virtually no non-accruals, OREO, or net charge-offs in arguably one of the worst periods for the banking industry since the great depression.

Current share price of $21.60 represents a great entry point in my opinion, given that it trades at ~9x TTM P/E and only a small premium (the smallest in its trading history) to its book value of $18.80. Today’s share price offers the long-term investor (2011-2016) the opportunity to make an upside of 40% to 200% with very limited downside.

One may ask why I am pitching some OTC bank at tangible book value when one can own a mega bank at an unbelievable discount of a lifetime and an opportunity to make a multi bagger return. My response – I would rather own a good business that I understand well at a “fair” price than a “less than good” business (as demonstrated by the mega banks in the last decade) that I don’t even understand (500 pages of 10K and a trillion dollar balance) at a “cheap” price. If mega banks are your core competence, I am not arguing against the value of owning them. Read on if what I have said so far interests you.

History:

American Business Bank was established by five senior bankers of 1^st Business Bank, a middle business bank in Los Angeles. The five founding members left 1^st Business Bank when it was being acquired a big diverse Pittsburgh financial institution, Mellon Bank (now Bank of New York Mellon). The doors to American Business Bank opened in Oct 1998, with the original capital of $14.2 million, which at that time was the second largest management formed bank in California.

Who is American Business Bank’s Customer?

American Business Bank’s typical customer is a company with sales on the low end of $5 to $10 million annually, and the high end of $150 to $200 million annually. They are private companies of all types such as manufacturing, distribution and profession. Most of their customers are cash rich seasoned companies that have been around for twenty to thirty years, have been through up and down business cycles, and have made money in good and bad times.

Most of their customers are established companies that have modest borrowing needs, but every now and then they seek credit-line extensions above $500,000 or commercial real estate loans in the $1 to $2 million range to buy their own buildings. On rare occasions when the loan requests exceed American Business Bank’s lending limits, the bank will participate with larger banks as the lead bank to make the loan.

What is American Business Bank’s Capital Structure like?

The bank’s ratio of net loans and leases to deposits is 39.40%, whereas the average ratio for its “peers” as per FDIC is 75.15%. The rest of the interest earning assets are in short to medium duration AAA securities. So, even though American Business Bank’s leverage looks high at 14.5 times, the Net Loans to Avg. Equity ratio is low at 5.5 times.

Its funding cost is among the lowest in the country at 35 bps leading to good interest rate spreads. 90% of the deposits are in demand, money market and NOW deposits. It has never done brokered deposits. Middle-market companies tend to keep a lot of money in their accounts. In fact, the average balance account is $1 million and some accounts have more than $20 million in deposits.

As of Q2 2011 (the Q3 call report is not out yet), 55% of loans are Commercial Real Estate, 35% of loans are Commercial & Industrial, 4.5% are Home Equity, and 6.5% are Others. 

Does American Business Bank have a Competitive Advantage?

American Business Bank operates its deposit office from the 9^th floor of a downtown Los Angeles Building. This isn’t your typical first floor banking operation where customers walk through the door, but where banking is taken to the customer and the needs of the customer are handled in an exceptional way. 

Many of the 30,000 potential American Business Bank’s customers value relationships with their banker more than transactions. A growing number of these business owners view the bankers at the mega banks as product-of-the-month sales people who are compensated to move from customer to customer, peddling the latest service that banking deregulation has provided. These customers still want the old-fashioned hand-holding that mega banks are increasingly unwilling to provide and small community banks are unable to provide.

It is very difficult for most large banks to generate enough revenue from small or middle-market business accounts to cover their significant fixed costs. For example, if a business goes to Citigroup and says they have $500,000 in their checking account and two million dollar limit of credit, somebody will fall asleep. The large banks have created automated systems to handle these business accounts, similar to how they handle individual retail accounts. These systems include toll-free phone numbers, where the business owner waits in line to be helped by an anonymous live voice, and the increasingly popular Web site for customer service inquiries. While highly efficient for banks, these innovations have rarely been the benefit of the middle-market business owner.

Contrast this automated approach with the way American Business Bank does things. Firstly, convincing the new customer of American Business Bank’s advisory capacity is not easy. The bank’s account officers spend six months to three years to get to know the customer’s business before they move their relationship to the bank. In the beginning, it’s not unusual for the customer to say: “You know, I really don’t want to name names, but XYZ bank said that four years ago, and this bank said that ten years ago – A bank is a bank.” But, over a period of time, as they get to know American Business Bank, they get to understand that all of the banks relationship managers are well-educated, big-bank trained, and have been in the middle market for ten years or more. The owners finally realize the bank’s depth of experience over time and begin to see the bank as “consultants with capital” and not vendors trying to sell the lowest price loans or the highest priced CDs.

As part of their banking relationship, dedicated account officers meet with clients on a regular basis to review their business cash flow, provide counsel on routine financial management issues, assist with making lease versus buy decisions, and help the business owners put in place a debt structure that would best meet the business’s needs. This model is not easy to run, bigger banks don’t have the staying power to run, and smaller banks don’t have the right experience.

It is not unusual that a client calls American Business Bank and gets put through to the bank’s president or vice president who then personally takes the extra steps to meet that client’s particular need. Despite the fancy titles, the senior managers at the bank are account manager at heart, and the bank is not a staff-run organization. The CEO Don Johnson handles about 24 accounts (each account is $1.3 million on average).

American Business Bank’s competitive advantage is its single-minded focus on its niche. It has no plans to go into other venues – wealth management, brokerage, trust services, insurance, or anything else that is not middle-market lending – since it would take management’s time away from running its core competence, require the bank to form a holding company, cost increased regulation expenses, and cost capital to be tied up to these various areas. Instead it has contracts with other specialists such as investment managers or investment bankers, and the two refer business back and forth.  

Can you give a specific example of a client moving over to American Business Bank?

Gary Kaplan at Resource Sales and Marketing LLC in Calabasas California switched his business from Bank of America to American Business Bank in 1999. His business sells frozen poultry to restaurant distributors. For most of the year it can operate with a limited line of credit, but once a year it needs to extend it by about $500,000 so it can lock in favorable prices on chickens. “At Bank of America, if you wanted to extend yourself beyond your line of credit, there was a lot of red tape you had to cut through, and I was just not comfortable doing business like that,” Mr. Kaplan said. At American Business Bank, “all it took is one phone call, and I got the verbal approval right away.”

What is American Business Bank’s Competitive Landscape like today?

Two-thirds of the banks in California are losing money. American Business Bank has benefitted from two things – Number one, with banks having tremendous problems and trying to salvage their own company, the eye has been taken off the ball as far as taking care of customers. Number two – top execs that handle accounts have been coming to American Business Bank because they have been afraid of their bank’s problems. The bank would probably not have gotten that talent in good times. The “new” hires bring with them their accounts.

1^st Business Bank was really their main competition but is now gone. The bank earned an “avalanche” of new accounts as this competitor, a strong, hand-holding, middle-market bank, got merged into a huge, one-size-fits-all-model. There is another group of individuals from 1^st Business Bank who started a bank, but they are years behind American Business Bank and are working on acquiring their old customers. The big banks who have bought Countrywide et al are trying to absorb these forced acquisitions, and are not interested in American Business Bank’s market as well.

Having said this, no one is immune from the laws of economics. The California government is in disarray with $20 to $30 billion in deficits, and the city, state, and counties starting to address that with layoffs or cutbacks.

American Business Bank’s business model is a good buffer against major problems, not only because their customers are cash rich, but because they are seasoned managers who have seen bad times before and quickly made cuts or adjustments to their own compensation to live to fight another day.

What is American Business Bank’s Growth Strategy and Outlook going forward?

American Business Bank strategy is old-fashioned growth, not a result of mergers or acquisitions. Account managers have a minimum of eight years of lending experience to middle-market businesses. Typically, these account managers have a book of business they bring in that gets converted over to American Business Bank and then the growth of the bank is the result of the account managers growing their book.

As of Q2 2011 (latest Call Report), the bank has 88 full-time employees (FTE), and $12.5M of assets per employee. This number has been rising – 3 years ago, it stood at $9.5M per FTE. City National Bank, another business bank based in Los Angeles (Disclose: I own CYN) has $7.1M in assets per FTE. The average bank in American Business Bank’s peer group has more like $4 million in assets per FTE. Even though its loans to deposit ratio is low, its earnings growth is really a result of this ratio.

Furthermore, its efficiency ratio has been coming down too from 66% in 2007 to 58% TTM. This is mostly a function of operational leverage and I expect it keep going down as it realizes further economies of scale on its fixed costs.

For a billion dollar bank, they have close to a thousand accounts while a regular bank this size would need tens of thousands of accounts. So, the business model is quite manageable as it grows to $2 billion. In the longer run, the model could be replicated in other cities like San Diego, Phoenix, Las Vegas or Dallas (names that have been mentioned on interviews). Each of these sizable cities has many middle market companies that are faced with the same banking problem. You either have the small community banks that are concentrated on SBA lending, title escrow, or you have the big banks, which have problems delivering the personal service that American Business Bank can provide. All one needs in any city are one or two people in a temporary office with minor rent calling in that territory. Once they have $30 million in deposits, an office can be built with no cost to the main office.

Why is it cheap?

American Business Bank has less than 500 shareholders. It only hit the $1 billion asset level recently, so it hasn’t hit the screens yet, and probably invisible to the institutional investors. The fact that it trades above tangible book value is another reason why many who are only looking at quantitative data may pass on AMBZ because there are abundant banks today that trade significantly below tangible book that represent “better” value.

Valuation:

Based on Book Value Approach:

Based on Earnings Approach:

Disclosure: Long AMBZ, CYN