Description

TL;DR: I believe HRGG is likely to be acquired for $19-21/share in 6-9 months, representing 54-70% upside from the CMP  

Introduction:

“If I was running $1 million today, or $10 million for that matter, I’d be fully invested. Anyone who says that size does not hurt investment performance is selling. The highest rates of return I’ve ever achieved were in the 1950s. I killed the Dow. You ought to see the numbers. But I was investing peanuts then. It’s a huge structural advantage not to have a lot of money. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that.”

- Warren Buffett.

HRGG, or Heritage NOLA Bancorp, is a ~$15mn market-cap, nano-cap subscale bank operating in the New Orleans region. The bank has a book value per share of $16.2,  and last year, was the subject of a takeover offer by MC Bancshares, a private NOLA based bank $20/share, back in June '23, coming out of the biggest banking crisis the US has seen in the last 10 years. 

Unfortunately for HRGG shareholders, this deal eventually broke, as the acquirer MC Bancshares was unable to get regulatory approval for the deal. The bank's PR around the deal break gives vague insight into what might have happened on 6/14/2024:

"While it is unfortunate that we could not finalize this deal, M C Bank remains a very strong and well-capitalized community bank," said Chris LeBato, President and Chief Executive Officer of M C Bank. "We will continue to focus on our human-centric approach to banking and on strengthening the communities we serve, while staying ready for new partnership opportunities."

David Crumhorn, the President and Chief Executive Officer of Heritage and HRGG indicated that, "after extensive review of the current uncertainties in the regulatory environment and merger approval process, the Board concluded that it was no longer in the stockholders' best interest to continue to pursue the proposed merger. Nevertheless, our organization remains strong and we continue to be laser focused on building value for our stockholders, customers and community. We are excited about the future of Heritage Bank of St. Tammany and Heritage NOLA Bancorp Inc."

Shares of HRGG crashed on the deal breaking, as arbs sold out of HRGG shares - given the scant liquidity in the stock, shares reverted to $11-12, close to the price that HRGG traded at before the takeover offer was made to shareholders. 

Roughly a month later, management of HRGG wrote the following letter to shareholders on 7/19/2024, indicating that the merger broke as MC Bancshares withdrew their application -- management clearly states that they are working in the best interest of shareholders, and would have preferred if the deal went through on its original terms:

For our company, 2023 was a year marked by extraordinary circumstances and events. The Federal Reserve’s aggressive increases in interest rates beginning in February 2022 created a profoundly challenging environment for our subsidiary, Heritage Bank of St. Tammany. Like so many other community banks, our primary source of earnings, our net interest income, deteriorated dramatically with interest expense increasing more rapidly than interest income, resulting in significant contraction in our margin. Moreover, our primary source of non-interest income, our secondary mortgage market operations, virtually disappeared as rising mortgage rates curtailed mortgage loan demand.

In July 2023 we announced a definitive agreement to merge and be acquired by MC Bancshares, Inc. in an all-cash transaction that would have netted our shareholders, under the agreement’s variable price structure, an estimated $19.50 - $20.50 per share. However, during the first quarter of 2024, MC Bancshares, Inc. withdrew its application with the FDIC, did not refile an application, and in mid-June 2024 the parties mutually agreed to terminate the transaction.

The decision to enter into the definitive agreement with MC Bancshares was made after considerable diligence and process as was laid out in our special meeting proxy statement. Your Board made that decision and all others with one overriding fiduciary principle in mind – to represent shareholders of the Company by overseeing management to do what is in their best interests. This principal will continue to guide management and the board’s decisions as we continue moving forward. Thank you for the confidence you have displayed in our team by your investment in our Company.

Banking experts speculate that the deal was blocked as MC Bancshares had limited to no experience in acquiring and integrating banks, creating doubt into the regulator's mind about their ability to close the deal and safeguard depositors interest - regulators prefer banks with a history of successful acquisitions - we saw this play out in the FDIC forced sales of distressed banks such as SVB, and Signature, which were sold to FCNCA/JPM, banks with a long-history of successfully completing FDIC brokered broken bank acquisitions. 

It is not hard to see why the management and board of HRGG were so keen on the MC Bankshares deal - insiders own 21.6% of shares, with the ESOP owning an additional 10.6% for total insider ownership of c. >32% of FD/SO so stand to benefit significantly from a higher stock price, even without considering the value of their CoC provisions. In the current rate environment, it is difficult for a subscale bank like HRGG to earn its cost of capital, creating a challenged standalone story.   The bank's merger related proxy gives more insight into the BoD's thought process:

Heritage NOLA Bancorp’s board of directors met on September 20, 2022, with representatives of Raymond James, representatives of Heritage NOLA Bancorp’s legal counsel and senior management attending. The board of directors discussed Heritage NOLA Bancorp’s strategic alternatives, including continued independence and potentially engaging in a strategic transaction, such as a merger or sale, and the perceived advantages and disadvantages of each alternative in light of the then prevailing market and economic conditions. The board of directors noted that the rising interest rate environment had significantly slowed mortgage banking activity, which was expected to reduce fee income and negatively impact earnings, and had increased funding costs, which had reduced, and was expected to continue to reduce, profitability and narrow profit margins. The potential that market interest rates would continue to rise given continuing inflationary pressures was also noted. The board of directors also discussed succession planning and the expected retirement of some of Heritage Bank’s senior management, and the financial and other resources that would need to be expended to attract and train qualified successors to Heritage Bank’s senior management. The board of directors also noted that evolving technology in the banking business would require Heritage NOLA Bancorp to invest significantly in infrastructure technology, which would place additional pressure on profitability and profit margins. After lengthy discussion, it was the consensus of the board of directors that Heritage NOLA Bancorp, given its size, prevailing economic conditions, and other factors, would likely face significant challenges to growth and profitability by operating independently under its existing business plan

Given that management understood that the value maximization path forward was a sale of the bank, they started a process for an outright sale, receiving 6 non-binding IOIs, one of which was MCBI, from the 19 institutions that expressed initial interest:

hen prevailing mergers and acquisitions market, including recent bank and thrift merger transaction pricing metrics. The board of directors also reviewed and discussed a list of banks and credit unions, developed by Raymond James in consultation with Heritage NOLA Bancorp’s senior management, which were considered both likely to have an interest in a potential business combination with Heritage NOLA Bancorp and the capacity to acquire Heritage NOLA Bancorp on terms which may be favorable to Heritage NOLA Bancorp stockholders. The board of directors also discussed with Raymond James and legal counsel the process for soliciting non-binding indications of interest from potential interested parties by distributing a confidential information memorandum (“CIM”). After further discussion, the board of directors determined to retain Raymond James to assist it in evaluating Heritage NOLA Bancorp’s strategic alternatives, and authorized Raymond James to work with Heritage NOLA Bancorp’s senior management and legal counsel to prepare a CIM for distribution to the potential interested parties identified by Raymond James in consultation with Heritage NOLA Bancorp, conditioned upon executing a confidentiality agreement with Heritage NOLA Bancorp. During October 2022, Heritage NOLA Bancorp’s senior management and Raymond James prepared a CIM. Thereafter, Heritage NOLA Bancorp populated a virtual data room containing financial and other information regarding Heritage NOLA Bancorp. Representatives of Raymond James contacted 21 potential interested parties, including both banks and credit unions (each on the list of potential interested parties identified by Raymond James in consultation with Heritage NOLA Bancorp) without revealing the identity of Heritage NOLA Bancorp, of which 19 parties signed confidentiality agreements and the identity of Heritage NOLA Bancorp was disclosed to them. The 19 institutions that signed confidentiality agreements, including MCBI, were provided a CIM and granted access to the virtual data room. Each confidentiality agreement included customary non-disclosure provisions and a standstill provision, however, the standstill provision would become null and void if Heritage NOLA Bancorp were to enter into a definitive acquisition agreement with the Heritage NOLA Bancorp counterparty or another party. As a result of this solicitation process, by the deadline of December 8, 2022, Heritage NOLA Bancorp received six non-binding indications of interest letters (each, an “IOI”), including from MCBI and five other bank holding companies (COMPANIES A-E).

Some of these acquirers put in offers that were too low, while others revised their offers following the SVB crash. Finally, there were three offers: Company D, Company E, and MCBI, with the other parties offering roughly $20/share, but in a mix of cash and stock, vs MC Bankshares' all cash deal 

COMPANY D’s revised IOI proposed a 65% stock/35% cash transaction, with the cash portion being $19.00 per share and the stock portion representing a fixed ratio against COMPANY D’s stock. The aggregate merger consideration would fluctuate based on the price of COMPANY D’s stock at closing, but based on the stock price at the time, the estimated aggregate merger consideration was valued at approximately $22.4 million, the lowest of the three revised IOIs. COMPANY E’s revised IOI proposed a 60% stock/40% cash transaction, with a cash portion of $19.40 per share and the 60% stock portion fixed against COMPANY E’s stock. The aggregate merger consideration would fluctuate based on the price of COMPANY E’s stock at closing, but based on the stock price at the time, the estimated aggregate merger consideration was valued at approximately $25.8 million, the highest nominal merger consideration of the three revised IOIs.

HRGG chose MC Bankshare's offer as it was a all-cash offer without the risk of stock consideration -- now that MC Bankshares has walked due to inability to get regulatory approval, it is likely that they will run a process again, and look to conssumate a deal with the other potential acquirers that were outbid by MC Bankshares. 

Given overall KRE valuations have recovered substantially since June'23, there is a chance that these companies can come up with an even higher offer, however even at the ~$20/share offered by these banks in the depth of the banking crisis, there is significant upside from the CMP, as it seems clear that insiders are looking to sell and cash out.   Given TBVPS of $16.2 a share, this is roughly 1.25x book,  in line with typical acquisition multiples for regional banks 

Catalyst

Announcement of an acquisition