Description

Intervest recently completed a highly dilutive recapitalization of their two billion dollar asset bank at a price to tangible book value below 30%.  IBCA has significantly cleaned up its balance sheet, after selling $200 million of loans in Q3, and is modestly valued given the improving credit situation reflected in its most recent filing and just completed regulatory review.

It trades dramatically below the multiples of its peers, after having fallen precipitously into this secondary offering.  With its capital issues at least temporarily behind it, this stock should recover so that its valuation might suggest some possibility of survival!

That being said, it is important to point out that Intervest is not a very typical bank.  It might be more accurately described as a real estate finance company with a bank charter.  As such, it isn't going to get much interest from traditional bank investors who would prefer to see a valuable retail deposit base coupled with relationship lending strengths. 

Yet the model does have its strengths.  The bank does not own or originate construction/development loans, has less than $20M in land loans, and has a manageable 3.7% NPA's/Assets.  2010 YTD yield on loans is 6.32%, and given the low percentage of land and C&D loans, most of Intervest's NPAs are loans backed by income producing collateral. 

IBCA has $2.2B in assets, $1.4B in net loans, $1.8B in deposits, $160M in tangible common equity, against a market cap of $49M.  It consistently generated $30M in pre-tax pre-provision income historically on a similar size balance sheet, so this situation is very levered to a successful outcome, and at first glance, this has hero-or-zero written all over it.  Let me explain why I don't think this is a zero.

Intervest has historically focused on income producing properties with strong collateral values.  They have no high-priced rental stand-alone anchor tenant properties, such as Blockbuster.  They have no refi's, no condo conversions loans, no capitalized interest loans.

They have just under 600 loans with an average loan size of $2.4 million.  Loans with a loan balance greater than $10 million consists of just 11 loans with an aggregate balance of $145 million, which is approximately 10% of the loan portfolio, and under 7% of total assets.

As of 6/30^th, just 21 loans, totaling $75 million, were nonaccrual, OREO, or troubled debt restructurings (TDRs).  95% of the loans are performing as agreed.  NY CRE loans (46% of the portfolio) are 99.5% performing.  FL Multifamily loans loans (6.3% of the portfolio) have some remaining issues with 86.9% performing.

Intervest has a unique deposits strategy.  Although they own a half dozen branches in Florida, it is my impression that most of their deposits have been gathered out of their office in Rockefeller Center by simply being one of the more competitive C.D. rates.  Their efficiency ratio is ridiculously efficient, and since they are underutilizing their balance sheet (with 30% being securities), they can let these C.D.'s roll off and dramatically decrease the cost of their deposits.  The average cost of deposits was 3.21% in Q2, down 66 bps from 2Q'09.  As brokered deposits (never that large at approximately 9%) roll off, they will save another 200 bps in improvements there.

Subsequent to third quarter results, IBCA completed a 10.6M share offering at $1.95 per share.  Including the 15% over-allotment, estimated gross proceeds would be $23.8 million for 12.2M new shares.  Therefore, the pro-forma numbers using September 30, 2010 reported financials:

Total stockholders equity (as of 9/30/2010):      $164,100,000
Preferred stockholder's equity (TARP):            $23,755,000
Preferred stockholder's dvds in arrears:            $1,100,000
Common stockholder's equity:              $140,317,000
Total shares outstanding (as of 9/30/2010):       9,120,812

Net proceeds of secondary offering:                  $23,800,000
New total shares outstanding:                21,320,812
Pro-forma common stockholders equity:           $163,017,000 (minus dvds in arrears)
Pro-forma per share:                                         $7.65/share
Current price/book:                                          30.1%

Total consolidated assets: $2,100,000,000
Total loans receivable: $1,360,000,000
Total securities held to maturity (mostly U.S. gov. agencies): $613,800,000
Total deposits: $1,810,000,000

Nonaccrual loans, troubled debt restructurings (TDRs), & real estate owned: $78,000,000
            (3.7% of total assets).
Allowance for loan losses: $32,300,000
            (2.37% of total net loans).

Regulatory capital ratios as of 9/30/2010:
            Tier 1 capital to total average assets (leverage ratio):   8.42% (required 9.0%)
            Tier 1 capital to risk-weighted assets:  11.17% (required: 10.0%)
            Total capital to risk-weighted assets:  12.43% (required: 12.0%)
           
           

Consolidated regulatory capital ratios were approximately 50 basis points higher in all three categories, as there is some excess capital at their mortgage origination division.

Credit trends: the migration of performing loans to nonaccrual or TDR status slowed to $10 million in Q3, from $47 million (Q1) and $23 million (Q2).  (As a side note, Intervest re-classified $21 million of performing TDR's to nonaccrual status, despite those TDR's continuing to pay under their renegotiated terms.)

MILESTONES:

The bank's restructuring has consisted of three major stages.  The first stage was in April, 2009, when the bank entered into a Memorandum of Understanding (MOU) with the OCC, its primary regulator, which was meant to improve its credit risk management and implement a three-year capital program.

The second stage was completed in May, 2010 when Intervest sold in bulk $207 million of underperforming loans and real-estate owned.  The assets were sold at a substantial discount-an aggregate purchase price of $121.5 million versus their net carrying values of $197.7 million.  It appears that this sale was forced by regulatory concerns, and anecdotal information provided by the bank suggests that some of these loans have been resold in the secondary market at a significant profit.  

Until that time, the bank had been getting 90 cents on the dollar in charge offs.  They were also modifying loans for borrowers being squeezed (some Florida hotels with significant borrower equity, for example). 

This transaction is fascinating in and of itself, with the purchaser acquiring a 9.9% stake (at the per share price of $5.00), and tells you a lot about how regulatory concerns have driven profitable loans into the willing arms of distressed debt managers.

The third, and hopefully final stage has been the recent recapitalization of the bank via a secondary stock offering two weeks ago.

Now there should be enough breathing room to allow time (via run-rate earnings) to heal the balance sheet, and enable the dramatic roll-down in deposit rates to work its magic on the Net Interest Margin.  Pressuring this will be the credit trends that surface over the next several quarters.  The market is anticipating that the rest of this year will be rocky, and I don't disagree.  However, with pre-tax, pre-provision earnings of approximately $20M (which is well under potential) versus a market cap of under $50M, this bank has a lot of earnings power once it turns the corner.

DEFERRED TAX ASSETS:

IBCA has net deferred tax assets totaling $47.8 million.  The bank received an opinion that the recent offering did not reduce the realizable tax attributes under section 382. 

The net deferred tax assets are a significant component of stockholder equity.  Net of this $48 million, against the pro-forma $163 million of common equity, there would still be $115 million in common equity-or $5.40 per share.

DEPOSIT STORY

Historically, the bank did not put much effort into developing a core deposit franchise.  The bank was content to list high C.D. rates and simply match fund a three or five year loan with a similar maturity CD.  They funded acquisitions where the borrower put in the required capital to get the property up to average local lease rates.  Intervest regarded themselves as a feeder bank for the Astoria's and NY Community Bank's, and the borrower would then turn to those banks for subsequent loans on the property.  In the meanwhile, Intervest would have then borrower locked up via sliding prepayment schedules, lockouts, fixed exit fees, and rate floors.

As a wholesale franchise, its value will come from its earnings.  They held steadily near $30 million in pre-tax pre-provision income even during the worst of it.  While that has dropped recently, due in part to loan sales, the earnings potential is compelling.

Pre-tax, pre-prov. Earnings last quarter were $4.9M, adjusted for the implementation of a new data processing system, giving IBCA a run-rate of nearly $20M/year.  This is with a balance sheet that is arguably only 2/3rds utilized, so there is upside here based on potential and historical ratios.

MANAGEMENT:

The CEO, Lowell Dansker, age 59, and the President, Keith Olsen, age 56, have historically made all the underwriting and lending decisions.  As part of the MOU, Intervest just hired a new chief credit officer and an asset/liability manager. 

Dansker succeeded his father, and the family has a good handle on NY real estate.  They got creamed by going out-of-state, with some projects in the Midwest being particularly troublesome loans.  Management is going back to their strengths, and is excited about the loan terms they are generating in the current market, with low LTV and conservative appraisals on income generating properties.

PEERS:

Relative to its peers, IBCA is off the grid on many metrics.  From a road-show slide, its peers average current market price to book value of 110% P/B.  Peers are at a P/TBV of $143%, and have a 7.0x multiple to PTPP earnings (IBCA is closer to 2x).

However, you don't need to know a lot about the peer group to understand that if the asset quality holds up, the earnings power alone will drive a dramatic change in valuation.

PUTTING THE BALANCE SHEET TO WORK:

With just over $600 million in securities funded with CD's, the negative carry is huge. In addition, that is a lot of balance sheet that can be used for loans.  A very sharp investor saw an early draft of this writeup, and stated the case quite well.  For intellectual honestly, I'll include the whole response (note his correction of my TBV figure) from his read of the 10-Q:

* IMC equity is 11 mil--over time that will come into the bank as reg capital

* I calculated pro-format tbv per share of $7.55 including the 1.59 mil extra shares in the shoe (close to what others have estimated I believe)

* 79% of the loans are fixed rate--this will help with the NIM due to prepayment penalties (and if the loans payoff, that will make me feel better about the overall credit quality as the older vintage is replaced with newer loans)

* the $21 mil TDR reclass into NPLs cleans out the accruing TDR bucket--the total NPL, REO and TDR bucket (total NPAs including TDRs) is now mostly NPLs ($38 mil with a $32 mil LLR) and REO ($39 mil). The total NPA+TDR bucket is basically flat at 9/30/10 vs 6/30/10 ($78 mil vs $75 mil)

* the $30 mil of "new" inflows to NPLs in Q3 is misleading since it includes the $21 mil TDR reclass--so net inflows to NPL in Sept qtr are really only $10 mil, down from $16 mil in June quarter and $26 mil in the March quarter

* the $17 mil of over 90 days and STILL accruing is a technical issue, due to past due maturity on loans that will be rewritten ( and are still performing)

* only $4 mil of the $32 mil LLR is specific reserves on impaired loans; not sure I gain comfort from that since they have never had large SVAs on loans

* the biggest factor besides credit is the dual repricing opportunity:

--they have $614 mil of securities (agencies mostly) yielding 1.67% funded with CDs (overall average cost=3.86% for the Sept quarter) so the negative carry is huge (2.19% x 614 mil=$13.5 mil pretax)

--- they basically broke even in the quarter despite carrying this huge negative carry

--- CDs maturing in the next 12 months cost 3.18% ($452 mil) and in the 1 to 2 years bucket the cost is 3.74% ($317 mil)

--- using the offered rates on their website I estimate they could replace these CDs at an average cost of ~1.90% (2 to 4 year CDs) for an annual savings of ~$12 mil pretax (after two full years--it will build up over each quarter)

--- if they take half the securities and roll them into new loans at 5.00% over the next two years (say $300 mil), the yield pickup is huge (5.00%-1.67%)x 300 mil=$10 mil pickup per annum (fully phased in after two years)

---add the two together and IBCA has the opportunity to pick up ~$22 mil pretax or ~$12 mil after tax (high tax rate due to NY and NYC on top of FIT)

--- on 21.3 mil shares o/s that is ~$0.56/share pickup vs recent run rate (which was ~break even)

--- the PTPP should go from the current ~$20 mil per annum run rate to closer to $40 mil in 2 years with incremental improvement each quarter; historically IBCA had ~$30 mil PTPP so with the steep yld curve $40 mil is not unreasonable (the current NIM is 1.98%; an increase of 100 bps to 2.98% produces the extra $20 mil of net interest income--which is doable just from the repricing in the next two years as shown above

---that level of PTPP can pay for a lot of sins on the loan losses if they are given time to work the problem loans out (absent another regulatory induced distressed bulk sale)

---if credit gets better you also get the pickup on reduced legal/foreclosure costs and reduced foregone interest income as well as reduced LLPs

---credit is obviously the most important factor but underlying NIM improvement will be huge

---if IBCA has $40 mil of PTPP in two years and normalized LLP is 35 bps (and assuming loans grow $300 mil in 2 years to $1.66 bil), the normal LLP would be ~$6 mil per annum leaving $34 mil pretax and approximately $19 mil after tax (approximately $0.90 a share)---I view that as perfect world, which won't happen in just two years, but it shows the upside potential

--- $0.90 per share would be a ~12% ROE and ~0.85% ROA--not out of line with historical results (they did over 15% ROEs and over 1.00% ROAs in the past)

--the reg capital pickup from the disallowed DTAs (assuming taxable income), IMC equity (11 mil), the FL lawsuit (a few mil) and future earnings will take care of the regulatory capital problems over time

--they don't even need to grow, they simply need to replace securities with loans and let the CDs reprice, while they focus on working out the loan book

THE BEAR CASE:

The bear case is simple-the loans might be bad.  I was speaking to a banker last week, and in response to the question what to look for in beaten down banks, he stressed to look for banks that have been through two exams.  Intervest completed an exam shortly before the recent offering, and the results were summarized in the earnings report.  The prior exam sequence led to the bulk loan sale.  By no means is IBCA out of the woods, but given the recent regulatory actions, there is some comfort.

If you take the reclassification of the $21 in TDR into NPLs last quarter, and simply include the total NPL, REO and TDR, that total of non-performing loans rose only modestly from 6/30/10 to 9/30/10, going from $75 million to $78 million.

But the biggest bear case is simply that one day, a regulator required a bulk loan sale, and it demolished the equity in the bank.  Losses were realized that were much greater than the loan loss reserves.  In contrast to the virtuous cycle in the dual repricing opportunity described above, being forced out of assets is a vicious circle for a bank, as equity is wiped out and new equity raises at depressed valuations highly dilutes stockholders.  That is, if the bank itself survives! 

I admit that I had plenty of questions about how the bank could suddenly have such a big write down from the bulk loan sale.  The answer, as we saw just last week with Wilmington Trust jumping into the arms of MTB, is that it can happen very suddenly.  Without being able to go through a balance sheet loan-by-loan, it is hard to see what is going on.  But even with that, it would be difficult for an investor or the bank to see what is going on-how are they to distinguish a borrower who is hanging on by their fingernails versus one who is flush? 

Of course, that is the nature of investing in a distressed bank. 

DISCLAIMER:

This is not meant to be a buy or sell recommendation, and my firm frequently has both long and short positions in many of the securities mentioned. 

Catalyst