Description

SUMMARY

Needham Bank, which has been a mutual bank for the entire 131 years of its existence, started trading publicly two weeks ago, on December 28th. The organization was restructured so that the bank is now a wholly owned subsidiary of NB Bancorp, Inc., the public entity now trading on Nasdaq (ticker: NBBK).

As is typical with these mutual-to-stock conversions, the IPO was priced at $10.00. The stock traded in a range of $13.10 to $14.18 in its first two weeks as a public company, closing Friday at $13.97.

I consider NBBK to be attractive at this price for investors with patience and a three-to-five-year time horizon, with a good likelihood of earning an annualized return exceeding 20% over that period.

There are structural reasons why I believe that we have the opportunity to invest in NBBK stock at an attractive price:

1. IPOs of these mutual-to-stock conversions happen without hoopla. The depositors at these banks have priority in applying for shares, and there are no roadshows to drum up interest.

2. As a result it will be some time before analyst coverage is initiated and the stock appears on investor screens.

3. Because of the absence of prior “ownership” of Needham’s retained earnings, which has been built up over decades, mutual-to-stock conversions are almost invariably priced so that the IPO price is well below tangible book value. Technically the depositors in a mutual bank “own” the bank, though the only real benefit they get from this ownership happens if the bank converts to stock form. If that happens, depositors get first rights to buy shares in the IPO.

4. Despite the pop of almost 40% from the IPO price since going public, the stock is trading at an 18% discount to tangible book value of $17.00. Post-IPO, with an overcapitalized balance sheet and a long and solid history of profitability, earnings should increase meaningfully over the next few years.

5. The bank is permitted to buy back shares (and pay dividends) after one year as a public company. If the stock is trading below TBV then, as it is today, buybacks could be very accretive.

6. Aspects of the management team lead me to believe that the bank is likely to be sold to a larger one when that is permitted, which is three years after the IPO.

I believe that the stock is worth at least 100% of TBV today, or at least $17.00 per share. It is not hard to imagine the stock trading at over $20 in a couple of years and being acquired at about $35 in four to five years, as I will discuss below.

HISTORY

Needham Bank was founded in 1892 in Needham, MA (suburban Boston), and has served the Greater Boston metropolitan area and, to a lesser extent, portions of neighboring states since that time. As was common in that era, local businessmen (including several homebuilders) recognized the need for a community bank which could be a safe home for savings and a conduit for financing mortgages. Needham’s initial “office” was a chair in the public library, staffed for a few hours each month to accept deposits, make loans, and collect loan payments. In 1906 in opened its first real office, in a small storefront, and in 1923 built its own building.

In the century since then, the bank has grown and prospered, and is now one of the largest community banks in the Greater Boston metropolitan area and throughout New England. At the end of 2022, Needham had total assets of $3.6 billion, and earned net income of $30 million that year. By September 2023 assets had grown further to over $4.2 billion, and the annual earnings run rate was $34 million. It operates through 11 branches and two administrative offices, all located in suburbs of Boston.

MANAGEMENT

In January 2017 Needham Bank hired a new CEO, Joseph Campanelli. Three months later the bank brought in a new COO, Salvatore Rinaldi. According to the prospectus, “. . . Campanelli and Rinaldi each have more than 40 years of banking experience, and have worked together for over 40 years at other financial institutions prior to joining Needham Bank.” The new CEO and COO were about 60 and 62, respectively, when they were hired. Campanelli was previously President & CEO of both Sovereign Bancorp (acquired by Santander) and Flagstar Bancorp; Rinaldi presumably had senior positions in both those banks. 

The ages of these two executives and the timing of the conversion, along with a conversation with the CEO, suggest to me that the IPO is part of their retirement plan. Both applied for and bought the maximum number of shares permitted (80,000) in the IPO.

THE CONVERSION

Needham Bank’s conversion from mutual to stock ownership was a “standard” conversion, in which 100% of the parent’s stock was sold in the IPO. (The other kind of conversion is a “first-step” conversion in which a minority of shares is sold to the public. The remaining majority is held by a mutual holding company and can be subsequently sold to depositors in a “second-step” conversion.) As is typical, an outside firm was retained to provide a range of values for the bank. In this case demand for shares by depositors in the IPO was very strong, and the maximum number of shares, 41 million, were sold at $10. Only the “Priority 1” stakeholders got any shares, and many were only allocated a portion of the shares applied for. (“Priority 1” was depositors who had an account at Needham at the end of March 2022; the second priority was depositors as of June 2023; followed by the bank’s tax-qualified employee plans and, finally, employees and directors of the bank, though most of those would qualify under the first two priorities as depositors in the bank). The application period for shares expired on November 14th, and NBBK started trading on December 28th.

Of the gross proceeds of $410 million, $165 million was retained by the parent company (NB Bancorp), $201 million injected into the bank, $34 million was used to fund a loan to the bank’s ESOP to buy shares in the open market, $8 million for offering expenses, and $2 million contributed to the bank’s charitable foundation.

In addition to the 41 million shares issued in the IPO, another 1.7 million shares were issued to the bank’s charitable foundation, resulting in total outstanding shares of 42.7 million.

INSIDER BUYING

Needham Bank insiders, both directors and officers, bought significant amounts of stock in the IPO. There has also been some modest buying by insiders in the first days of trading:

I am encouraged that directors and officers of Needham bought significant amounts of stock in the IPO, a total of about 645K shares (at a cost of $6.45 million, now worth about $9 million). Even more encouraging is that several bought another 31K shares in the open market after the IPO, at prices ranging between $13.25 and $14.12. Particularly significant is Paul Evangelista’s purchase over the past week of 21,888 shares at an average of $13.62, a total cost of $298K. Evangelista became an employee of the bank in April 2022 after its acquisition of Eastern Bank’s cannabis business, just missing the 3/31/22 deadline that would have put him in the first priority—depositors who had bank accounts at that date. There have been no reported sales of stock thus far.

SHAREHOLDERS’ EQUITY & BOOK VALUE

Adjusting for the IPO proceeds and third quarter and estimated fourth quarter earnings of the bank, shareholders’ equity was about $725 million at the end of 2023, and book value and tangible book value were both an estimated $17.00 per share. (There is a de minimis amount of intangible assets).

Not surprisingly the bank is heavily overcapitalized following the infusion of capital in the conversion. The bank had a Tier 1 capital ratio (capital to risk-weighted assets) of 10.5% before the IPO, well above the 8.0% required to be considered “well capitalized.” By the end of 2023, including the net proceeds of the IPO and earnings for the second half of the year, the Tier 1 capital ratio will have more than doubled to over 20%. This leaves it with plenty of capital for future deposit and loan growth, and the capacity to buy back shares and pay dividends in a year. All of these should significantly increase per share earnings over the next several years.

REASONS FOR CONVERSION

The IPO prospectus cites the usual reasons for converting from a mutual to a stock company, including:

-   Enhanced financial strength;

-   Positioning the bank to remain an independent community bank;

-   Supporting future lending growth;

-   Enabling the bank to make larger loans to larger customers

-   Better able to compete for larger loans;

-   Attract and retain qualified personnel through equity plans;

-   etc. 

All of this may be true, but it would not surprise me to learn that the CEO and COO of the bank have been pushing for the conversion from the time they joined the bank in 2017, as part of their retirement plans. Both were hired in early 2017 and are now 66 and 68 respectively. Running a public company, with a larger balance sheet and higher net income is likely to bring them higher cash compensation, in addition to equity-based compensation in various forms. Also, each was entitled to buy up to 80,000 shares ($800K) of stock at that price, and both applied for and bought the maximum amount.

Given the ages of these two, along with a conversation with the CEO, I think there is a high likelihood that NB Bancorp will be sold to a larger bank when that is permitted. A sale cannot occur for at least three years; I think there is a good chance that one happens 3-5 years from now.

Although a limited amount of information is available on the CEO and COO, the President of a much larger NJ bank who worked with both of them some years ago told us that he has the highest regard and respect for both as bankers.

FINANCIAL PERFORMANCE

Annual 2015-2022

Quarterly--2023

The six tables above summarize the financial performance of Needham Bank. Annual information is provided for 2015-2022, and quarterly information for the first three quarters of 2023. The information is largely self-explanatory, and I will just make a few observations:

1. The bank has grown steadily, with total assets increasing from $1.73 billion at the end of fiscal 2015 (the fiscal year at that time ended on March 31) to $3.59 billion at the end of 2022, and $4.23 billion at the end of September 2023. Investment securities were less than 5% of assets at the end of September. Deposits have grown at an even faster pace than assets, from $1.23 billion at the end of FY 2015 to $3.44 billion at the end of the most recent quarter. Shareholders’ equity (all retained earnings) increased from $234 million in 2015 to $366 million just before the IPO.

2. Needham has been consistently profitable with net income growing from $10.9 million in FY 2015 to $30 million in 2022, and a current annual run-rate of about $34 million. This is before the new capital infusion from the IPO. Profits are expected to increase significantly in 2024 and beyond.

3. The financial ratios indicate to me that this is not an outstandingly managed bank, but there are indications that the quality has improved in recent years and could improve further over the next few years. The efficiency ratio was 62.3% in 2022, down from 70.1% in fiscal 2018, the first full year after new management took over.  ROAE has similarly improved from 3.6% to 9.0% in 2022, and ROAA has doubled from 0.46% to 0.92%. All of these suggest an increased focus on managing costs and growing the bottom line.

LOANS

Needham’s loans are a broad mix: one-to-four-family residential (28% of total loans); CRE (29%); construction and land development (17%); commercial and industrial (13%); multi-family residential (6%); and consumer loans (6%). Non-performing loans are a manageable 0.38% of total loans. The allowance for credit losses is 2.3x NPLs.

CANNABIS BUSINESS

In April 2022, Needham acquired Eastern Bank’s (EBC) cannabis-related banking and money service banking businesses, including 23 employees of EBC who worked in those businesses. EBC had inherited this business when it acquired Century Bank (headquartered in Medford, MA) in November 2021. The cannabis business, which includes banking services for growers, processors, and dispensaries, is now part of Needham’s Structured Finance division, which also includes their wind and solar lending businesses. Although cannabis lending is likely to have regulatory compliance and credit risks, it can also be a high-return business if prudently managed. Needham has over 700 cannabis-related customers in several states which have legalized marijuana, but there remains uncertainty about what enforcement actions the federal government will take on the use of marijuana in states where its use is legal. At the end of September 2023, the bank had $264 million of cannabis-related deposits, about 7.7% of total deposits, all of which are lower-cost core deposits. At the end of September, Needham had $158 million in loans to borrowers in the cannabis business, 98% of which is collateralized by real estate.

END-GAME?

The CEO and COO were about 60 and 62 respectively when they joined Needham Bank in early 2017. They are now 66 and 68. My conjecture is that they were planning the conversion to stock form when they joined the bank. The CEO has said that he wants to retire in a few years. The CEO and the COO each bought $800K of stock in the IPO, and will very likely get more through options, restricted stock, and other employee plans. I think there is a high likelihood that the bank will be sold when that is permitted three years from now. If that happens, what price could it fetch?

My model assumes that the bank continues to earn a 9% return on TBV on its “old” capital, and that the “new” capital from the IPO will earn 4% in 2024, increasing gradually to 9% over four years as it deploys its excess capital. This would result in EPS of just over $2.00 and TBV of almost $25 in 2028. (A similar or better result could be obtained in a sale if the stock continues to trade below TBV, and management starts buying back stock after one year.) Banks like these are purchased at an average of about 1.35x to 1.4x TBV in an acquisition, or about $33 to $35 in 2028. This price also seems plausible relative to projected earnings, as there will be room for significant cost cuts by an acquirer, which would result in higher pro-forma earnings. A sale at $34 after four years will result in an IRR of 24.9% from the current price; if it takes five years the IRR will be 19.5%.

RISKS

1. Credit losses in a bad economy.

2. Interest rate fluctuations resulting in weaker net interest income and profitability.

Catalyst

Higher earnings and TBV as excess capital is deployed.

Improvement in bank valuations.

Acquisition of bank in a few years.