Description

Summary: NorthEast Community Bancorp is an interesting situation trading at a pro forma, fully converted tangible book value of 79% that could return 55% with a 2nd step conversion. That's pretty cheap for a bank in and around New York City. The bank has been growing nicely over the past five years, particularly in commercial lending. I have reason to believe that the bank is nearing a point where it needs to raise capital via a 2nd step. That may seem counterintuitive but in the thrift conversion space, it is a positive.

History: The bank was founded in 1934 as the Fourth Federal Savings and Loan Association of New York. In 2006, the bank rebranded itself as NorthEast Community Bancorp and completed a partial IPO, often referred to as a first step. What that means is that the mutual holding company (MHC) maintains majority control of the bank while still being able to raise equity capital. This structure allows management to sell shares and not have to worry about activists. This became quite evident when noted bank activist Joseph Stilwell locked horns with the CEO, Ken Martinek.

The Stilwell Saga: You can't discuss NECB without mentioning Stilwell. Following the first step in which 45% of the shares were sold, or 5,951,000, Stilwell starting accumulating shares.  Initially, the fund owned a little over 1 million share for a 9.3% stake (now 1,236,102 shares and over 10% due to buybacks). However, that represented almost 20% of the outstanding shares. There are a few things that the MHC cannot vote on, and incentive plans is one of them. Thus, Stilwell was able to block the initial equity incentive plan in the 2007 proxy, the first and the only time this has occurred in thrift conversions. Thus began a long-running pissing match. You can get an idea by going to the bottom of the following SC 13 D/A filing or this one. The fleeting victory for shareholders resulted in a management team that had few incentives. As a result, the current price is only up 30%...in 12 years. There is some truth to the Gordon Gecko quote: "Greed is good." I have heard that a recent Stilwell partner letter mentioned that he is willing to reach agreement with the bank so that management can have its payday.

So what has changed? In 2013, Jose Collazo was promoted to president and chief operating officer, and he has dramatically improved the balance sheet and earnings. The bank also increased its multi-family residential and commercial lending, as noted in this article. At the end of 2015, the company went dark. In 2016, Stilwell lost a lawsuit to force the MHC to 2nd step. The bank opened a new branch earlier this year and will open another soon. The CEO is now 66 years old and does not appear to have any family lined up to succeed him, save for a younger brother.

Loan Book: NECB is not your typical thrift, as evidenced by its loan book. Here is the breakout:

The elephant in the room is the construction loan book. Adding to that is a rumor that a large portion of those loans appear to be in one zip code. I have not been able to verify that but several people, including one who attend the annual meeting and asked a question about it, have indicated it involves a religious community an hour north of New York City. A clue can be found in this announcement where the bank is opening a branch. That being said, the construction loan performance has been pristine. All of the construction loans are current. For the total loan book, non-accruals are less than 0.70%. Despite the good performance, construction loans are still considered riskier and regulators require more capital backing those loans than other loans. There is some interest rate sensitivity, but not much, as a majority of the loans are less than five years.

Deposits: Due to the focus on commercial lending, the bank does rely more on CD's, particularly jumbo CD's (>$250,000).

Earnings: This is where the story gets interesting. Last year's EPS was $0.67/sh, including the MHC shares. Excluding the MHC shares, EPS would be $1.64/sh. Not bad for a stock trading just over $13. ROE was 11% last year. Most people may yawn at that number, but that is pretty sexy in banking. Here is a snapshot of EPS, both by full shares and by minority shares. A broader summary of the financials is provided at the bottom.

2nd Step Dynamics: When looking at MHC's, it is helpful to value the banks on a fully converted basis. The calculation is fairly simple. First multiply the MHC shares by the current price and add that to the existing equity to determine pro forma equity. Then divide the market cap by pro forma equity to obtain P/TBV ratio.

The actual 2nd step offering is not as simple, as the MHC shares are not actually sold. Instead, a new offering is priced taking into the account the existing equity and shares, and devising a minimum number of shares to sell and a maximum number of shares. The prospectus usually lists the pricing based on minimum, mid, max and adjusted max. Based on the pro forma capitalization, it will indicate what the pro forma P/TBV ratio is. Typically, the shares are priced at $10. Existing shares will be exchanged for new shares based on how the offering prices.

Mid-Southern Bancorp (MSVB) was the most recent bank to compete a 2nd step conversion on 7/12/2018. It was priced at 77% of TBV at the top end of the offering. There are two important factors with 2nd step pricing: size and location. MVSB had $176 million in assets and is located in southern Indiana. In terms of assets, bigger is better. In terms of location, the closer to the metropolitan areas of New York City, Boston or Philadelphia, the better. MSVB popped 25% after the conversion and trades around 100% of TBV. When BNCL did its 2nd step on 1/13/2015, it was a $4.4 billion asset bank in the Philadelphia area and priced at 100% of TBV in the offering and traded up 8% after the 2nd step. Fairfield, NJ based KRNY, with $3.5 billion in assets, did a 2nd step on 5/19/2015 at 96% of TBV and traded up 7% on the first day. Another New Jersey 2nd step was MSBF on 7/16/2015. That was smaller at $340 million of assets and priced at 80% of TBV and traded up 20% on the first day.

Let me run through the numbers for NECB, while providing comparisons to four other MHC's of similar asset size.

You can see that NECB is trading cheaper than its peers except for LSBK. While LSBK is located in New York, it is on the shores of Lake Erie in Upstate New York, its management team is all under 60, is not growing much that it needs the capital, and has ROE's < 5. On the positive side, LSBK pays a nice dividend, has steady earnings, buys back shares (albeit in small amounts), and Stilwell is involved. MGYR will likely 2nd step soon due to its capital position. It has a checkered history and seems like the 2nd step is largely priced into the its stock price. PDLB just did a 1st step and won't be doing a 2nd step any time soon. Finally, PVBC is fully valued.

Financials: Below are some selected figures from 2005 through the 1st Half of 2018. Although the bank is dark, it does issue quarterly press releases and an annual report. Information on the bank subsidiary is also available on the FFEIC site.

Risks: These should be fairly obvious:

- Illiquid microcap

- Construction loans go south

- Does not do 2nd step

Catalyst

2nd Step Conversion