Description

Northwest Bancshares, a $7.7 billion asset bank based primarily in Northwest Pennsylvania, just completed a second step demutualization to fully convert from being a mutual holding company.  The stock is currently trading at a discount to its peer group of well capitalized banks, despite being well-positioned to capitalize on current opportunities. 

NWBI trades at 115% price / tangible book (P/B = 87.5%), compared to an average of 136% P/TB for its peers.  (The list below is conservative.  The prospectus puts both its peer group average and median near 147% P/TB.) 

Northwest has over 220 locations, which includes approximately 50 locations for its consumer finance division (only $130 million in loans outstanding).  NWBI's footprint spills over the Pennsylvania border into northeast Ohio, southwest New York, and the Baltimore region of Maryland.  It also has three branches in Florida, which gives it a toehold there in case it finds a suitable acquisition. 

Since its IPO 15 years ago, Northwest has grown from a modest sized mutual to a robust regional bank.  Assuming an open market purchase 15 years ago, NWBI shares have annualized 16.2% over that period (including dvds, from Bloomberg data).  During that period, NWBI has completed 25 acquisitions, and has grown its total banking offices from 41 to 170, and its assets from $1.4 billion to $7.7 billion.

Northwest was a very smart acquirer along the way.  NWBI took advantage of its status as a mutual holding company to roll up other mutual banks at compelling prices, often paying a modest premium to tangible book value.  Northwest took advantage of the brief window before remutualizations were discouraged, for example, purchasing Leeds bank in 2002 to establish its presence in Maryland.  Due to Leeds being an MHC, and thereby owning more than 70% of its own shares, Northwest was able to purchase the bank for a cash payment of $44 million.  Leeds had stockholders' equity of $50.9 million at the time, and over $300 million in deposits.

The investing premise for NWBI is simply that this is a bank that has been very astute about its acquisitions.  It has focused on complimentary acquisitions, and it was making acquisitions that were accretive to tangible book while other banks were doing dilutive deals.  It has also expanded via de novo branching to fill in gaps in its geographic footprint.  For example, over the last year, it has opened four new branches in Rochester, NY.

But it is its ability to take advantage of a unique pricing environment that most interests me.  While it is no longer able to purchase mutual banks, the environment has changed, and it seems that the sweet spot for bank acquisition would include banks that are having difficulty in raising money without significant dilutive effects on tangible book. 

Unlike other converted thrifts, Northwest always had a decent ROE over the years.  From 2004 through 2008, it's ROE was 8.2%, 9.7%, 8.6%, 8.2%, and 8.7% respectively.  It's ROA ranged from 0.68% to 0.86%, and its net interest margins likewise ranged between 2.98% and 3.57%.  NPA's and REO were a decent 1.95% of assets going into the offering. 

The investment premise when purchasing financial institutions at a significant P/TB discount to its peers is that the stock's appreciation will come via two routes-first, the return on equity, and secondly, the narrowing of the discount.  Having a significant ROE is important in terms of getting paid to wait.  Northwest always appealed to me because an ROE of greater than eight percent provided that return as a minimum assumption whenever the opportunity arose to purchase near tangible book value. 

The knock on Northwest had been that it was a low-beta banking play, but the ability to get paid while I waited led me to categorize the stock as more bond-like than a typical equity at its modest valuations.  Northwest has been the slow-and-steady bank investment in a decade that has seen valuations spin between half book and twice book, and ROE's between one-third and three times that of Northwest.  I believe that the stock still retains its bond-like characteristics at the current valuation. 

Northwest's geographic area has experienced relatively stable housing prices and boasts a diverse economy.  The speculative excesses of other areas did not seem to sweep the western half of Pennsylvania.  Of course, no region has completely ducked the recession, but the major question marks that hang over bubble area banks aren't as much of a significant factor there.

However, neighboring Ohio has been one of the more challenged economies of the Midwest, and that provides Northwest with a contiguous market area that is prime for intelligent acquisitions.  In the current market, banks that are trading at a discount to book value, oftentimes simply because the ROE is subpar, will have a difficult time raising capital.  It makes more sense for some of those banks to sell rather than to swallow a dilutive offering.  With its just completed secondary, NWBI is now in a position of having already raised the capital that is closed to its more challenged brethren. 

While there are other overcapitalized thrifts, many of those are in competing footprints, and it is less likely that they will find bargains in their area as they compete for the available targets.  The sweet spot of owning a bank currently is to have a well-capitalized, experienced acquirer in a region that provides contiguous acquisitions.

There are banks out there that are being pressured by regulators to raise equity, and for some of these banks, if they had intended to sell in the next five to seven years, overcoming the dilutive effects of a current capital raise might compare unfavorably to simply selling now for somewhere closer to tangible book.

In addition to the possibility of purchasing Ohio valley and western NY banks, NWBI could make an FDIC-assisted deal.  How would that look?  Iberiabank Corp (Louisiana) rallied close to 20% on its mid-November announcement that it was making two FDIC-assisted deals in Florida.  The market typically regards these deals as highly accretive and meaningful.  This is basically a call option on the stock, given the market's love of these deals.

Whether Northwest does an FDIC-assisted deal or not, these deals provide benchmarking for other deals.  As an experienced acquirer with a record of astute purchases, NWBI should be able to take advantage of this attribute of a buyer's market. 

An FDIC-assisted deal puts the acquiring bank in the simultaneous position of being both a traditional banker and a collections-and-recovery agent of the FDIC.  The typical FDIC-assisted transaction has the following characteristics:

• The maximum exposure (which assumes all loans go bad and have no collateral recovery) is 20% up to a certain amount, then 5% above that. 
• The loss-share agreement provides five to ten years of protection.
• The winning bidder receives up front cash from the FDIC.
• The bidder must account for the cost of carrying the non-performing loans.

The accounting works as following: apply purchase accounting to the fair market value of the assets and liabilities assumed.  This is discounted back, which accounts for the Carrying Cost Asset (CCA).  The acquiring bank does not simply net out the loss sharing, but rather enters in the gross amount of loan losses against a receivable from the FDIC.  These are netted as losses are realized.  Assets written down in the purchase accounting accrete back into income over time.

Following the completion of its recent offering, Northwest now has the capital to pursue these deals.  For 15 years, the bank has done nifty deals that purchased good banks well below what non-MHC's were paying.  I thought Northwest would stay an MHC for a long time, given the favorable dynamics of these deals.  When a management team this astute about acquisitions decides to make a transformational move in a buyers' market, I see this as the beginning of a new and exciting chapter.  No doubt, this will be another avenue for Northwest to purchase core deposit franchises on favorable terms.  Given its history, NWBI is a very sensible horse to ride in a buyers' market.

Finally, a significant number of shares were bought by depositors and members of the community--nearly half its recently completed $688 million offering.  As the overhang of flippers dissipates, the stock will be in stronger hands.  The offering also removed the float percentage minimum restriction that had excluded it from indices.

Catalyst

Recently completed offering leaves it in a strong position to pursue FDIC-assisted deals and contiguous acquisitions.

Offering also removes the float percentage minimum of 50% and makes it eligible for inclusion in more indices.

Meaningful discount to peers.