Premara Financial, Inc

Potential upside based on

Regional Peers: 106%     Tangible Book: 208%      Earnings: 236%

Investment Thesis

Premara Financial Inc. is an opportunity to buy into an exceptional, high quality regional bank that has been oversold due to unwarranted selling by a retail investor base. Due to the market capitalization and illiquidity of the situation this investment is best fit for individual accounts.

v  Premara Financial is a healthy, profitable, and growing bank that has been thrown out with the bath water of its undisciplined regional peers

v  A weak economy, investment financing, and a retail investor base have unjustly exacerbated selling in Premara Financial to a record disconnect to its intrinsic value

v  Thanks to a well-timed launch, Premara Financial is in a position to grow and make quality loans at a time when many regional banks are struggling for survival

v  Premara Financial has rejected brick and mortar banking in favor of technology and low overhead.  This has allowed them to profitably operate with an above-average NIM and ROA, as well as create a scalable and perpetual platform.

v  At their core, Premara’s management and employees believe in a clear brand that speaks to old fashioned customer service

History

Premara Financial, Inc is a recently formed holding company that was created to own and grow what is known as Carolina Premier Bank.  John Kreighbaum is the bank’s founder and CEO, having come from a lifetime of banking experience in Texas and Ohio.  John’s niche has been to develop regional banks in up-and-coming areas just outside of more prominent city boundaries.  Such were his hopes in 2005 when John began raising funds to form a new bank in Ballantyne; an affluent suburb of Charlotte, NC.  At the time John’s goal was to create a bank in the corridor between the financial heavy city of Charlotte, NC, and its daughter-city, Fort Mill, SC.

Management

Premara Financials is steered by its founder and CEO, John Kreighbaum.  I have had the fortunate opportunity to meet John on numerous occasions and he is a true gentleman.  John embodies an individual of hard work ethic, passion, a Dale Carnegie demeanor, and a drive to achieve one’s dreams.  In addition to his role as CEO of Premara Financial, John is also on the board of directors for the Charlotte branch of the Federal Reserve Bank of Richmond.

Since it is unfitting for an investor to rely solely on my word, I have attached several news articles about John:

http://www.charlotteobserver.com/2010/08/22/1635480/back-porch-banking-is-his-way.html#storylink=misearch

http://www.charlotteobserver.com/2011/03/06/2111940/smaller-bank-has-grand-plans.html#storylink=misearch

Prior to founding Premara Financial, John Kreighbaum ran CoBancorp, a regional bank in Ohio. In May of 1998 John sold the bank to FirstMerit Corporation for 2.8x book value and 21x earnings.  At the time the bank had $665MM in assets.

Sellers, Financing, and Stock Discount

The key to understanding Premara Financial’s current stock begins with the macro environment and the financial crisis of 2008.  As noted in the bank’s history, John began fundraising for the bank in late 2005 and launched as a denovo bank under a limited charter in 2007.  As a result of the timing of the bank’s launch, it had the fortunate circumstance to avoid lending in the blow off top.

What has proven as a favorable fortune to the bank’s loan book has proven an obstacle for its stock price.  95% of the current non-management investors in the bank are retail investors.   Many of them invested a few hundred thousand dollars in 2006 & 2007 when the economy was strong.  As the economy floundered many individuals soon found themselves deleveraging and starved for cash. These investors called their brokers and had them sell their shares at the prevailing price.    I have been to the bank’s annual meetings and can confirm that many of its current shareholders believe that the stock’s price represent the intrinsic value of the bank.  The majority fail to realize that over the past few years the bank has grown assets at a tremendous pace, maintained a sound portfolio, and moved into profitability.   

The stock’s retail selling has been exacerbated by the addition of boom-time credit and easy money. Prior to the recession, NC banking laws favored an environment where small start-up banks garnered huge returns in just a few years.  As a result, IPO loans secured by Premara’s shares were underwritten by other regional banks. Ridiculous as it seems, many times the financing of these shares were 100% of cost. Now that the economy is slow and other investors have sold, causing many of the original investors are walking away from their notes.  This has caused a large chunk of stock to become available in the special asset division of lending institutions.

Bank Quality & Growth

John’s goal is to grow the bank to $1 billion in assets within the next 2 years. Whether he does this via organic growth or acquisition remains to be seen but he has come on the record that he has little interest in buying a troubled bank.  Rather, management hopes to explore healthy banks or grow assets via non-traditional routes that will allow the bank to grow deposits without compromising costs.   Should the bank decide to move forward with acquisitions, then the current macro environment will allow Premara to purchase healthy banks at a significant discount to historical valuations (Average price/TBV since 1994 is 1.7x for the SNL bank & thrift index).

Despite having only 2 locations Premara Financial has grown its assets by 53% CAGR from inception while maintaining a conservative equity / asset ratio of around 10x leverage over the past 3 years. 

A recent study of all (22) North Carolina and South Carolina regional banks, three to six years old and with total assets >$100MM in Assets ranked Premara Financial #2 in earnings and ROA, #1 in NIM, #1 in interest, and #3 in $/employee.  Current ROA comes in at 44bps and John believes it is reasonable to achieve 75bps in the next year or two.  Unlike many of the big bank bulls, John believes the golden 100bps ROA is going to be difficult to achieve in the current environment unless banks find a way to minimize regulatory and brick and mortar costs. The banks NIM stands at 3.97% vs. its peer average of 3.42%.  Its Texas Ratio comes in at 19.91.

As part of our investment in the bank we have engaged in extensive scuttlebutt with the bank. This includes multiple conversations with all members of the staff ranking from the personal bankers, transaction tellers, back office administration, the CFO, and the CEO.  In addition we have opened multiple accounts with the bank, as well as gained a firsthand experience of the application and underwriting process.  In such circumstances we can confirm that the bank has gone out of its way to understand the qualitative factors of the loans. It has been especially reassuring that we have seen them both accept strong loans and reject poor ones. 

In 2010, Premara Financial was awarded an “outstanding” rating by FDIC, a designation awarded to only 10% of the nation’s 10,000 financial institutions. Since inception loan loss reserves have remained steady at less than 2% of outstanding loans.  This comes after all of the bank’s real estate assets received an updated appraisal and factored a valuation shock of 30%. Throughout the entire recession the bank has managed only 2 REO assets; one of which was ultimately sold for the price of its note.  As it currently stands only one property remains and it is carried at $469K.  I am familiar with the asset and am confident it will be moved without significant impairment.

Culture & Technology

Two characteristics combine to make Premara Financial unique.  The first is Premara’s culture. A walk into the bank is always greeted by a warm and personal touch where the client relationship is valued above all else.  Staff members go out of their way to personally introduce themselves and satisfy needs. This ‘old bank’ mentality is extended throughout the bank’s culture where bankers go out of their way to understand the business or mortgage loan, both qualitatively and quantitatively. 

Second, Premara Financial has used experience to build a bank centered on technology. Two years ago John Kreighbaum communicated that branch building would become a burden on the industry.  By outsourcing many of its electronic operations and creating a paperless infrastructure, Premara has been able to grow its bank without significant increases to payroll and rent. In a recent letter John commented on the secular shift away from brick and mortar banking:

 “Last year, for the first time in memory, customer visits to banks and branches actually went down… technology has leveled the playing field and we can compete on equal footing with the big banks…these branch networks are a huge overhead expense that is a drain on banks’ profits. Now, the people who run big banks are not dumb and see what is happening. Many banks are already closing branches and consolidating locations. But it is going to take years to ‘right size’ the branch networks. Meanwhile, banks are carrying the expense in a time of slim margins due to low interest rates.”

In addition to its 21^st century infrastructure the bank has developed a process to electronically record and interact with all of a client’s accounts and potential products.  By disseminating the need for product billfolds and advertisements the bank hopes to license its proprietary technology (Omistrater ™) to thousands of other banks throughout the country.

In a world of big banks, dodo bankers, and financial product alchemy, Premara Financial has made a point to differentiate itself from the crowd. In doing so it has built relationships and created a brand that will allow it to win business over its big bank peers without sacrificing its above average NIM (Net Interest Margin).   

SLBF Funding & Peer Group

This past quarter Premara Financial received $6.23MM in Tier 1 Capital via the Small Business Lending Fund (SBLF).  The SBLF was created by the treasury in order to spur small business lending throughout the country.  Of 933 applications, 332 institutions were approved to be of sound quality and worthy of funds.  Premara Financial was one of nine banks with a North Carolina location, and one of two banks in Charlotte.   Due to the Treasury’s overview and application process regarding the selectivity of qualified banks, Premara can be compared to other Southeast banks that are recipients of the fund.

Peer Group of Listed Banks Receiving SLBF Funds in NC:

Additional Peer Comps

When it comes to micro-cap banks many jaundiced investors have looked at the FDIC failed bank list and made the decisions to throw the baby out with the bath water.  This has proven especially true in the Charlotte region where three regional banks that were launched in the latter half of the past decade completely lost discipline and have sustained continued losses since 2008. 

Of the 22 banks presented in the earlier study, Premara Financial ranked #3 overall in the region and # 2 in the Charlotte metropolitan area.  With the economy keeping regional bank comps poor at 0.55x TBV, Premara Bank still looks compelling on a micro basis. As a bank with positive earnings, few impairments, and extremely favorable peer group rankings, the current 70% TBV discount between Premara and its peer group is unjustifiable.

In November 2011, Piedmont Community Bank Holdings, Inc of Raleigh, NC announced a tender to purchase shares in Crescent Financial Corporation (CRFN) of Cary, NC.  Coming off 2 years of negative earnings the transaction values Cresecent Financial at 1.0x TBV. 

Ownership Holdings

As of the April 2011 proxy statement, directors and officers currently account for 15.89% of the company’s outstanding common stock. With nearly all of the original board member’s stock having been purchased at the original investor price of $11/share, they are well incentivized to make sure that any future transaction garners a favorable price.  A non-executive individual shareholder and an investment fund currently rank as the firm’s largest shareholders with 7.68% and 4.22% of the respective shares. 

If there is a negative worth noting it is that John Kreighbaum is rarely concerned with the company’s stock price.  John operates his business from the mindset of a private owner and his care is about building the bank while making sure it sustains the principals that are the building blocks of its culture.  While this can be a negative to a current shareholder of the bank, it will prove extremely rewarding to investors favoring patience.  It is my belief that great organizations are often a reflection of their culture and ‘owner’ managers. 

Potential Catalysts

We currently foresee 3 catalysts to unlocking Premara Financial’s value. First, would be broad acceleration in earnings growth across the banking sector.  Since we are unable to predict when the housing market ultimately bottoms or when the economy accelerates we must remain rational optimists regarding the timing of the economy’s recovery.

Second, would be an increase in M&A activity. As demonstrated by the recent comp in Raleigh NC, the thirst for healthy institutions to grow may allow regional banks to achieve potential premiums of 0.8x to 1.2x TBV in even a slow environment.  Ironically, the increase in regulation that may prove a hindrance to current banking economics may provide a catalyst for future acquisition activity.  The drag on returns that Dodd Frank will likely cause may provide a boost to M&A transactions in 2012.

The final catalyst would be an event directly involving Premara Financial.  In April of 2011 the bank, formerly Carolina Premier Bank, formed itself into a holding company in order to open up all options of growth.  While we will not speculate as to any future activity regarding the bank its clear it has many attractive qualities that make it unique versus its peers.  With management owning such a large % of the bank (at a higher cost basis) and with investors nearing 500 shareholders, it is not unreasonable that the bank might undergo a liquidity event in the next few years.  Any pickup in the stock’s volume should at a minimum, allow it to trade alongside the average TBV of its weaker peers.

IRRs – Book Value Approach

Based on current TBV of 0.32 and stock price of $3.00 / Share.  Assumes no growth in TBV

IRRs- Earnings Approach

Based on the current share price of $3.00/share, 1.69M shares outstanding, and John’s estimate of a ROA of 75bps. Current ROA is 44bps.

Conclusion

Premara Financial is a sound bank with an experienced and well seasoned team.  A healthy loan portfolio and low overhead has allowed the bank to achieve profitability in the face of a poor lending environment and costly regulation. With share price to tangible book value trading at such a large discount, the margin of safety is sizeable.  With limited downside risk a prudent investor only requires patience.

Risks

• H.R. 1965 recently passed the House of Representatives 420-2. The bill raises from 500 to 2000 the number of shareholders a community bank can have before being required to go public.  If made into law this bill could potentially prolong a liquidity event.
• Poor liquidity and wide spreads in the bank’s stock
• Continued weakness in the economy and lending market
• Competition over competing loans, thereby eroding NIM.
• Regulatory burden and expenses