I saw a bank that said "24 Hour Banking"... but I don't have that much time. 

-- Steven Wright --

...Nor do we have enough time to wade through the balance sheets of Wells Fargo and B of A, while America's thrifts continue their IPO parade.

A few weeks back, I wrote up Wolverine Bancorp (WBKC) for this web site.  While I was leaning towards posting something on a cheap tech company I've been following that trades for around cash, the recent Citigroup posting has made the posting of yet another cheap thrift nearly unavoidable.  No offense to the Citi-poster, Firmgmt, but the once in a lifetime opportunity in the converting thrift space makes investing in a balance sheet as complicated as Citi's a non-starter for us cheap-os.

Need a refresher?

Here is a quick summary of why newly public thrifts have come public to begin with and why their shares are so cheap:

Q: Why are thrifts that don't need capital coming public?

A:  Because of a rule change: 

Details:  Sometime this summer, the Office of Thrift Supervision (OTS), which has served as the regulator of federally chartered thrifts for over 20 years, will disappear and the Federal Office of the Comptroller of the Currency (OCC) shall assume regulatory oversight for banks currently under the OTS umbrella.  The OCC is seen as a far more stringent regulator than OTS.  Thrifts are "seizing the opportunity of regulatory realignment to convert to stock ownership under the rules before they change, or may change" ie coming public before the OTS/OCC rule changes go into effect.

A:  Few buyers remain:

Details:

o   Small cap financials have been in a five year bear market.

o   Sheer enormity of paper that's been issued by big names like Citi, Bank of America and others.

o   Depositors, who are offered a first crack at shares, are not the rabid buyers of new issues that they used to be.  Whereas pre crisis, many offerings enjoyed oversubscription by deposit holders, nowadays it is hard to get the average depositor interested in anything other than the safety of his deposit.

Few buyers, coupled with a money raising IPO to get public before a rule change, means banks have capital they don't need:

YES !

o   These banks are not raising capital to shore up their balance sheet.  They are doing it to get public, fast.

o   This combo leads to steep discounts to book value and high levels of overcapitalization.

Other reasons to be excited...

1.  Management invested alongside us:

o   In almost every single one of these new issuances, Management is a significant buyer of stock in the offering.

o   These mgmt teams are not high powered Wall St bank executives, ie in many cases their stock investment is significant in relation to their comp.

o   Management is also given options at the IPO price:  thus they are incentivized to bring costs down.

2.  A huge wave of consolidation is coming:

o   U.S. one of the most overbanked places in the world.

o   Regulatory change means it will be very expensive to 'go it alone' as a small institution given the levels of systems, capital and controls that you will need in place.

o   Newly public banks have 3 years from the IPO date to sell themselves.

o   American Banker "The prospects of growing revenue are dim as loan demand remains weak and regulatory changes threaten to clip fee income.  For bankers, the potential workload looks exhausting."  <May 3 2011 issue>

o   Stern Agee published the results of a study they conducted which tracked all standard and second step conversions since 1982 through the present day.  Stern discovered that standard conversions came public priced at 67% of TBV on average, while second step conversions issued shares at 90% of TBV.  Subsequently, 60% of all 504 conversions analyzed by Stern Agee were sold.  Converted banks were sold at an average deal price that was 164% of TBV. < Report date: Jan 24, 2011>

o   In some cases, Joe Stilwell, of The Stilwell Group, is a 13-D filer on these small banks.  Stilwell has a long history in the small bank-activist space, and has worked to unlock value at several publicly traded thrifts.

4.  Political wind blowing in favor of the sector:

o   "These [small banks] are politically favored entities right now. People hate Wall Street. People hate Bank of America. Nobody hates First Federal Savings & Loan of Wichita." < Grant's Interest Rate Observer (Oct 29, 2010 issue)>

Now that this summary/refresher is all cleared up, let me introduce you to:

SUNSHINE FINANCIAL INC

Sunshine is fairly 'plain vanilla', attracting retail deposits from the general public and investing those funds, along with borrowed funds in loans secured by first and second mortgages on one- to four-family residences, lot loans and consumer loans, including home equity, automobile, and credit card loans.  At September 30, 2010, the loan portfolio was comprised of 79.9% one- to four-family loans (including home equity and residential construction loans), 7.54% lot loans, 2.8% automobile loans, 7.2% credit card and other unsecured loans, and 2.7% other consumer loans. 

Sunshine Savings Bank's share of deposits in the Tallahassee, Florida Metropolitan Statistical Area was approximately 3%.  Tallahassee is the state capital and home to Florida State University, Florida A&M and Tallahassee Community College and is significantly impacted by government services and education activities. The bank's primary market area includes a diverse population of management, professional and sales personnel, office employees, manufacturing and transportation workers, service industry workers and government employees, as well as retired and self-employed individuals. The population has a skilled work force with a wide range of education levels and ethnic backgrounds. Major employment sectors are government; education, health and social services; retail trades; professional & business services; leisure & hospitality services; and financial services.

Make no mistake.  The Tallahassee market is as oversupplied as any other in Florida, and this investment is by no means a proxy for calling a Florida real estate bottom.

But Florida could be looking up...

Just 2 months ago, JP Morgan Chase announced an aggressive expansion into Florida.  This follows an awful 2010 for the State, when it lead the entire US in bank failures.  Wells Fargo has been busy converting Wachovia branches in the State, and real estate bargains are attracting new buyers, albeit slowly.  Recent reports point to a growing number of foreign buyers flocking to the Florida property market to take advantage of low prices.  Florida did see a decline in the number of foreclosures from 9,353 in March to 8,224 in April of this year; a 12% drop. Of the ten top Florida cities of foreclosures, only Jacksonville had an increase (less than 1.4%) from March to April.  With a third of all new U.S. branches that Chase builds getting built in Florida, banks like Sunshine could make attractive acquisition targets.

Here are some financials:

Keep the following in mind...For each of these periods noninterest expense exceeded net interest income.  Thus, the bank relied on noninterest income in order to generate net income. Several events have pushed noninterest expense higher in recent years:

-          Expense incurred from the transition to a full-service retail bank from a credit union.

-          The cancellation of our proposed sale of sale of stock in 2008.

-          Severance expenses in 2009 related to our branch closing and reduction in personnel.

We don't need Sunshine to earn a ton, but it would be nice if they didn't lose money.

Our cost: $0.56 (as a percentage of book)

Average ROE: 1.5%  (Yes, we think this is achievable given a combination of expense reduction and intelligent deployment of the IPO proceeds)

Starting Book Value: $1.00

Year One: $1.015

Year Two: $1.03

Year Three: $1.045

Year Four: $1.061

Year Five: $1.077

Target Sale Price:   .9x Book in Year 5 (the averages tell us it should be higher than this, and if Sunshine can earn some money it will be, but for now we will play it ultra conservative)

Sale Price = $.969

Return = $0.41  ($0.969 - $0.56)

IRR ~ 11.5%

If the bank were to be acquired for book in year 5, the IRR would be 14%

***

Newly public banks can sell themselves after a 3 year moratorium, and given our consolidation thesis, we think that something closer to 3 years would be more likely than something closer to 5. 

The ever-present activist Stilwell did indeed file on Sunshine on April 18th 2011 (9.7% stake).  A link to his filing can be found here:  http://1.usa.gov/iib0xM 

Share buybacks or dividends would also increase the IRR, and one would hope that managment would take a look at that should no other opportunities present themselves.

11-14% IRR on an equity may sound light, but in lieu of what we think is strong downside protection (plus, this name is part of a portfolio of these), we find it attractive if sized appropriately.

***

To sum up, we have:

- an IPO that nobody really needed.

- High insider ownership.

- Huge discount to book with high level of tan equity/assets and low levels of non performers.

- Activist shareholder with a large stake.

Coupled with:

- All of the industry elements we outlined in the beginning of this post.

Once again, we are not calling a Florida bottom, but the signs for consolidation are stong.  Let's not forget demographics either.  As Jerry Seinfeld once said "My parents didn't want to move to Florida, but they turned sixty and that's the law."