Description

Territorial Bancorp is a $260MM market capitalization, $2.1B asset bank holding company based in Honolulu, Hawaii. The company is a legacy demutualization, completing a standard conversion in July of 2009. TBNK is largely a “traditional” thrift with approximately 97% of the company’s $1.6B loan portfolio consisting of 1-4 family residential loans secured by property in Hawaii. Territorial operates 29 branches with 24 located in Honolulu County. TBNK is the fifth largest bank in Hawaii with a 3.8% deposit market share in aggregate. The company has branches on the islands of Oahu, Maui, Kauai and Hawaii. 

Territorial traces its roots back to 1921 when ten individuals joined together to establish the Kaimuki Building and Loan Association. The company had severe credit issues in the 1980s as a result of a poorly executed expansion into CRE lending on the mainland. The current management team led by Allan Kitagawa (CEO), Vernon Hirata (Vice Chairman/Co-COO/General Counsel) and Ralph Nakatsuki (Vice Chairman/Co-COO) joined Territorial in 1986 from American Savings bank and turned around the company by pulling back from the mainland and largely sticking to their core “bread-and-butter” business of operating as an SFR portfolio lender in Hawaii. 

The investment thesis for Territorial is based on the following points: 

• Territorial is a solid absolute value trading at 109% of TBNK, 12x EPS, and a total dividend yield (including special dividends) over 4%. Despite sound operational performance, TBNK trades at a discount to its peers, driven by its Hawaiian domicile and non-promotional management team. 

• Territorial is a high quality institution with pristine credit quality and a fortress balance sheet. The company had peak charge-offs of 9 basis points in 2010 and non-performers topped out at 37 basis points of assets in 2013. Earnings increased from $5.7MM in 2007 to $7.2MM in 2008 to $8.9MM in 2009 to $11M in 2010. A recession and credit cycle will not materially alter earnings power and if anything could lead to an eventual revaluation. Territorial has a 12% TCE ratio and an RBC ratio of 25.6%. 

• Territorial has a solid management team that is highly compensated in a change in control. TBNK will continue to grow TBV while paying out an attractive current yield and there will likely be a healthy takeover premium at some point. CEO Allan Kitagawa is 73 years old and his lieutenants, Vernon Hirata and Ralph Nakatsuka are 66 and 63. Kitagawa is paid $7.8MM in a change in control while Hirata and Nakatsuka are paid $4.9MM and $4.4MM. 

Business Summary: 

Territorial Savings Bank is a Hawaii-state-chartered savings bank and is the wholly owned subsidiary of Territorial Bancorp. The company provides financial services to individuals, families and businesses through their 29 banking offices located throughout the State of Hawaii. 

TBNK’s business primarily consists of accepting deposits from the general public and investing those deposits along with funds generated from operations and borrowings in one-to-four family residential mortgage loans and investment securities. To a far lesser extent, the company also originates home equity 

loans and lines of credit, construction, commercial and other real estate loans. Territorial offers a variety of deposit accounts, including passbook and statement savings accounts, certificate of deposits, money market accounts, commercial and regular checking accounts and Super NOW accounts. TBNK has a small insurance brokerage subsidiary – Territorial Financial Services Inc. They also offer non-deposit investment products to their customers including annuities and mutual funds through a third-party broker dealer. TBNK conducts business from their corporate offices and from 29 full service branch offices in Hawaii. 

Balance Sheet & Earnings: 

Territorial has a clean and simple balance sheet that reflects the company’s thrift heritage. Total assets are $2.1B with a loan portfolio of $1.6B. The company’s loan portfolio is made up of 97% one-to-four family residential mortgages with fixed rates. The stock has been out of favor over the last several years because TBNK’s business model is largely funding fixed rate mortgages from customer deposits. Below is a summary of the company’s loan portfolio. 

TBNK’s security portfolio is made up entirely of U.S. Government sponsored MBS with $13.3MM classified as held for sale and $356MM classified as held to maturity. In aggregate, Territorial’s loan portfolio has a 4.02% yield and their securities portfolio has a 3.10% yield. The average yield on total interest earning assets was 3.82% at 6/30. 

Territorial has a deposit base of $1.6B, or a loan to deposit ratio of 99%. Savings accounts with an average rate of .49% account for 59% of deposits, CDs with a 2.02% rate account for 29% of deposits and Checking/Now, accounts account for 12% of deposits. Total costs of deposits are 88 basis points, which is well above market for Hawaii. Other liabilities include FHLB advances of $122MM and securities sold under repurchase agreements of $10MM. Aggregate cost of interest bearing liabilities was 1.03% and Territorial reported a 2.93% NIM in the second quarter, down 11 basis points year over year. 

Historically Territorial has reported a reasonably stable net interest margin ranging between 3.05% and 3.55% since becoming a public company in 2009. The company reported lower NIMs of 2.78% and 2.48% in 2006 and 2007 but the balance sheet had a far different composition at that point with the securities portfolio accounting for 48% and 46% of assets relative to 18% of assets. 

I am modeling the NIM compressing from 3.05% in 2018 to 2.94% in 2019 to 2.8% in 2020 with a rebound to 3.0% in 2021. The charts below display TBNK’s historical NIM as well as the company’s NIM contrasted with the preceding year-end 3mo/10yr curve. I anticipate lower FF rates and a steepening yield curve eventually translating into margin expansion over time. 

Non-interest income is minimal for Territorial. A “core” run rate for the company is between $750K and $1MM quarterly in non-interest income excluding securities gains. Territorial reported a full year efficiency ratio of 59% in fiscal 2018. While not optimal, the company has shown consistent improvement from the 74% reported in their historical filings in 2007. 

I have modeled earnings of $2.26 in 2019, falling to $2.00 in 2020 on NIM compression to 2.8% and then rising to $2.62 in 2022 as the company’s NIM rebounds to 3.00% and earning assets grow at a low single digit rate. 

Looking back, Territorial has been profitable each and every year that historical financials are available. Earning assets have increased at a 4.9% CAGR since the IPO while loan growth has been a more impressive 11.45%. Tangible book value has increased at a slow 3.5% CAGR with “total value creation” (TBV growth + dividends) growing at a 6.1% CAGR. EPS growth has been 11.5% since the IPO. 

Credit 

Territorial has pristine credit. This is a result of their singular focus on disciplined mortgage underwriting in their home market of Hawaii. TBNK is one of the few institutions where losses did not materially rise in the prior cycle despite 7%+ unemployment in Hawaii and falling house prices. Year-to-date charge- offs have been $3K (thousand). They have no loans past 90 days due. Non-accruals are $892K. Credit losses will not be an issue in a recession. While other banks are beginning to see initial problems in their SNC portfolios or in some commercial construction, TBNK's credit remains pristine. The below charts convey how Territorial has historically compared to the bank industry. 

Hawaii 

Hawaii is known as a “business-unfriendly” state with slow growth, significant regulations, an extremely high cost of living, and steep taxes. While all of these may be true – Hawaii is actually a great banking market for several specific reasons. The banking market in Hawaii is unique in that none of the large national banks is present. The market is dominated by local competitors with the top six players combining for 97% of deposits. First Hawaiian and Bank of Hawaii are the dominant institutions in the state with a combined 67% deposit market share. Banking, like most commodity businesses, is ultimately about supply and demand and the concentrated nature of the Hawaiian industry has lent itself to an environment of sticky, low cost deposits, good efficiency, and better than average credit quality. Ultimately, competition is more rational in Hawaii and the economy, while admittedly slow-growth, has shown more stability then the aggregate U.S. economy. Considering the extreme remoteness of Hawaii and the fact that it has only 1.6MM residents – the state of affairs is unlikely to change and the banking environment is likely to remain positive.

Valuation 

Territorial is an attractive absolute value at 109% of tangible book value, 12x estimated 2019 EPS and 13x estimated 2020 EPS. The company allocates capital in a disciplined manner with a goal of returning 100% of earnings to shareholders through share repurchase and dividends. Territorial will allocate more capital to share repurchases if the stock is discounted and more to dividends if the stock has appreciated. Territorial could easily operate with 7.5% TCE and still be overcapitalized. This basic math implies that easily $85MM in excess capital that could be used to repurchase stock. 

Territorial has a base dividend of 22 cents quarterly or 88 cents annually – a 3.3% implied yield. Over the last twelve months the company paid out an additional 30 cents – thus an aggregate trailing yield of 4.3%. Territorial has a new $5MM share repurchase authorization. Since the company’s conversion they have repurchased 28.6% of their original outstanding shares. 

Management 

Territorial has been managed by the same team since 1986 with CEO Allan Kitagawa and Vice Chairman/Co-COO/General Counsel Vernon Hirata and Ralph Nakatsuki (Vice Chairman/Co-COO) as the top three executives. As noted earlier these three executives are poised to receive substantial payouts in a change-in-control transaction. That noted, I recently spent time with the management team and they are very engaged and appear content to continue to execute their simply and consistent strategy. There is no succession plan at Territorial and the youngest named executive is 63 years old. The youngest board member is 60-year old Jennifer Isobe. Insider ownership is 8.5%. Management does not hold quarterly calls and does not attend industry conferences. The IR presentation on their website is from 2015. 

Looking at M&A, the mean P/B valuation for West Coast transactions since 2014 are 1.52x and the mean PE ratio is 25.5x. Hawaiian deals have been extremely sparse with no deals in the last five years. That noted, ultimately banks (and companies in aggregate for that matter) are sold, not bought – and the probabilities point to an eventual takeout. 

Below are several additional comp sheets comparing TBNK to Proxy Peers, West Coast Peers, and Hawaiian peers. The company is discounted relative to all peer groups. 

Risk Factors 

The most significant risk factor for Territorial is interest rate risk. If long-term interest rates “go negative” this will pressure Territorial’s NIM. While historically this would seem like an absurdity, that is certainly no longer the case at this point. I do not consider credit quality a material risk to Territorial and believe this is an ideal bank security for this stage of the credit cycle with elevated recession probabilities.

Catalyst

• Continued book value compounding
• Shareholder friendly capital allocation
• Revaluation post credit cycle
• Yield curve steepening
• Takeover