After reading a number of articles and blog posts last year, I became convinced that as a group the small community banks were cheap compared to historical trading levels and that there is a long trend of consolidation among these small banks that is likely to continue. That’s why I bought a basket of community banks. I think I have a rough idea of what I’m doing, but I’m obviously not a bank analyst.
That said, I also believe that if things are cheap enough, you stick to a simple quantitative approach and you take a basket approach, often you don’t need to be an expert to make a good bet. That is what I tried to do with Japanese net-nets and I think my basket of community banks should be seen in the same light.
There are currently 8 community banks in my portfolio. I will briefly discuss one of them today, Perpetual Federal Savings Bank (PFOH). The company trades over the counter.
Perpetual Federal Savings Bank (website) is a one office bank located in Urbana, Ohio. On Sept. 30, 2014 the company had assets of $346m and shareholders equity of $61.2m.
There are 2.47 million shares outstanding, giving the company a market cap of $49.2 million at the current ask price of $19.90. PFOH is currently trading for 80% of book value, which equals tangible book value in this case.
One-to-four family real estate loans make up 46% of the loans receivable. Non-performing assets have been below 3% since 2009, I don’t have data before 2009. The efficiency ratio has averaged around 35% in this period, which is very good for a small bank like this. I don’t know why PFOH has been able to operate at this efficiency ratio.
The bank looks overcapitalized. The equity to assets was 17.7% on Sept. 30, 2014. It has been above 15% since 2009. This has also led to a mediocre return on equity of around 4%-6% over the last six years. That is probably one of the main things that is holding down the valuation of PFOH in the market. One way to use excess capital would be to repurchase shares either on the open market or by way of a tender offer. The company has not done this in the last few years. Perpetual Federal does pay a nice dividend though. The latest quarterly dividend was $0.19, which would give an investor a 3.8% annual yield.
A positive is the insider ownership of the bank. Directors and officers collectively own 20.1% of the outstanding shares. The President and CEO Michael R. Melvin owns 6.6% . He is 70 years old, the chairman is 80 years old and many of the directors are also in this age range. I’ve heard that the chances of a small bank like this merging with a bigger bank increase when the CEO and Chairman are 60+ years of age.
One negative is that the bank had to make a $3.3 million charge to earnings in the 2014 fiscal year. Perpetual Federal loaned money to Urbana University, but the university has suffered serious financial problems for years and ultimately had no other option but to merge with another university called Franklin University. A few local banks suffered millions in losses in the process. Perpetual Federal Savings Bank was one of them. The alternative would have been to close the university and nobody wanted to do that. More information can be found in this article. I guess that is one of the dangers of operating a community bank. A strong sense of community that all community bank CEO’s seem to take pride in, can also lead you to make loans to institutions that are well respected by locals, but are at the same time financially unsound.
This charge impacted earnings for fiscal 2014. Net income was $2.7 million (EPS: $1.10) versus $3.9 million (EPS: $1.60) in 2013. The earnings record has been very consistent since 2009.
All in all Perpetual Federal Savings Bank looks pretty cheap to me at 80% of book value. The low non-performing assets, the consistent earnings and the strong capitalization of the bank make me believe that it should also be a fairly safe investment. As so often there is no obvious catalyst in sight, but I do think there’s a decent chance that a bank in my basket will be bought by a bigger institution. Perhaps it will turn out to be PFOH. I don’t have a great sense of what a bank like this would sell for in an acquisition, but I do think it would bring at least a modest premium to book value.
It is also possible that investor sentiment for community banks further improves, leading to increased market valuations for small, under the radar banks like Perpetual Federal. In the meantime an investor in PFOH gets a nice dividend while he waits.
Disclosure: long Perpetual Federal Savings Bank (PFOH)
Nice article, have you backtested this strategy?
What is your expected forward return?
Hi there, I’ve been enjoying the blog. In the 2015 annual report it says that almost all of the multi-family and commercial real estate loans in Franklin and Delaware Counties (33.6% of gross loans) are obtained through an outside loan originator. Perhaps this can explain why their efficiency ratio is so low, and at the same time raise the spectre of poor credit underwriting?
Have you been able to locate any financial data on the company around ~2007-2009 when credit across the country performed poorly and observed their performance? (I haven’t been able to) Perhaps their satisfactory results the last few years have been a result of an exceptionally benign credit environment?
Mike, thanks for the comment. The outside loan originator could explain the efficiency ratio.
I don’t have much information about their performance in the 2007-2009 period. The 2012 annual report does provide some selected financial data about 2009. NPA were fairly low at 1.89% in September 2009. That makes me think that they did not have major problems during the financial crisis, because that would likely have resulted in a much higher level of non-performing assets at that date.
Their return on assets was well below 1% during 2009-2012. Perhaps the market is skeptical of the company maintaining the profitability of the last couple of years. If they slip back to a ROA of around 0.7% then the current valuation looks far more reasonable.
Update: PFOH is being acquired by Farmers & Merchants Bancorp, Inc. (FMAO): https://www.globenewswire.com/news-release/2021/05/04/2222851/0/en/Farmers-Merchants-Bancorp-Inc-Announces-Agreement-to-Acquire-Perpetual-Federal-Savings-Bank-of-Urbana-Ohio.html
Shareholders can choose between a cash consideration of $41.20 or stock consideration of 1.7766 shares of FMAO (subject to adjustment based upon 1,833,999 shares of FMAO to be issued). At current prices, I think the total consideration amounts roughly to a value of ~$40.00. That would be around 1.25x book value on March 31.