Sugar Creek Financial Corp. (OTC:SUGR)

Last week I bought a few shares of a very small community bank called Sugar Creek Financial Corp. (OTC:SUGR). This position is part of a basket of micro-cap community banks with similar characteristics. I hope that some of these small banks will be acquired at some point. So the basket is mostly a bet on the continuing consolidation in the community bank space.

Individually none of these banks can be counted on to work out very well. You simply don’t know which ones will be acquired, or when. So concentrating your investments is probably a bad idea, but I think a basket approach works pretty well in this situation. SUGR has many of the things I look for in the banks in my basket: a large discount to tangible book value, small size, a bank activist that holds a substantial stake and some insider ownership.

Here’s some summary financial data about SUGR:

Share price: $10.25
Outstanding shares: 785,192
Market cap: $8.05m
Tangible book value: $11.8m (June 30)
Price / tangible book value: 0.68x
Total assets: $96.1m
Equity to assets: 12.3%
Non-performing assets: 0.96%

SUGR is marginally profitable with net income of just $91k in fiscal 2019 (ended March 31, 2019) and $143k in fisc. 2018. SUGR is the holding company for Tempo Bank, which does business in Trenton, Illinois. SUGR’s loan book is concentrated in single-family, owner occupied real estate, which made up 84% of their total loans of ~$86m on March 31. The company only has $96m in total assets which makes it an extremely small bank, even among OTC listed community banks.

The bank’s deposit base is not attractive. SUGR only had $5.5m of non-interest bearing deposits on March 31, and $40.6m of certificates of deposit on which they paid a 2.09% weighted average rate in fisc. 2019. Other banks are always looking for attractive deposit bases when they’re evaluating potential acquisitions and this is often reflected in the premiums they are willing to pay. Banks that are interested in acquiring SUGR are not going to pay a large premium over book value.

In April, 2014 SUGR completed its “second step” conversion in which the Mutual Holding Company (MHC) converted to a stock holding company. There are some rules that provide limitations around share buybacks and selling the company after a conversion. I think the restriction for a sale after a conversion is three years. So if management wants to sell the make, it should now be possible to do so.

Activist and insider ownership

It always helps to have an activist bank investor in a small bank like this. SUGR has one in Terry Maltese, whose Maltese Capital Management holds 10.1% of the outstanding shares. SUGR is only a rounding error in their total portfolio of bank stocks though, so it is probably not a top priority for them to realize value here. That said, they do own it and Maltese probably wants to see the bank sold at some point.

Insiders owned 11.9% of the outstanding shares as of June 28, 2019.

Stilwell activism in 2015

In March, 2015 another well known bank activist, Joseph Stilwell, had a position in SUGR as well. In their 13D-filing the Stilwell funds said this:

Our purpose in acquiring shares of Common Stock of the Issuer is to profit from the appreciation in the market price of the shares of Common Stock through asserting shareholder rights. We do not believe the value of the Issuer’s assets is adequately reflected in the current market price of the Issuer’s Common Stock.

We hope to work with existing management and the board of directors to maximize shareholder value. We encourage the Issuer to pay dividends to shareholders and, at such time as the Issuer is permitted to repurchase shares of outstanding Common Stock with excess capital, we encourage management and the board to do so. We oppose adding a branch until the Issuer has consistently earned a normalized return on equity and until the stock trades above book value.

Share buybacks

How did SUGR respond? By buying back $1.1m of stock at $11.78 per share. Most of these buybacks took place during fisc. 2016. This buyback program was completed in fisc. 2017.

This was followed by another buyback in fisc. 2018. The Stilwell funds sold their stock to SUGR in this buyback in July, 2017. A quote from that filing:

We are filing this Second Amendment to report that the Group has sold its shares of Common Stock. We believe management and the board of directors acted in good faith to maximize shareholder value through share repurchases.

On page 19 of the filing you can see that they sold most of their stock at a price of $13.90.

And this is from SUGR’s fisc. 2018 annual report:

During the year ended March 31, 2018, the Company repurchased 73,335 shares of common stock at an average price of $13.89 per share.

The fisc. 2017 annual report shows that book value was $12.4m as of March 31, 2017. At a buyback price of $13.90, the company paid very close to book value (0.96x) for its shares in this buyback. These levels are well above today’s share price.

The company still has a bit of room to buy back stock. This will probably happen slowly over time. SUGR spent just $55k in fisc. 2019 (avg. price $12.61) on buybacks, but it’s likely they are more interested in buying back stock at current levels.

Conclusion

I think SUGR is a good addition to my basket of community banks. It seems like a decent bet that management will sell the bank within the next few years. They listened to the request made by a bank activist and bought back a lot of stock in the last few years. That probably means they are open to the idea of selling the bank. If this is not the case, they probably would have made a stand against Stilwell instead of shrinking the bank’s capital base through these buybacks.

I could be wrong about this. I invested in Home Bancorp Wisconsin (OTC:HWIS), which was company 2 on VIB premium. The company was selling below book, someone with some history of activism had a substantial stake and the bank was sub-scale. It just seemed a matter of time before they sold to a larger bank. In May 2019 an unpleasant surprise was announced: the company completed a ~$4m private placement at a price of $9.75 per share. Fortunately I was already out of the stock by then, because the stock had moved close to book value at some point. But I did not expect HWIS to raise capital and to try to grow the bank. I don’t think that capital raise will lead to an attractive return for shareholders.

For an outsider like me it’s very tough to get an idea what is going on at a small bank thousands of miles away. One thing that concerns me a little bit is that there was quite a bit of volume in SUGR’s stock last week. The company just held its annual meeting. It is possible that something was said at the meeting by SUGR’s management that indicates they are not open to a sale of the bank. I wasn’t there and do not know.

Any sale of SUGR will not happen at a large premium to book value. SUGR is very small, has almost no earnings and does not have an attractive deposit base. I don’t think it has any major issues though. It could probably fetch a small premium to book value. If SUGR is sold for 1.1x book value, it would be a 61% premium to today’s price.

Disclosure: long Sugar Creek Financial Corp. (OTC:SUGR)