A Catalyst for Returns
A Profitable Small Bank Trading At A 15% Discount
This article is the second of a series of deep dives into promising mutual savings conversions. I wrote a quick overview of mutual savings conversions and listed out some interesting names in previous articles.
The classic mutual savings conversion is cheap and durable but not very profitable.
It eventually gets acquired by a larger bank that can eliminate redundant costs and achieve more attractive returns on its assets.
Today’s bank is not only cheap and durable but also becoming increasingly profitable.
While it trades at 0.98x of its tangible book value (TBV), its quality should command a premium. Valuing a bank is not an exact science, but it wouldn’t be unreasonable for this bank to get acquired at a 15% premium to book value (1.15x TBV).
The Business
Catalyst Bancorp (CLST) is the holding company for Catalyst Bank. Formerly known as St. Landry Homestead, Catalyst has been serving South Louisiana for over a hundred years.
Until recently, Catalyst was a more-or-less straigthforward mutual savings conversion investment candidate. It was trading at 0.77x TPV and looked pretty strong across the board.
Then it acquired neighboring Lakeside Bank for $41M last month. This transformed it from a super-safe but somewhat innefficient small bank into a bank with less excess cash but a much higher profitability potential.
Whether this opportunity works great or just okay will come down to how much more efficiently the now larger bank can operate, and how fast it can get there.
If management reaches its efficiency ratio (overhead divided by revenue) goal, the combined entity will achieve close to 12.5% return on equity (dollars of profit per dollar of book value) within a couple of years.
This is after removing almost $19M in excess capital (~28% of the market cap), which could be returned to shareholders.
Needless to say, if we are going to deploy capital here, we need to be very comfortable with management’s ability to execute on integrating Lakeside into Catalyst.
Management’s track record gives me some comfort. CEO Joseph B Zanco has previous experience acquiring and integrating banks as CFO of Home Bancorp.
He was there between 2008 and 2020. Over his tenure, he grew TBV per share at an average rate of 5.8%, with double-digit TBV step-ups on the second year after each of the two acquisitions the bank made during this time.
By the way, Home Bancorp has continued making acquisitions since he left (last one in 2022) and is one of several potential acquirers for Catalyst.
Management also collectively owns 20% of the company, and has been buying more shares in the open market over the years. Their interests should be aligned with those of minority shareholders like us.
The Catalyst
If last week’s bank passed this test with shining colors, Catalyst is easily at the top of the class.
Its M&A window is already open. While management seems more focused in increasing the value of the bank than in shopping it, an offer could arrive any day.
There is an activist involved. Stillwell, a well-known mutual savings conversions specialist, owns 6.4% of shares. Its influence will be helpful in unlocking value for shareholders.
It is actively buying back shares (~6.5% of shares bought back over the past 12 months). I explained why buybacks below intrinsic value are a good thing in a previous article.
I get the feeling management had a plan when they renamed the bank ‘Catalyst’ after its conversion.
The Risks
“Risk comes from not knowing what you are doing” — Warren Buffet
Catalyst’s setup is complicated by their recent acquisition of Lakeside Bank. This creates more opportunities for being wrong.
I could be wrong about the premium. Our entire margin of safety here comes from my assessment of the premium to book value an acquirer is likely to pay for CLST.
This is based on current market valuations for other small banks and recent transactions in the area, but it is only an estimate.
Interest rates could go up. This would make the mortgage portfolio less valuable. It is less of a concern here since shorter-term commercial loans make up a large chunk of CLST’s portfolio.
The acquisition could drag out. The M&A window has been open for roughly two years, which could point to a lack of interest to sell.
Stillwell’s involvement is a risk mitigant here. Also, this would give more time for synergies and buybacks to work their magic. Owning a safe bank earning a 12.5% ROE is not a bad prospect.
Integrating Lakeside Bank could go poorly. It wouldn’t be the first time a mutual savings bank’s cost structure becomes bloated after an acquisition. CEO Zanco’s track record is the mitigating factor here.
Credit risk losses from the growing commercial loan book could rise.
CLST’s loan book used to be 50% commercial / 50% mortgage-based before the acquisition. Lakeside ran an even higher commercial concentration at 70%.
This can be a source of concern as commercial loan portfolios, especially commercial real state loans, have a way of blowing up on small banks.
However, both banks have been running a high commercial loan concentration for a long time and seem to know what they are doing.
What about natural disasters? Catalyst Bancorp is headquartered just 150 miles from Fifth District Bancorp. If you read last week’s article, you may be thinking that we have failed at diversification. However, natural disasters are less of a concern here since it’s further inland and not in a high-flood risk area.
The Verdict
“I would argue that one filter that's useful in investing is the simple idea of opportunity cost.” — Charlie Munger
When I make investment decisions, I look for situations with very limited downside and material upside. And even then, I need to compare the opportunity at hand with all other opportunties available (within reason).
CLST is almost there for me. But given the merger integration risks, I would like to see a margin of safety of more than 15% before parting with my hard-earned money. Otherwise, I believe I should be able to find an even better opportunity elsewhere.
This is a very personal assessment to make. For instance, if mutual savings banks are the only types of companies you feel comfortable researching and investing in, then Catalyst could be a very solid addition to your portfolio.
I will nevertheless keep watching and consider buying in the future if the price point drifts down, especially if synergies seem to be materializing. It could be a good place to park some cash while I continue looking for better investments.
In addition to the other interesting mutual savings banks I mentioned in this article, I am researching another company (of the rarer ‘quality’ species) that will deserve its own article soon.
I expect to be back next week with another idea to share.
In the meantime, happy hunting!
The Lynx Investor is for informational and educational purposes only. Nothing published here constitutes financial advice or a recommendation to buy or sell any security. I am not a registered investment advisor. Always do your own research and consult a licensed financial professional before making investment decisions. I may hold positions in securities discussed.
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