Fifth Goes First
A Pristine Mutual Savings Conversion Trading At 0.7x Tangible Book Value
This article is the first 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.
What better way to start this series than with what may be the cleanest example of the bunch. While not a perfect cinch, this mutual savings conversion checks most of my boxes. I even like the town it serves.
Let’s take a look.
The Business
Fifth District Bancorp (FDSB) is the holding company for Fifth District Savings Bank, a federally-chartered savings bank that conducts its business from its main office and six branch offices located in the Greater New Orleans area.
FDSB fits the “boring’” mutual savings stereotype to a tee. Its portfolio is full of conservative mortgages (83% of loans), and credit losses are virtually non-existent. Home prices have been holding up well in the neighborhoods it serves.
It is vastly overcapitalized, with an equity/risk-weighted assets ratio of ~40%. 10% would be considered solid. This means it can absorb a lot of losses before getting in trouble.
It has a decent net interest margin (the difference between interest earned on loans and interest paid on deposits) and manages to earn a modest profit despite its lack of scale.
The CEO, Amie L. Lyons, is a Fifth District Savings Bank veteran of almost 30 years. She was recently promoted with no previous CEO experience.
I like CEOs of mutual savings banks I invest in to have a successful track record leading small banks, so this is not ideal. But it is not a red flag either.
All officers and directors have been at Fifth District for at least 10 years and achieved a ~2.4% book value CAGR (annual growth rate) since 2010.
Not the stuff of legend, but we are not looking for the next NVIDIA here.
Lastly, management owns ~19% of the company. This is important, as they are less likely to burn the bank’s capital making poor investments if their own money is on the line.
In short, the bank looks unimpressive but solid.
The Value
As of this writing, FDSB trades at 0.72x tangible book value.
This means we’d expect a larger bank to pay at least 35% more than the current $17.64/share to acquire FDSB, and possibly a good deal more.
Now how do we get our hands on the money?
The Catalyst
This is where this small savings bank story shines.
Its M&A window opens in just 12 months. This means that it could be aquired by a larger bank in as few as 12 months. There are several acquisitive banks in the area that could be interested in snatching FDSB.
There is an activist involved. Stillwell, a well-known mutual savings conversions specialist, owns 1.5% of shares. Its influence will be helpul in bringing about a prompt sale.
It is actively buying back shares (~5% of shares bought back over the past 12 months).
Better yet, an additional $18M in cash seems to be set aside at the holding company, ready to be deployed into buybacks.
At current prices, that would be enough to retire another 19% of shares.
As a quick aside, if you are wondering why this is a good thing, here is an example:
If you pay $25M to buy half of a bank with $100M in book value and later the bank gets acquired for $100M, you make $25M (your $50M cut of the $100M sale price minus the $25M you paid). Not bad.
But if the bank first uses $25M of its book value to buy out all the other shareholders and then gets acquired for the remaining $75M, now you get to keep all the money and make $50M (the full $75M from the sale minus the $25M you paid).
If that wasn’t very clear — sorry — the important thing to remember is that buybacks at prices below book value can be a very good thing.
The Risks
You knew this section was coming. There are a few risks worth mentioning.
Interest rates could go up. A big part of what we are buying is a portfolio of mortgage loans. If interest rates go up substantially, this portfolio could be worth a lot less.
After all, who would want to buy a mortgage loan from us if they can lend money to the government risk-free and make just as much?
To be more specific, if interest rates go up 2%, the entire 25% discount we are getting on the book value would be gone.
Another risk is that the acquisition drags out or never happens. This is not the end of the world, since it would give more time for the buybacks to play out.
In addition to these standard mutual savings conversion risks, we also need to worry about natural disasters.
All those mortgages are secured by real estate in a high-risk weather zone. A bad storm season could trigger substantial credit deterioration.
While this is a real concern, the bank’s balance sheet is extremely solid and could withstand a lot of stress.
The Verdict
I have invested in FDSB, so that tells you what I think about it. While I bought my shares around $15, I think it is still a compelling opportunity today.
Nevertheless, I wouldn’t invest more than 5% of my capital into this kind of business.
When other compelling opportunities are available, risks like natural disasters make it so that it is better to diversify.
What other compelling opportunities you ask? Well, that is a question for next week…
In the meantime, happy hunting!
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