Two Thrift Conversions for Your Portfolio

One of the most profitable ways to invest in stocks is also one of the most boring. Mutual savings banks (a type of thrift institution) were first introduced in 1816 to serve low-income clients. They have no capital stocks and are owned by their members who share in profits and losses. When a mutual savings bank converts to a stockholder-owned bank, it generally does not attract a great deal of attention. 

Although the initial offering generally creates a gain for IPO buyers because of how the conversion process works, the offerings are usually oversubscribed by depositors, executives and the bank’s employee stock ownership plan (ESOP) or retirement plan. The general public does not generally get to buy shares in these offerings. Post-IPO, these are mainly smaller banks that are way off the radar screen of Wall Street and the vast majority of investors.

The mechanics of a thrift conversion are unique. If a thrift with $100 million of equity decides to convert to stockholder ownership, they might sell (ignoring offering costs) 10 million shares at $10 each. Post offering, there will be 10 million shares outstanding, but the equity will now be $200 million as the offering proceeds are added to the equity of the bank. Given the math of these offerings, it is easy to see why many bank stock investors and institutions keep deposits in the remaining thrifts around the country in hopes of eventually participating in an IPO.

Once the offering is complete, what we usually have is a smaller financial institution that does not attract a lot of attention from investors. Because of the additional equity capital bought in from the offering, many of the newly stockholder-owned banks trade well below book value. There is a change-of-control provision in the laws that prohibit a newly converted thrift from being acquired for the first three years of operation, so there is little buying interest from outside investors. They are too small for the larger institutions to be interested in the shares, and Wall Street does not usually follow them. The banks often fall into the corners of the market and are ignored by the vast majority of investors.

This creates a real opportunity for investors with the patience to hold the stocks for a few years. Buying those thrifts that were converted two years ago and are nearing the point where the change of control provisions expire can be quite profitable. This is even truer today where a combination of low net interest margins and higher regulatory costs make acquisitions the best way for most banks to grow their assets and earnings. Many of these recently converted banks have activist investors as shareholders who are campaigning for management to consider a sale to unlock shareholder value. If we look back to banks that converted in 2013, we find several banks that are selling at bargain prices and could be takeover candidates in 2018.

Westbury Bancorp Inc. (WBB) completed its initial conversion offering in April 2013. The bank, headquartered in West Bend, Wisc., has eight branches with about $797.4 million in total assets. Commercial real estate and single-family and multifamily homes make up about 83% of the loan portfolio, and management has done a good job of underwriting the loans. Some 0.03% of the bank's loans were  90 days past due (or more) or were non-performing loans. This figure is as of June 2017. The national average is 1.04%.

Most interestingly, Westbury delisted its stock from the Nasdaq exchange in October 2017, and set a deregistration date with the SEC of Jan. 15, 2018. Such a delisting can be a step toward either a takeover or a merger. Word of warning: Delisting sometimes indicates a company is going to declare bankruptcy. After its delisting, the company announced its sixth stock repurchase program. Such a move typically indicates management's confidence in the company.

Charter Financial Corp. (CHFN) also completed their initial conversion offering in April 2013. The bank is based in West Point, Ga. and has 20 branches spread across Georgia, Alabama and the Florida panhandle. As of September 2017, total assets were $1.6 billion. Charter Financial’s management took advantage of the credit crisis to purchase three banks with FDIC loan-loss sharing arrangements between 2009 and 2011 to expand their Florida and Georgia operations. 

Almost 70% of the loan portfolio is commercial real estate and single-family homes. It's latest earnings report shows earnings per share (EPS) growth of 20.3% over the previous year. The shareholder list includes bank stock specialists including FJ Capital and Banc Funds LLC. Charter Financial operates in a very competitive market, and they will either have to grow by acquiring more banks going forward or they could easily become a target for one of the larger banks growing in the regions. Bank M&A activity has been brisk in the Southeast, and is expected to continue.

Buying these boring little thrifts can lead to enormous profits. With takeover premiums for banks currently averaging 1.35 times book value, the upside from current prices is large enough to justify the purchase at current prices. Given that both banks are growing their book value and repurchasing stock, the potential profit is rising every quarter.

Disclosure: At the time of writing, the author owned shares in Charter Financial Corp and Westbury Bancorp Inc.