Community Bank Consolidation (Part 2)
Identifying community bank takeover targets
Reading Time: ~ 10 minutes
Last week, I published an overview on the community banking sector and made a case for an acceleration in consolidation. In summary:
Structural margin pressures persist (driven by technology and regulatory costs) as the yield curve remains flat and interest rates remain low.
Larger regional and super regional banks are experiencing the highest level of consolidation in 25 years, putting additional pressure on smaller banks.
Community banking remains incredibly fragmented despite a largely commoditized product offering.
Up to 30% of fixed costs can be eliminated in merger transactions.
Despite regulatory concerns, there appears to be no deceleration in activity. Last week, three publicly traded banks were acquired. As long as banks continue to announce transactions, investors can mitigate regulatory risk by selling after a transaction announcement but before closing, if they find themselves fortunate enough to hold a takeover target.
I mentioned last week how recent changes by the Federal Reserve on bank ownership restrictions had potentially enabled increased investor activism. And it was precisely the presence of an activist investor that first piqued my interest in a community bank based in Philadelphia: Republic First Bancorp (FRBK).
Since its launch in 2018, Driver Management has targeted undervalued banks and fought to drive shareholder value through active engagement with management, directors, and other shareholders. And the activist has been a good harbinger of takeover activity: out of four activist campaigns, two have resulted in a bank sale or merger. Now, Driver Management is in the midst of a proxy battle at Republic First Bancorp as it agitates for a sale.
Our community bank takeover targets, like Republic First Bancorp, have a couple of other attributes that benefit the investment thesis:
Smaller companies are more likely to be takeover targets.
Smaller companies tend to display higher structural inefficiencies than the largest and most liquid companies.
Community banks trade at a discount to the broader market (the ABA Nasdaq Community Bank Index trades at ~13x P/E vs. ~24x for the S&P 500).
Community bank investments also come with unique risks. They are often thinly traded, so it’s important to be aware of the daily volume, use limit orders to drive reasonable price execution, and exercise patience when entering and exiting a position.
Before I jump into my picks, here’s an overview of valuation levels in the community banking sector to help frame the discussion:
Community Bank Valuation Overview – Price to Book
Community Bank Takeover Targets
Prices as of 3/9/2022
CF Bankshares (CFBK) – $20.50
Major shareholders, Board members, and management all have significant “skin in the game” – aligning incentives in this high performer with branches in attractive metro markets.
CFBK currently trades around the median multiple for community banks, despite above-average performance metrics. Today, an acquirer could offer $26 - $30 per share without stretching on valuation or underwriting substantial synergies. Here are a few reasons I believe CFBK is a likely takeover target:
Castle Creek Capital, an alternative asset manager focused on the community banking sector, led a private placement in CFBK in 2019. Castle Creek owns ~25% of the Company (split between voting and non-voting common stock to satisfy ownership restrictions). Castle Creek Managing Principal Sundeep Rana serves on the Board of Directors. I suspect Castle Creek will be receptive to monetizing their substantial ownership stake in the Company; regardless, they are sophisticated investors and likely good stewards of shareholder value.
Private investor Edward Cochran owns ~6.5% of the voting common stock (5% of the total equity) and serves on the Board of Directors. Mr. Cochran, a Harvard and Columbia educated lawyer and businessman, is another shareholder advocate with skin in the game that sits on the Board.
The Company streamlined operations in 2021, divesting non-core bank branches and winding down direct-to-consumer lending operations. Just as a homeowner may spruce up the house before selling, a Company exiting non-core and/or unprofitable operations is often a precursor to a larger sale.
Management is fully invested. CEO Timothy O’Dell owns ~3.5% of the total equity. And the Company has an immaculate track record of insider purchases:
Codorus Valley (CVLY) – $21.98
A new CEO and Chairman settle into seats as their predecessor bemoans activist agitation.
An activist thinks CVLY could fetch $31 per share or more. Simply achieving a “market multiple” with no synergies would imply ~$28.50 per share. Here’s why CVLY made the takeover target list:
Shareholder activist Driver Management first disclosed a ~6% position in the bank in July 2021 (cost basis: $19.74, high watermark: $21.85). Driver has pushed for a sale from the gun, calling on the Board to “immediately hire a financial advisor and conduct a comprehensive review of all available options for increasing shareholder value, including a sale” amid underperformance relative to peers. The campaign has been an acrimonious affair, with Driver launching a proxy contest alongside a legal fight regarding a request to inspect corporate books and records.
Former CEO and Chairman Larry Miller stepped down in 2021, ending a tenure that began in 1986. Separating responsibility for the two roles will likely improve governance and increase the odds of a takeover bid.
The Company repurchased ~5% of outstanding shares in 2021, suggesting a belief that its stock is undervalued and perhaps concern over a “low-ball” bid.
Key Date: 2022 shareholders meeting (the date has not been set, but previous meetings were held mid-May). I think the odds of Driver Management winning the proxy contest are below 50% (which has precedent: Driver lost a proxy battle at First United (FUNC)). I don’t think a loss in the proxy contest will deter Driver or negate the probability of an eventual sale.
Risk: Driver Management enters a settlement agreement with CVLY. Again, this has precedent with Driver. In the First United (FUNC) campaign, amid a second consecutive proxy contest, the Company repurchased Driver’s shares and paid a settlement in conjunction with a standstill and remediation of legal action.
Hawthorn Bancshares (HWBK) – $25.52
Two community bank-focused investment funds now own ~10% of the Company. I suspect they are on the lookout for a buyout.
Given HWBK’s operational outperformance, a 1.6x P/B buyout multiple is within the realm of reasonable – implying 30%+ upside. Here is why HWBK is a takeover target:
Jonathan Holtaway of Ategra Capital Management owns ~5% of the Company and joined the Board in 2019. Jonathan is an expert in the bank and thrift industry, and I trust that the Board will be receptive to acquisition inquiries under his stewardship.
PL Capital Advisors, an investment fund focused on consolidation and shareholder activism within the community bank sector, disclosed a 5% stake in February 2022 (cost basis: $25.50).
HWBK is showing increasing willingness to buy back shares, suggesting that the Company believes its valuation is cheap. The Company repurchased $2mm worth of shares in 2021 and authorized a $5mm share repurchase plan.
The Company has an excellent track record of insider transactions. Insiders often have advanced knowledge of activities that lead to takeovers (hiring an advisor, activist negotiations, etc.). Not to mention, insiders may have a “hunch” that a transaction is forthcoming without conclusive knowledge. Why would an executive sell if they knew a premium was forthcoming in the near future?
Republic First Bancorp (FRBK) – $5.21
Takeover target “triple-play”: an activist investor is pushing for a sale, an independent outside beneficial owner is snapping up shares, and a fissure in the board room.
FRBK shares have benefited from share purchases by the investors mentioned above but settled around ~$5 / share in the last month. An acquirer should find value in its valuable deposit base and branch network. An outside beneficial owner has been buying as high as $5.15, and the activist thinks $5.50 a share would not be the highest value the company could receive “by any stretch of the imagination.”
Activist investor Driver Management (1% shareholder) began agitating for change in December 2021, after FRBK announced intentions to raise equity capital to fund branch growth. Driver is now waging a proxy battle to unseat CEO and Chairman Vernon Hill and two other incumbent Directors at the upcoming annual meeting.
The potential removal of Vernon Hill as both CEO and Chairman will likely benefit shareholders. Hill’s playbook has grown deposits, but share price and profitability performance have broadly trailed peers. The situation is familiar to Hill: he previously resigned from Commerce Bank; it was shortly after that sold to TD Bank. And he ran into the same fate across the pond at Metro Bank. A separation of the Chairman and CEO roles should improve corporate governance and improve the chances of a takeover.
Weeks after Driver Management launched a proxy contest, a second outside investor group led by George Norcross established a 9.6% stake in the Company (cost basis: $4.17, high watermark: $5.16) and expressed interest in a “substantial, long-term equity investment” in FRBK. Recently, the investor group has retained Raymond James, submitted a books & records request, and requested the Board grant approval to exceed 10% ownership without triggering a poison pill.
On March 4, four “concerned Directors” filed a statement urging Vernon Hill and three other directors not to pursue “self-dealing transactions” that “might destroy shareholder value.”
FRBK has hired Keefe, Bruyette & Woods to advise the Board and are “open to any and all proposals to maximize value.”
Key Date: 2022 shareholders meeting (the date has not been set, but previous meetings were held in late April). Unlike Codorus Valley (CVLY), I think Driver has a good chance of succeeding in this proxy contest. The investor group led by George Norcross has pledged to support Driver’s candidates. And the recent Board fissure suggests other institutional investors (as well as the proxy advisory firms) will need to think hard before supporting the incumbents.
United Security Bancshares (UBFO) – $8.14
A sale could finance a nice retirement for the bank’s Founder and Chairman.
A strategic acquirer should value consolidating deposits in the crowded but attractive Fresno market. I think a takeover at $10 - $12 per share is achievable.
Founder and Chairman Dennis Woods owns ~6.5% of the Company and is in his 70s. As industry insider Phil Timyan suggested, perhaps it is time he cashes his check and enjoys retirement.
Strategic Value Bank Partners, an investment partnership focused exclusively on community banks, owns 5.5% of the Company. Co-founder Benjamin Mackovak is the Lead Director of the Board. I trust Mackovak to seek to maximize shareholder value when possible.
This is another instance of heavy insider buying over the last several years (although the insider track record before 2018 is not notable). Rather than repurchasing shares, UBFO pays an attractive dividend, which should tide over investors while waiting for a takeover premium.
I promise to do a diagnostic on my picks to hold myself accountable in due time. I have more info on all of these – reach out if you would like to discuss.
This article is not investment advice. The statistics and analyses herein are the author’s opinion and should not be relied upon as fact. Do your own diligence before making any investment decisions. The author retains the right to buy, sell or otherwise transact in any security without prior notice.