INTERVEST BANCSHARES CORP IBCA
May 25, 2011 - 4:46pm EST by
sunny118
2011 2012
Price: 2.90 EPS -$2.60 $0.37
Shares Out. (in M): 21 P/E NM 7.8x
Market Cap (in $M): 61 P/FCF 0.0x 0.0x
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT 0.0x 0.0x

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Description

Since IBCA was written up in November of last year, the story has improved with the company posting its second consecutive quarter of positive earnings, nonperforming assets ("NPAs") declining 10% sequentially in Q1 2011, and capital ratios 10%+ above the minimum requirements and continuing to rise.  In addition, Frontpoint Partners, a 2.7% shareholder as of March 31, 2011, is winding down and liquidated its position temporarily depressing the stock price.  Frontpoint off-loaded the last of its shares in a clean-up trade last Friday, eliminating this overhang.  We see IBCA's current price of $2.90 as an attractive entry point.   Using our 2012 estimate of tangible common book value ("TBV") per share of $8.34 vs $7.56 at 3/31/11, and multiples of 0.50x, 0.75x, and 1.00x, fair value is $4.17/sh (+43.9%), $6.26/sh (+115.8%), and $8.34/sh (+187.7%) respectively.  Take your pick of the appropriate TBV multiple, but as the company has historically returned >10% on its common equity and we estimate 49c of EPS in 2012 (ROCE of 5.9%, less than half the 2000-2008 average of 11.9%), we think it is realistic that IBCA trades at 1.0x TBV. 

Background

Raf698 posted IBCA to VIC in November of 2010.  For those that did not read the post, in April 2009, IBCA entered into a Memorandum of Understanding ("MOU") with the OCC to improve the bank's risk management and develop strategic and capital plans (this was later formalized in December 2010).  Worried by the level of IBCA's underperforming and nonperforming assets, the OCC forced IBCA to sell $198mm of its underperforming and nonperforming assets in a fire sale in May 2010, cleansing IBCA of its riskiest assets.  Additionally, the OCC increased IBCA's minimum capital ratios, which led to a dilutive capital raise in October 2010 in which management participated.  More recently, IBCA entered into a written agreement with the Federal Reserve Board ("FRB"), which limits the company's ability to declare or pay dividends without prior approval, as well as appoint new directors/senior management or change their responsibilities without notifying the FRB. 

Our Thesis

1.       Very cheap on book value, trading at 38% of current TBV, and 35% of 2012E TBV compared to 1.4x TBV peer average.  Over the next 1-2 years, this valuation gap should decrease as the company's credit quality improves. 

2.       Cheap on EPS, trading at 7.8x 2011E, and 5.9x 2012E (note: EPS estimates are fully taxed, but IBCA's cash tax rate will be close to 0% for the foreseeable future).  As credit quality improves, the bank's earning's power will be highlighted.  Additionally, the re-pricing of high cost certificates of deposits ("CDs") over the next two years will be an earnings tailwind adding 28c in EPS through 2012. 

3.       Nonperforming assets have peaked and will continue to decrease over 2011 (rationale below). 

4.       We believe this opportunity exists because it is underfollowed due to its nontraditional loan portfolio and funding base, the forced asset sale, and the highly dilutive capital raise which has caused investor fatigue.

Business Description

IBCA is a full-service commercial bank specializing in real estate acquisition loans that are backed by cash flow producing properties.  Of the $1.3b in gross loans as of Q1 2011, commercial real estate loans ("CRE") represented 71% and residential multifamily loans represented 28%.  68% of the bank's loans are concentrated in New York, 23% are concentrated in Florida, and the remaining 9% are scattered throughout the East Coast.  IBCA's average loan has a principal amount of ~$2.3mm, a 3.5 year term, and a loan-to-value ratio of 75% or less.  While the majority of IBCA's 559 loans are sub-$5mm, there are 10 loans with principal balances between $10mm and $20mm and 54 loans with principal balances between $5mm and $10mm. 

Unlike traditional banks that fund a substantial portion of their loans through checking and saving deposits, IBCA funds the majority of its loans with CDs primarily collected through its New York and Florida-based branches.  These deposits come at a higher cost than traditional deposits, but they allow IBCA to match the term of deposits to the duration of loans.  This reduces the bank's duration gap and allows IBCA to run its operations at a lower cost than traditional banks.  Therefore, while net interest margin is thinner than a traditional bank, non-interest expense is also lower resulting in a net income margin and ROE similar to other small banks. 

Management

Lowell Dansker, the CEO, is the primary loan originator of IBCA.  He and his family have a long history of investing in New York real estate.  Dansker approaches loan underwriting with a "loan to own" mentality.  This mentality shows in conversations with him as he seems to know the details of every loan in his portfolio such as surrounding rents, the borrower's other real estate deals, why a loan is classified as a criticized asset, the current LTV, etc.  This mentality makes sense as Lowell and his family are significant shareholders.

Prior to the dilutive equity raise, Lowell and his family owned approximately a quarter of the company, which is the majority of Lowell's net worth.  Post the equity raise, Lowell and his family own 10.9% of the company and management in total own 14.4%.  As part of the equity raise, Lowell and his family's Class B shares were converted to Class A shares, further aligning management and shareholders. 

Due to the OCC agreement, IBCA added a Chief Credit Officer ("CCO") and an Asset and Liability Manager to the management team.  These positions were created in order to implement and formalize risk management systems at IBCA.  Over the last year, the CCO has put in place a formalized quarterly loan review to assess the top 30 borrowers by identifying potential problems, and a loan rating system.  We have met with CCO Bob Tonne and our opinion is that he has implemented a thorough credit review process for both existing, and future, loans. 

Credit Portfolio

We believe that IBCA's nonperforming assets have peaked and will continue to decrease through 2011.  When analyzing the bank's credit quality it helps to keep in mind the average term of an IBCA loan is 3.5 years.  While not every loan has a term of exactly 3.5 years, in simplistic terms loans currently coming due were written in Q4 2007.  If these borrowers have paid for the last 3.5 years through the worst of the recession, it stands to reason that it is unlikely that they default in an improved economy.  IBCA's CEO, CFO, and CCO all agree with the logic and expect nonperforming assets to decline throughout 2011.   Additionally, it stands to reason that the last high-risk loan was written in late 2008.  Therefore, it has been more than two years since these loans were originated and borrowers have continued to pay during 2009 and 2010.


3/31/10

6/30/10

9/30/10

12/31/10

3/31/11


Q110

Q210

Q310

Q410

Q111

NPLs

$96.2

$18.9

$38.6

$52.9

$45.2

OREO

$57.9

$34.3

$38.8

$27.1

$27.1

NPAs

$154.1

$53.2

$77.4

$80.0

$72.3

TDRs

$116.9

$21.4

$0.6

$3.6

$5.6

NPAs + TDRs

$271.0

$74.5

$78.0

$83.6

$77.9

% of Assets

11.9%

3.4%

3.7%

4.0%

3.9%

 

Concerned by the level of criticized assets in Q1 2010, the OCC gave IBCA 90 days to sell $207.0mm ($197.7mm, net of charge-offs) of nonperforming loans ("NPLs"), underperforming loans, and foreclosed real estate.  Due to the time constraint, these loans were sold at fire sale prices to distressed debt hedge funds, with the company receiving 59c on the dollar.  While anecdotal, Lowell Dansker noted that since 2007 the company has averaged 90c on the dollar for sales of other criticized assets and he is aware of loans in the May 2010 asset sale that have been re-sold for a significant premium.    

NPAs have subsequently increased due to a variety of factors.  During Q3 2010, $21mm in troubled debt restructured loans ("TDRs") were reclassified as nonperforming due to regulatory guidance even though these loans were performing in accordance with the renegotiated terms.  Therefore, we include TDRs in past quarters to make the comparison apples-to-apples.  In Q4 2010, IBCA's 4th largest loan became nonperforming due to the underlying real estate, an office building, being placed into bankruptcy.  Without going into great detail, it's important to note that this loan had a perfect payment history prior to bankruptcy and is a bit of a special situation.  IBCA is close to renegotiating this loan on terms similar to pre-bankruptcy terms with a write-off of less than $1mm. 

Another reason to believe that NPAs + TDRs should decline is that a nonperforming loan with 6 months of timely payments is eligible to be removed from nonperforming status.  Movement of some, or all, of the $21mm of reclassified TDRs back into performing status will decrease NPAs over the next couple of quarters as these loans have been performing in accordance with their restructured terms. 

While IBCA's loan book is primarily concentrated in CRE and multifamily, the company avoided writing risky construction and development loans, and condo conversion loans.  Loans are diversified among a number of borrowers with 559 loans outstanding with an average loan size of $2.3mm and the maximum loan size being $16.2mm.  While the company does not report the average LTV of the portfolio at the current time, the CEO has indicated it is 75-80% given the decline in the real estate markets over the past few years.  Looking at the loans listed on i-netmortgageclearinghouse.com (a website that IBCA created to sell its loans; 38 of the 40 loans listed are IBCA's) gives a sense of IBCA's underwriting standards.  The average LTV of the 36 performing loans listed is 60% with an average debt service coverage ratio of 1.4x and the majority of loans are recourse to the borrower. 

One particular nonperforming loan of interest on the website is a multifamily loan in Cleveland, Ohio.  The principal balance of $3.5mm matches a loan from IBCA's SEC filings that went nonperforming in Q3 2009.  In Q1 2010, this loan was held on the books at $1.6mm (53% lower than the principal amount).  In May 2010, this property was reappraised at $3.0mm, 88% above what IBCA currently carries it at.  We highlight this loan to show that it appears that past charge-offs have been sufficient, if not aggressive.

While the loan portfolio of a bank can be a black box, we feel confident that there are no skeletons in the closet as: (i) the OCC is considered the strictest of the bank regulators - it would be surprising for a material worsening of credit quality after an OCC examination, (ii) IBCA undergoes quarterly loan reviews performed by an outside party and both the outside party and the CCO have to sign-off on quarterly NPAs and LLRs with the OCC checking the outside party's review, and (iii) within the last week management has indicated to us there has been no change in credit quality since the end of Q1, and that they believe that NPAs will continue to decline.

Increased Earnings

Unlike traditional banks, the majority of IBCA's deposits are funded by CDs, which have a higher cost compared to checking and savings deposits.  Rates offered on new CDs are at lows, which benefits IBCA as its CDs roll off and are replaced at lower rates, decreasing its cost of deposits as shown below.

Certificates of Deposits








Tranches

Q109

Q209

Q309

Q409

Q110

Q210

Q310

Q410

Q111

< 1 year

4.00%

3.89%

3.71%

3.63%

3.42%

3.15%

3.18%

3.09%

3.02%

1-2 years

4.45%

4.22%

4.31%

4.28%

4.10%

4.02%

3.74%

3.63%

3.47%

2-3 years

5.07%

4.94%

4.50%

4.45%

4.33%

4.23%

3.91%

4.26%

4.23%

3-4 years

4.95%

4.76%

4.37%

4.61%

4.57%

4.55%

4.50%

3.78%

3.64%

> 4 years

5.02%

4.90%

4.69%

4.31%

4.17%

4.17%

4.14%

4.13%

4.32%

Wtd-Avg

4.49%

4.36%

4.18%

4.11%

3.98%

3.88%

3.74%

3.65%

3.55%

 

Of IBCA's $1.7b in deposits as of Q1 2011, CDs comprise $1.3b with $776mm repricing within the next 2 years.  Below is the current repricing schedule of IBCA's CDs.

CDs Repricing - Q1 2011 ('000s)

Time to Reprice

$'s

Rate

 

< 1 year

$436.4

3.02%

 

1-2 years

$339.1

3.47%

 

2-3 years

$270.9

4.23%

 

3-4 years

$125.8

3.64%

 

> 4 years

$86.6

4.32%

 

Total

$1,258.7

3.55%

 

 

 

Current CD Rates - INB Website

Duration

APR


6 month

0.60%


12 month

1.20%


24 month

1.50%


36 month

1.80%


48 month

2.04%








 

The rates above are taken directly off IBCA's website and are significantly lower than IBCA's historical rates.  Using current rates, we estimate that this repricing tailwind will add $0.07 in fully taxed EPS during the remainder of 2011 and $0.21 of fully taxed EPS in 2012.

Taking into account this earnings tailwind, normalized provisions, and some shrinkage in the loan portfolio (ideally the loan portfolio would remain flat, but as IBCA is re-starting its loan origination process, the loan portfolio is likely to shrink), we estimate 2011 earnings of $0.37 and 2012 earnings of $0.49.  (Note: cash earnings will be higher as there is a $45.3mm tax asset at the state and federal level.  IBCA will pay almost no cash taxes for the next several years.) 

There is potential upside to these earnings.  IBCA currently has $590mm in securities invested in low yielding government securities.  Management has indicated that they currently hold this amount primarily for liquidity purposes with yield being a secondary concern, but if management earns an additional 0.5% on the securities balance the incremental benefit to EPS is 8c annually.   

Peers

At the end of this writeup is a list of peers taken from the S-1 filed for the October 2010 equity raise.  I would note that while these are listed comparables, IBCA should trade at a discount given its CRE concentration and lack of deposit franchise.  However, the median P/TBV multiple is 1.4x, highlighting significant potential upside even at a large discount to peers.

Capital Ratios

Following the equity offering in Q4 2010, all three of IBCA's capital ratios were above the minimum thresholds.  The bank's capital ratios currently stand as follows:





Q410

Q111

vs Min.

Total capital to risk-weighted assets


14.22%

14.81%


Minimum under OCC agreement


12.0%

12.0%

23.4%

Well capitalized Ratio



10.0%

10.0%

48.1%








Tier 1 capital to risk-weighted assets


12.96%

13.55%


Minimum under OCC agreement


10.0%

10.0%

35.5%

Well capitalized Ratio



6.0%

6.0%

125.8%








Tier 1 capital to avg assets



9.61%

10.04%


Minimum under OCC agreement


9.0%

9.0%

11.6%

Well capitalized Ratio



5.0%

5.0%

100.8%

 

We expect these ratios to continue to improve throughout the year and it is management's expectation to end 2011 with a Tier 1 Capital to average assets ratio in the range of 10.5-11.0%

TARP

The company currently has $25.0mm in TARP funds and in February 2010 ceased declaring and paying dividends on TARP as required by their regulators.  $1.7mm of unpaid dividends in arrears is owed on TARP.  These funds carry a 5% interest rate until the beginning of December 2013 when the rate increases to 9%.  The company currently hopes to pay this through organic earnings, although if the stock is trading close to TBV, we believe management is likely to issue equity. 

Risks

1.       Credit quality severely deteriorating - while management has indicated, and our analysis confirms, that credit quality should improve going forward, there is the possibility of nonperforming loans increasing in the future. 

2.       Key man risk - Lowell Dansker is the loan generator.  If he were to leave or were unable to perform his duties, IBCA would be adversely impacted.  During our meeting with Dansker, he noted that he is committed to repairing IBCA (he is looking to rebuild his family's wealth) and is in it for long haul. 

3.       Loan portfolio shrinkage - CEO Dansker has indicated that he thinks he can keep the loan book flat.  While that may be the case, we believe the most likely scenario is that the loan book shrinks and have used a 12% decline in the loan book from Q1 2011 to Q4 2012 in our estimates of 2012 earnings.  

4.       FDIC takeover - if IBCA's credit metrics were to deteriorate substantially, it is likely that the bank would be taken over by the FDIC.  While we feel this is a very low probability event given the high capital ratios, declining NPAs + TDRs, a formalized risk management system, and additional risk management personnel, the possibility does exist.

Peers

        Credit Quality Capital Ratios Valuation (LTM) Profitability (LTM)
Ticker State Mkt Cap Assets NPAs / Assets NPLs / Loans LLRs / Loans Texas Ratio NCOs / Avg Loans TCE / TA Total Capital  Tier 1 Capital  Leverage Ratio L / D P / E P / B P / TB ROAA ROAE NIM Efficiency Ratio
CCBG FL $173.5 $2,662.5 5.8% 5.7% 2.0% 74.0% 1.4% 6.6% 14.8% 13.5% 9.7% 80.3% 40.2x 0.7x 1.0x 0.2% 1.7% 4.1% 76.4%
CNND NY $167.6 $1,711.3 1.5% 2.0% 1.4% 20.6% 0.3% 6.6% NA NA NA 76.5% NM NM NM 1.1% 15.5% 3.5% 65.4%
CSFL FL $185.3 $2,225.5 3.7% 5.8% 2.3% 34.5% 2.8% 9.8% 18.0% 16.7% 10.0% 67.2% NM 0.7x 0.8x -0.3% -2.4% 3.7% 80.8%
FNFG NY $4,263.1 $21,439.8 0.4% 0.8% 0.9% 4.9% 0.4% 7.8% 12.0% 11.2% 6.9% 79.6% 18.7x 1.1x 1.8x 0.9% 6.0% 3.8% 62.2%
FLIC NY $232.4 $1,735.0 0.2% 0.4% 1.6% 2.1% 0.0% 9.6% 21.5% 20.2% 9.4% 69.1% 12.1x 1.4x 1.4x 1.1% 13.0% 3.8% 56.4%
FUBC FL $187.6 $1,260.5 2.6% 3.0% 1.7% 19.5% 1.6% 12.4% 20.9% 18.8% 8.8% 79.4% 69.2x 0.9x 1.2x 0.0% 1.2% 4.9% 78.8%
HUVL NY $388.6 $2,655.3 2.4% 3.3% 2.2% 21.2% 2.6% 9.9% 13.7% 12.4% 9.1% 81.1% 75.8x 1.3x 1.5x 0.2% 1.7% 4.4% 60.4%
SBNY NY $2,263.4 $12,380.3 0.4% 0.7% 1.3% 4.3% 0.6% 8.3% 14.9% 13.9% 8.3% 55.4% 20.0x 2.3x 2.3x 1.0% 12.5% 3.6% 40.8%
SBCF FL $165.5 $2,081.3 4.3% 5.4% 2.8% 60.0% 3.2% 5.7% 16.7% 15.4% 9.4% 72.7% NM 1.4x 1.4x -1.5% -31.1% 3.5% 85.6%
SUBK NY $144.9 $1,621.6 3.5% 4.8% 4.2% 31.1% 1.1% 8.2% 12.5% 11.3% 8.2% 78.0% NM 1.1x 1.1x 0.0% 0.4% 5.0% 59.9%
TMP NY $421.3 $3,278.9 1.4% 2.3% 1.5% 17.4% 0.3% 7.2% 13.8% 12.5% 8.9% 73.0% 12.5x 1.5x 1.8x 1.1% 12.8% 3.8% 62.9%
TIBB FL $213.9 $1,724.7 4.7% 5.6% NA NA 2.0% 7.8% 13.3% 13.2% 8.4% 76.9% NM 1.2x 1.5x 0.0% -24.0% 3.3% 98.5%





















Median
$200.8 $2,153.4 2.5% 3.2% 1.7% 20.6% 1.2% 8.0% 14.8% 13.5% 8.9% 76.7% 20.0x 1.2x 1.4x 0.2% 1.7% 3.8% 64.1%





















IBCA (LTM) NY $61.5 $2,014.1 3.8% 3.5% 2.5% 39.0% 8.0% 8.0% 14.8% 13.6% 10.0% 76.5% NM 0.4x 0.4x NM NM 2.1% 44.0%
IBCA (2011E)                         7.8x 0.4x 0.4x 0.4% 4.7% 2.2% 39.8%

Catalyst

 1.  Improving credit quality with NPAs continuing to decline in 2011.
 2.  Improved earnings due to credit improvement and CD repricing tailwind.
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