|Shares Out. (in M):||28||P/E||432.0x||25.0x|
|Market Cap (in $M):||226||P/FCF||N/A||N/A|
|Net Debt (in $M):||113||EBIT||0||0|
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The Bancorp, Inc. (TBBK) is a Philadelphia bank holding company with an experienced management team and a unique, highly valuable deposit-gathering franchise. While the company is growing very fast at the moment (40%+ annual deposit growth in some of their programs), it’s worth at least twice the current market cap at its current size, based on directly comparable transactions. With continued growth and scale economies, TBBK could be worth multiples of the current price in just a few years. There is even further upside if interest rates rise, since TBBK’s deposits are concentrated in low-cost and no-cost products, a feature that is of limited benefit in today’s interest rate environment, but which could provide for the highest NIMs in the industry in a more normal environment. The bank’s CEO sold a bank a decade ago for an attractive price, and I believe she is likely to sell TBBK at the right time.
The Cohen Factor
The first thing to know about TBBK is that the founder and CEO is Betsy Z. Cohen, the 69-year-old matriarch of the Philadelphia Cohen family. As many people know, her sons and husband all run public companies as well (REXI, ATLS, APL, AHD). Since each of these businesses uses complex financing techniques and/or material amounts of leverage, the last two years have not been kind to the fortunes of anyone who invested alongside the Cohen family, TBBK shareholders included. The company raised outside capital and accepted TARP money (repaid in early March 2010) in order to shore up its balance sheet, doubling the share count along the way. That said, Cohen still owns 8% of the stock and other insiders/family members own another 10%.
What Went Wrong?
Earnings collapsed in 2008, going from an all-time high of $14.1 million in 2007, to a loss of $42.6 million in 2008. A goodwill impairment of $35 million, and a decrease in the net interest margin, driven by lower interest rates, accounted for part of the swing. But bad loans were the real story. Loans to commercial borrowers, commercial real estate borrowers, and residential construction borrowers (6 total loans) produced charge-offs of $5.37 million in 2008 and a $17 million allowance at the end of the year. Charge-offs grew to $11.2 million in 2009, with a $19 million allowance at the end of the year, though the bank was slightly profitable in 2009 (more details later). As indicated in TBBK’s December 2, 2009 investor presentation (see the 8-K or go to http://bit.ly/cQ2y4D to listen to the presentation), and the most recent earnings release, non-performing assets were 1.26% at December 31, 2009, a level that’s relatively stable over the last four quarters.
TBBK accepted $45 million in TARP funding in December of 2008. That money was paid back in March 2010, though the TARP warrants have not yet been repurchased. In August 2009, the company issued 11.5 million shares at $5.75 per share, bringing the current share count to 26.18 million. At year-end, the Tier 1 capital ratio to average assets was 12.68% and the Tier 1 capital ratio to total risk-weighted assets was 15.81%. Pro forma for the TARP repayment, the Tier 1 capital ratio is still in excess of 10%.
The Business Model
On the loan side of the balance sheet, TBBK is a pretty standard community bank. The loan book of $1.523 billion consists of 26.3% commercial loans, 37.3% commercial mortgages, 13.6% construction loans, 5.2% leases, 5.6% residential mortgages, and 11.8% consumer loans. The company has de-emphasized construction loans over the course of the last two years while increasing lending to commercial and commercial mortgage borrowers. Typical loans include seasonal lines of credit and commercial mortgages for owner-occupied businesses on their headquarters/offices. The company targets small and mid-sized businesses, including professional services practices, and their high net worth owners. The company’s long-stated strategy is to poach business customers from large banks that have consolidated the PA/DE/NJ market by emphasizing superior customer service. It’s a similar story to what’s told by most community banks, and not what makes TBBK unique.
Deposits – Affinity marketing equals low costs
The deposit-gathering strategy is what’s unique at TBBK. Page 13 of the December investor presentation lays out the story very effectively. Whereas two years ago, CDs, savings and money market accounts added up to 91.4% of total deposits, as of September 2009, they were just 55.5% of total deposits. “Transactional” deposits grew from 8.6% of the total in 2007 to 44.5% in 2009, but that growth understates the story, since much of the “savings” accounts currently on the balance sheet are low cost deposits today, far more so than in 2007. In 2007, the average cost of deposits was 4.40%, while in 2009 that number was just 0.94%. Of course, in today’s low interest rate environment, many banks are paying that much for deposits. In the case of TBBK, those deposit costs are structural, not temporary.
TBBK gathers deposits through five channels – its community bank and four channels that it calls, as a group, affinity banking: merchant processing, private label banking, health care deposits, and stored value cards. Of the four lines, merchant processing is the smallest and simplest to understand (credit card processing), so we’ll ignore it for now.
The private label banking business allows registered investment advisors and other non-bank financial institutions to offer to their customers bank-like features. The most prominent partner in this business is SEI Investments, a back-office custody and software company for thousands of RIAs. SEI is a limited service trust company and thus cannot offer bank-like solutions to compete with the banking products offered to RIAs through Fidelity, Schwab and other broker-dealers, or to captive brokers through platforms like Merrill Lynch’s cash management accounts (CMAs). By partnering with TBBK, SEI and other institutions can offer features like these, most notably 1.) core deposit accounts like checking accounts and 2.) lending products like margin debt for securities accounts. Since these banking products are sold to discerning clients through sophisticated intermediaries, they are not as low-cost as TBBK’s other programs: the average cost of deposits was 1.89% in 2009. In the two years ending Sept. 30, 2009, deposits have grown from $44 million to $183 million, a CAGR of 103%. That growth accelerated to 141% YOY by year-end according to comments made by President & COO Frank Mastrangelo on the Q4 conference call, driven by new customer wins.
Health savings accounts and flexible spending accounts are the second-biggest source of affinity deposits. TBBK partners with small health insurance companies, insurance brokers, and other companies in the health care space to offer HSA and FSA accounts to their customers. Each of the top 7 health insurance companies in the country now has a captive bank through which they offer such programs, which means that TBBK is limited to operating among smaller partners. That said, TBBK is #6 in total deposits nationwide in this category. In the two years through Sept. 30, HSA deposits grew to $278 million, a CAGR of 84%. Year over year, growth was 42% in the fourth quarter of 2009.
The biggest, and most profitable affinity program at TBBK is the stored value card business. Stored value cards (also known as cash cards or prepaid open loop debit cards) are cards branded with the Visa, Mastercard or Amex label that can be used anywhere those cards are accepted. They are “loaded” with a certain cash balance and distributed by financial institutions, marketing agencies, and other distributors. Each card is essentially a non interest-bearing checking account that also generates some fees for card processing.
TBBK entered this business when they acquired Stored Value Solutions from Marshall BankFirst Corporation in November 2007. They paid $60.6 million in cash and stock for a business that had $115 million in deposits at the time. Marshall BankFirst pioneered the cash card business under the leadership of their former executive Brad Hanson, who now heads Meta Payment Systems, a unit of Meta Financial Group (CASH). Hanson left Marshall after losses in other lines of business constrained the growth of Stored Value Solutions, and TBBK bought the unit shortly thereafter. Today, deposits at TBBK’s cash card business (now called Payment Solutions Group) total $800 million as of Sept. 30, for a CAGR of 163%. As of the fourth quarter of 2009, this business was growing at 37% annually.
There are two things to understand about Payment Solutions Group. First, the growth opportunity is open-ended. According to the Mercator Advisory Group, open-loop products are forecast to grow to $125 billion in 2011, compared to $39 billion in 2007. The report seems to encompass a broader definition of open-loop products than the markets in which TBBK and CASH operate, since combined they have $1.4 billion in card assets and they each bill themselves as a top 5 player in the industry. Even if you assume that each deposits last only a quarter and thus volume is four times the number recorded on the balance sheets, Mercator's estimate seems high, but it's the directionality and scale of the growth is what’s important. Also, the growth is easy to see in the financial statements of both CASH and TBBK, has been going on for years, and shows no sign of abating. In fact, CASH raised additional equity in February 2010 to pursue growth opportunities, specifically citing program disruptions among other banks (unidentified, but certainly not TBBK) in the market. Other banks in the market tend to be much larger, including US Bank and JP Morgan chase, or much smaller relative to TBBK and CASH. TBBK is forecasting 30% to 35% growth in PSG deposits during 2010.
The second thing to understand about PSG is the extremely low-cost nature of the deposits. The average cost of deposits in this unit was 0.14% in 2009, according to the December presentation. The overwhelming majority of card programs have no interest income, making them very attractive assets in a rising interest rate environment. To understand just how attractive these assets can be, let’s look at the company’s net interest margin over the past few years, across the entire bank.
Net Interest Margin
Yield on interest-earning assets Cost of interest-bearing deposits Net interest margin
2004 5.42% 2.14% 3.86%
2005 6.70% 2.93% 4.57%
2006 7.90% 4.47% 4.32%
2007 7.89% 4.75% 3.90%
2008 6.04% 3.22% 3.44%
2009 4.69% 1.45% 3.74%
If you were to compare these results to almost any other bank, they’d look just about the same. Interest rates dropped, bringing down the cost of funds and the interest rates that banks can charge to their borrowers. For almost any other bank, the opposite will be true as interest rates rise, and banks will continue to earn spreads of 3% to 4%. But that won’t happen to TBBK. TBBK enjoys structurally low interest rates in their PSG and HSA lines of business, and to a limited extent in their white label private banking group. Across the bank, if interest rates rise to 2005 and 2006 levels, the cost of TBBk’s interest-bearing deposits is likely to stay below 3%, and deposits that don’t earn interest will bring the weighted-average down to 1.5% to 2.0%, suggesting that TBBK could earn a net interest margin of 6.0% to 6.5%. As such, it would be one of the most profitable banks in the country. If our country’s deficits lead to inflation and even higher interest rates…well, use your imagination.
Many banks issue cash cards that compete with TBBK. The leaders among big banks include JP Morgan, US Bank, Banorte Financial’s Inter National Bank (a US division of a Mexican bank). and Columbus Bank & Trust, a unit of Synovus Financial. These banks are all huge (or in the case of Synovus, merely large), so we have no window into their prepaid card business through their financial statements. The most direct competitor is Meta Financial Group (CASH), whose Meta Payment Systems (MPS) is the Pepsi to TBBK’s Coke. The companies share a heritage, as MPS and PSG were both founded by Brad Hanson, now the President of MPS. MPS has $600 million in card deposits, making it 75% of the size of TBBK’s PSG. That said, MPS is much more profitable than PSG, since MPS has leadership in products with very heavy fee income. In 2009, MPS earned $78 million in non-interest income from these fees.
MPS dominates the tax business, issuing cards for refund anticipation loans and other products through both H&R Block and Jackson Hewitt. These cards carry loans with them, not just prepaid deposits, so they’re a different beast than what’s typical in the industry. Within classic prepaid, MPS offers payroll cards, gift cards, and government agency rebate cards. In February, MPS sold 8.6% worth of new stock to Cash America International(CSH), and 4.9% of stock to NetSpend Holdings, two card marketers that had been large partners of Meta. The company has indicated that the stock sales were intended to bolster capital ratios (which were adequate before the transactions) in order to pursue large growth opportunities that they had identified.
For investors interested in a very illiquid stock, the MPS parent company CASH is also quite undervalued. I may post a write-up of CASH in a few days. We are long both companies.
As of December 31, TBBK’s book value was $7.64 per share, so the company trades for 113% of book. Intangibles are only $10 million out of $245 million in equity, so the book is quite solid. Regional banks have often traded for up to 200% of book value, and may do so again after they have cleaned up their balance sheets, so on that basis TBBK would be worth $15.28 per share. I would argue that the nature of TBBK’s deposit base calls for an even higher valuation, but readers can judge for themselves. In the meantime, all of the company’s affinity products are growing rapidly, and the company is returning to profitability, so the book value is likely to be much higher in a year or two than it is today.
Another way to think about valuation is to look at the price TBBK paid for Stored Value Solutions in 2007. Admittedly, it was a top of the market purchase, but the division was crippled within Marshall Bank (deposits at the end of 2006 were $122 million and they were $115 million on November 30, 2007 when the deal closed), so it’s clear that TBBK didn’t pay top price for a well managed, growing business. To review, they paid $60.6 million for $115 million in assets, or 52.6% of total assets. On that basis, the successor to Stored Value Services, Payment Systems Group, would be worth $421 million ($800MM in card deposits on 9/30/09 * 52.6%), or $16 a share today. This ascribes no value to the company’s community bank assets, its health savings accounts, its merchant processing business, its white label banking group, or its experienced management team. It also ascribes no value to the much increased scale of PSG today. If the business can grow at 35% annually for a couple of years (which is what the current guidance calls for), Payment Systems Group alone would be worth more than $30 per share by early 2012. Since I have no idea how long it will be before TBBK returns to full profitability, or how well their growth projections for 2010 will be met, I’ll put an $18 target on the stock for the next one to two years. This leaves room for substantial upside that could develop.
Continued growth in Affinity Banking: Each of the four business units at TBBK's affinity banking group is growing in excess of 30% annually.
Increased NIMs: The net interest margin inched up 10 bps to 3.84% in the fourth quarter, versus 3.74% in the third quarter. Going forward, that number should increase further even without a movement in interest rates, since there are $137 million of CDs maturing during 2010 that will be replaced by low cost deposits from the affinity programs.
Loan losses: Non-performing assets and reserves have been stable for almost a year now, and should begin trending down within a couple of quarters. The relatively stable markets in which the company operates (PA/southern NJ, DE) should cushion the company against any adverse developments in the commercial real estate market that may or may not develop in the future. Obviously, if you believe that there is a very large shoe left to drop in that market, then this stock is not for you.
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