Texas Capital Bancshares: Credit Trend is Not Good
Aug/100
Texas Capital Bancshares (TCBI) is an interesting organic growth banking story, but the bank’s declining credit metrics make it a better short from here. The bank is 12 years old and has grown by lifting out relationship bankers from the big banks. These relationship bankers bring their best customers over to TCBI. This is an efficient and capital friendly growth strategy. This strategy also allows the bank to grow even in periods of weak loan demand.
However, the credit metrics of the bank have deteriorated significantly over the past 4 quarters. The only potential catalyst that matters is a sign stability in the bank’s credit metrics. The next data point won’t be for another 7 weeks when the bank releases Q3 numbers.
Here’s a look at the credit numbers for TCBI
| 2009 Q2 | 2009 Q3 | 2009 Q4 | 2010 Q1 | 2010 Q2 | |
| Loans Outstanding | $4,211 | $4,290 | $4,457 | $4,443 | $4,463 |
| Loan Loss Provision | 11.0 | 13.6 | 10.1 | 13.1 | 15.7 |
| Net Charge-Offs | 6.8 | 2.8 | 8.0 | 9.3 | 12.6 |
| Loan Loss Reserve | 54.3 | 65.8 | 67.9 | 71.7 | 74.9 |
| Non-Accrual Loans | 49.6 | 85.3 | 95.6 | 115.9 | 138.2 |
| Other Real Estate Owned | 31.4 | 34.7 | 27.3 | 28.9 | 42.1 |
| Non-Performing Assets | 81.0 | 119.9 | 122.9 | 144.8 | 180.3 |
| Non-Accruals/Loans | 1.18% | 1.99% | 2.15% | 2.61% | 3.10% |
| Reserves/Loans | 1.32% | 1.54% | 1.55% | 1.63% | 1.68% |
| Reserves/Non-Accruals | 109% | 77% | 71% | 62% | 54% |
| Tangible Common Equity | 456 | 466 | 473 | 491 | 504 |
| Texas Ratio | 16% | 23% | 23% | 26% | 31% |
TCBI’s numbers are showing a disturbing trend. Non-accrual loans have accelerated the past two quarters. Plus, it looks like management has not been adding to the loan loss reserve aggressively as non-accruals have climbed.
One could argue that TCBI has been under reserving for loan losses during the past 4 quarters. The loan loss reserve to non-accrual loan ratio has declined from 109% to 54% over the past 12 months. If management had kept this ratio constant, TCBI would have report a losses instead of profits over the past 4 quarters.
TCBI shares trade 1.15x tangible book. I think the profitability of the bank is questionable given the declining reserve ratios. If you add in the worsening credit metrics, I think TCBI will have a lid on its stock price until it reports a quarter with stable credit metrics. Since TCBI is well-capitalized, the viability of the bank is not in question. But, the decline in the credit quality suggests that the credit issues are open-ended. I think investors should demand a discount to book value to own a bank stock with credit quality continuing to worsen at rate like this. At 70% of tangible book, the stock would trade at $9.50 or a decline of 35% from the current price.
Gator Capital’s Small Cap Portfolio Listed on kaChing.com Platform
Aug/100
FOR IMMEDIATE RELEASE
TAMPA, FL [8/27/10] — Gator Capital’s Small Cap Portfolio has been selected by kaChing to be a featured portfolio on the kaChing.com platform. kaChing.com is the nation’s leading online destination that connects independent investment managers with individual investors. The Gator Small Cap Portfolio earned an Investing IQ of 154 based on the risk-adjusted returns, quality of investment rationale and adherence to the stated management style.
Gator Capital Management, a private investment management firm, manages concentrated portfolios of stocks of high-quality businesses. High-quality businesses have durable competitive advantages, business models with attractive economics and management teams dedicated to creating shareholder value. Historically, Gator Capital’s portfolios have had low turnover, which has allowed management teams time to create shareholder value and has reduced taxes for our clients.
kaChing evaluates investment managers based on Investing IQ, a proprietary data-driven metric that separates the lucky from the good. Investing IQ is based on some of the same factors used by Ivy League endowments to select investment managers: risk-adjusted returns, quality of investment rationale, and how closely a manager sticks to their stated investment style. An Investing IQ of at least 140 is required to be listed on the kaChing platform, and Gator Capital is one of a select group of investment managers from across the country that has achieved this status.
“We are extremely pleased and excited to be included on kaChing’s platform of leading investment managers,” commented Gator Capital’s Portfolio Manager Derek Pilecki. “kaChing has made an important innovation in the financial advisory business to give investors the tools and transparency to hire independent investment managers directly. Their scalable technology creates efficiencies for both the investor and the investment manager.”
“Many investment managers have difficulty providing low-cost investment management services for smaller clients. At Gator Capital, we have received requests for investment management from many individuals with smaller amounts to invest,” explained Pilecki. “By working with kaChing, we are now in a position to offer our Small Cap Portfolio to people with as little as $10,000 and open a channel for investors to invest in our portfolios directly online.”
For more information or to open an account, please visit http://www.gatorcapital.com/ or http://www.kaching.com/gator-capital
About Gator Capital Management
Gator Capital Management is a boutique investment management firm dedicated to the professional management of focused, high‐quality growth investment portfolios for high‐net worth individuals and institutions. Gator’s Investment Philosophy is to build portfolios of stocks by viewing each stock purchase as an investment in the underlying business, by investing in high‐quality growth businesses, and by focusing its portfolios on its best ideas.
This press release does not constitute and is not intended to constitute an offer or solicitation for an investment in any Gator Capital’s investment portfolio, including the portfolios mentioned herein.
Contact:
Gator Capital Management
Derek Pilecki
Managing Member
+1 813 282 7870
derek.pilecki@gatorcapital.com
<<<END>>>
Realtors Request Reduction in GSE Senior Preferred Dividend
Aug/102
Vicki Cox Golder, the President of the National Association of Realtors, sent a letter to Treasury Secretary Timothy Geithner requesting a retroactive reduction in the preferred dividend rate that Fannie Mae and Freddie Mac must pay the Treasury. The NAR argues that the high dividend rate is delaying the housing recovery, isn’t fair compared to the terms of the bailouts of the commercial banks and AIG, makes no sense to have negative compounding work against the GSEs.
What do you think of the NAR’s letter. How do you think Treasury will respond? Please post a comment.
The complete text of the letter follows:
August 13, 2010
The Honorable Timothy F. Geithner
Secretary
Department of the Treasury
1500 Pennsylvania Ave., NW
Washington, DC 20220
Dear Secretary Geithner:
On behalf of the 1.1 million members of the National Association of REALTORS® (NAR), I am writing to urge you to reduce, on a retroactive basis, the dividend rate on senior preferred stock issued to the U.S. Treasury Department in exchange for contributing capital to Fannie Mae and Freddie Mac to assure that they maintain a positive net worth.
The National Association of REALTORS® (NAR) is America’s largest trade association, including NAR’s five commercial real estate institutes and its societies and councils. REALTORS® are involved in all aspects of the residential and commercial real estate industries and belong to one or more of some 1,400 local associations or boards, and 54 state and territory associations of REALTORS®.
When Fannie Mae and Freddie Mac (the housing government sponsored enterprises, or GSEs) were placed into conservatorship by the Federal Housing Finance Agency in September 2008, the Treasury Department and each GSE entered into a contract providing for an initial $1 billion issuance of senior preferred stock with a 10 percent quarterly dividend, including warrants representing ownership of 79.9 percent of each GSE. Pursuant to the contracts, additional preferred stock has been issued in recent quarters as Treasury provided additional capital to each GSE to maintain their positive net worth. The agreements also provide for an additional quarterly fee starting in 2010.
Recent news reports have highlighted the 10 percent dividend that the GSEs are required to pay to the Treasury Department on the preferred stock. This dividend is twice the amount charged to banks that received assistance under the Troubled Asset Relief Program (TARP) and more than other firms have been required to pay in exchange for federal support. The Treasury-GSE contract imposes what we think is a punitive dividend that works as an unnecessary drag on the housing and economic recovery. The required dividend should be significantly reduced for a number of reasons.
First, the GSEs are working assiduously to reduce their losses, as they should. But the unintended consequence of their imposing high fees and very tight underwriting standards is to delay the housing recovery. NAR supports strong underwriting standards. In fact, NAR went on record, starting in 2005, at the beginning of the current crisis, warning about predatory lending, including the payment option adjustable rate mortgages and the “teaser” rate 2/28 and 3/27 mortgages that doomed so many homeowners to failure. We now just as firmly believe that the pendulum has swung too far and potential homeowners who are reasonable credit risks are too often unable to find a fair and affordable mortgage. As noted in one recent article, the GSEs’ current book of mortgage business is “pristine.” We think that achieving a pristine book of business means that the GSEs are falling short of their mission to maintain a liquid residential mortgage market, throughout the nation, that serves a wide range of borrowers, including qualified low- and moderate-income families. Reducing the current punitive dividend will enhance their ability to eliminate their losses, which will be further enhanced as the housing markets continue to stabilize and recover. This will give the GSEs the flexibility to adjust their underwriting standards to take into account reasonable lending risks, which will benefit the consumer and the entire economy, without undue risk of additional cost to the taxpayer.
Second, minimizing the amount of preferred stock held by the Treasury Department will make the challenge of restructuring the GSEs easier. One of the thorniest problems will be how to handle the amount of outstanding preferred stock held by the Treasury Department. From today’s perspective, it is hard to imagine how the capital infused into each GSE can ever be repaid. But whatever the solution, it will be easier if the obligation of the GSEs is not artificially increased by imposing the current punitive dividend rate at a level not imposed on banks or other firms, such as A.I.G., receiving government financial support.
Finally, it makes no apparent sense for the Treasury Department to transfer amounts to the GSEs so they will have enough money to pay the dividend back to Treasury. If the GSEs were not required to pay the 10 percent dividend, which significantly increases each of their quarterly losses, it would reduce the amount of additional capital Treasury is called upon to provide to them. The problem is exacerbated because a growing amount is necessary to pay the dividend on amounts received in order to pay earlier dividends. The “miracle” of compounding in this case has become a nightmare that is creating a permanent drag on the ability of the GSEs to fully achieve their mission. It would make more sense to charge the GSEs an amount equal to the Treasury borrowing cost, or the borrowing cost to the GSEs based on the current federal assurance that they will maintain a positive net worth. Both of these amounts are far less than 10 percent.
The interest of the National Association of REALTORS® in the relative financial health of the GSEs, in receivership, is based on the desire of our members for robust real estate and mortgage markets that recover as quickly as possible to assist the nation as it regains its footing after the worst economic downturn since the Great Depression. Regulators have many enforcement tools and the duty to ensure that finance corporations comply with laws, regulations, and sound underwriting. However, with respect to the GSEs, it appears that government policy has imposed a dividend rate and capital structure that singles them out for particularly onerous treatment. This strikes us as misguided at best and destructive to the housing market and economy at worst.
As you know, NAR does not defend past GSE practices that resulted in the conservatorship and recommends their total restructuring at the appropriate time. Eliminating a punitive dividend is a step that should be taken now, regardless of how the GSEs may be restructured in the coming years. NAR’s proposal for their restructuring is founded on eliminating the prior private profit and public loss structure, which was inherently flawed. We believe that it is the mission of the GSEs that must be protected, not their structure. For the benefit of homeowners, home buyers, renters, and the entire economy, the nation must have a way to assure the flow of capital to the mortgage market, regardless of the state of the housing or mortgage markets or the overall economy. The path out of receivership that achieves this result will be easier if the contract with the GSEs is amended to minimize the amount of preferred stock held by the Treasury Department.
Accordingly, NAR urges you to reduce, retroactively, the current punitive dividend rate now imposed on Fannie Mae and Freddie Mac, which together with the Federal Housing Administration, currently make possible the vast majority of mortgage lending. Doing so will speed our nation’s recovery and facilitate the movement towards a permanent GSE reform solution. If you would like additional information or an opportunity to discuss our concerns, please contact Jeff Lischer, NAR’s Managing Director for Regulatory Policy, at jlischer@realtors.org or 202.383.1117.
Sincerely yours,
Vicki Cox Golder, CRB
2010 President
National Association of REALTORS®
cc: Edward J. DeMarco, Acting Director, Federal Housing Finance Agency
Student Loan Corp is Stupid Cheap
Aug/109
Student Loan Corp (STU) is so cheap that I’d call it stupid cheap. It trades at 37% of tangible book value. It is profitable and trades 5.9x the annualized run rate of last quarter’s earnings. It also sports close to a 6% dividend yield. Plus, on a sum-of-the-parts valuation, it is significantly cheaper than Sallie Mae.
Student Loan Corp is a well established company. It is consistently the #2 student lender behind Sallie Mae. It is also the student lending subsidiary of Citibank. Citibank owns 80% of the common shares and the remaining 20% of shares are publicly traded. Citibank IPO’d Student Loan during the 1990-91 recession when it had to raise capital during the previous cycle.
The student lending industry is undergoing significant change as the federal government has ended its FFEL Program for private lenders to make government guaranteed student loans. Sallie Mae and STU are left with large run-off portfolios of these FFEL Program loans and a smaller, riskier (but growing) private lending business.
Why is STU so cheap?
Coming into 2010, STU was generally (but not excessively) cheap. It traded at 75% of tangible book value but faced the obvious headwind of the end of the FFEL Program. Although the company also makes private loans, shareholders were faced with the uncertain prospects of how earnings would look as the existing portfolio of FFEL Program loans ran-off the balance sheet and were replaced with purely private student loans. At the time with a 75% of book value, I thought the stock was cheap for a profitable business with a solid book value.
Since the beginning of 2010, STU has been one of the worst performing stocks. It declined 45% through July. What caused this decline? There are two theories about the poor YTD performance: 1) Citibank tried to sell its 80% interest in STU during the Spring of 2010 and found no buyers, or 2) STU reported 2 events that were taken negatively: a) it signed a new warehouse credit agreement with Citibank with high rates and high fees and b) Q1 earnings were close to break-even. Maybe one or two of the larger minority shareholders didn’t like these negative events and exited the stock. However, with the small float and no sell-side coverage, the seller(s) drove the stock price down to these levels.
I lean towards the latter theory of the reaction to the new credit agreement and disappointing Q1 earnings. Although the failed auction may have brought some sellers to the market, I believe it is unrealistic for Citibank to sell the STU franchise at values significantly below tangible book value. I think a couple of shareholders were worried about the new credit agreement as a signal of a change in the relationship between STU and Citibank. Plus, the poor Q1 earnings hurt visibility just as the Greek credit issues resurfaced.
Generally, short sellers do not traffic in this stock because of the small float. It is consistently on the list of stocks with the least short interest.
If Citibank sold STU, how would minority shareholders fare?
Citibank has placed its holdings of STU shares within Citi Holdings, which is a collection of businesses and assets that the large bank wants to exit. Dick Bove mentioned that Citi couldn’t find any buying interest for Student Loan Corp this spring. Sallie Mae’s CFO mentioned at an investment conference that Sallie Mae would be interested in buying Student Loan’s FFEL portfolio.
Considering the stock trades at 37% of book value, it is difficult to imagine a scenario where minority shareholders receive less than the current stock price in a sale. I think it is unlikely that Citibank is desperate enough to unload STU for less than the current market value. Plus, in such a scenario, the risk of shareholder lawsuits would be high. The worst case scenario for minority shareholders is Citi sells down its stake in STU through an offering to the public markets.
Should Citibank sell Student Loan Corp?
I don’t think it makes sense for Citibank to sell Student Loan Corp. The competitive advantage that Student Loan Corp has for originating new loans is its relationship with Citibank. The CitiAssist student loan has a brand quality to it with student loan community. Citibank would receive no value for this competitive advantage in a sale because no buyer would want to be beholden to Citi for new business. So if no buyer is going to pay for prospective new business, it is a question of what a buyer will pay for STU’s existing portfolio. I don’t believe now is the correct time to sell a large portfolio of both FFEL and private student loans because they would trade at par or at a discount to par.
A better solution for Citibank would be to run-off STU’s portfolio and dividend the earnings and freed-up capital to shareholders. If the loan portfolio declined 10% per year and STU paid out earnings and excess capital as dividends, shareholder would receive $19 per share over 2 years and still own a stock with a book value of $53. No matter how distressed Citibank is for liquidity, the run-off solution has to be more attractive than an outright sale. In fact, we have evidence that Citibank is not acting desperate in structuring divestitures by looking at their actions with the IPO of Primerica. In the Primerica IPO, Citi retained 80% of large portfolio of term life policies and will let them run-off over the next 10 years.
If Citi doesn’t sell STU, how will Citi treat minority shareholders of STU?
As the majority and controlling shareholder of STU and its main source of financing, Citibank has considerable power in the relationship with the minority shareholders of STU. To own the shares, we have to get comfortable that Citibank won’t treat us maliciously. I don’t think here is any chance of such a scenario. Looking at the history of Citi’s actions, minority shareholders have benefitted from consistent dividends and growth of book value. Since 1999, book value per share has risen from $26 to $65 and shareholders have received $39 in dividends.
STU and Citibank have changed the terms of their credit agreement. Essentially, they have repriced the agreement to market rates. The new rates are quite high with stiff fees even for the unused portion of the credit lines. STU management has been proactive in reducing the unneeded amount of the open credit lines to save on these fees. An open question I have is: can STU management renegotiate this agreement if the credit market improved or if they could get better funding from a 3rd-party bank?
Funding the Balance Sheet
In addition to end of the FFEL Program, the main issue for the student lenders is access to funding. Student Loan Corp is considered by analysts to be an asset generator because it creates more assets than deposits in its business. The situation with STU is very acute because it does not have any natural funding business such as a branch network to generate deposits. Instead, the company is using loan securitizations to provide permanent funding of its assets.
The stability of this funding source is in question given the credit crisis from which we are still trying to emerge. Once a loan securitization is complete, the fund for those loans is permanent. However, as the loans payoff, the securitization pays down as well. To fund new loans, the company must continually have access to the loan securitization market for new securitizations. This constant access is what is in question. The loan securitization market was closed between September 2008 and June 2009. When it reopened in 2009, the terms were stiff with much higher interest rate spreads and much high requirements for collateral.
Terms for student loan securitizations are much worse than before the credit crisis, but terms have improved recently. For example, the table below compares three private student loan securitizations completed by STU.
| Issue | 2006-A | 2009-A | 2010-B |
| Pool Balance | $3,055MM | $2,307MM | $254MM |
| Class A Note Balance | $2,711MM | $1,396MM | $207MM |
| Class A Overcollateralization | 112% | 165% | 123% |
| Class A Index | 3 mo. LIBOR | Prime | Prime |
| Class A Margin | +0.095% | +1.50% | 0.75% |
Securitization 2006-A was issued at the height of the credit bubble. 2009-A was STU’s first private student loan securitization since the credit crisis started. We can see where the terms materially worsened: investors demanded much high overcollateralization (165% vs. 112%), a worse interest rate index (Prime vs. Libor), and a higher margin (1.5% vs. 0.095%.) In the past year, terms have improved as shown with 2010-B. Hopefully for STU shareholders, we’ll see continual improvement in securitization terms in the years ahead.
Note: The difference in the margin between 2006-A and the other two securitizations is overstated because the collateral in the 2006 was guaranteed by outside insurance companies. STU had to pay for this insurance which cut into its margin.
Valuation Comparison: Student Loan Corp vs. Sallie Mae vs. Nelnet
Student Loan and Sallie Mae are in the same boat. They both must transition to full private student lenders while managing a large the run-off of a large government guaranteed portfolio of student loans. Nelnet is slightly different because they don’t focus on private loans, and they have a larger proportion of their business is fee-based.
| Stock | STU | SLM | NNI |
| 8/2/10 Stock Price | $24.64 | $12.28 | $20.44 |
| Annualized Q2 EPS | $4.16 | $1.12 | $3.80 |
| Price/Q2 EPS | 5.9x | 11.0x | 5.4x |
| Tangible Book | $65.74 | $6.37 | $12.91 |
| Price/TB | 37% | 193% | 158% |
| Dividend | $1.40 | none | $0.28 |
| Dividend Yield | 5.7% | NA | 1.4% |
On a sum-of-the-parts (SOTP) analysis, STU looks even more compelling. All numbers are per share.
| Stock | STU | SLM | NNI |
| Tangible Book | $65.74 | $6.37 | $12.91 |
| FFEL Portfolio (2% premium) | $28.57 | $5.61 | $10.01 |
| Private Loan portfolio (no value) | $0.00 | $0.00 | $0.00 |
| Other Businesses | $0.00 | $2.00 | $9.36 |
| Total SOTP | $94.31 | $13.98 | $32.28 |
| Price/SOTP | 27% | 87% | 64% |
My SOTP is conservative in that it assigns no value for the private student loan portfolios. I believe the market for private student whole loans is quite limited and both STU and Sallie Mae have issues with certain cohorts within their private student loan portfolios. In a run-off scenario, these companies may realize more value from their private loan portfolios than my SOTP analysis. If you were to assign positive values for the private student loan portfolios, both STU and Sallie Mae would look even cheaper on a SOTP valuation.
Negative: No Visible Catalyst for STU
Unlike Sallie Mae’s recent hiring of Goldman to explore strategic alternatives, there is no visible catalyst at Student Loan Corp. The catalyst that makes the most sense would be for Citi to buy out minority shareholders at a premium to the current stock price but a discount to book value. Then, Citi can realize the value and eliminate some public company expenses. If Citi paid a 30% premium to STU’s current stock price, the total purchase would only cost $128 million. Citi could extract this amount in 3 years of run-off.
Conclusion
Student Loan Corp is at such a compelling valuation that investors should consider it. Of course there are the headwinds of the end of the FFEL program and of a challenging funding environment. However, a lender at 37% of book value and consistent history of profitability is too cheap too ignore. Plus, if you own Sallie Mae on a sum-of-the-parts investment thesis, you should consider swapping some of your investment into STU for a more compelling trade.
Companies Mentioned: C, STU, SLM, NNI, PRI
Disclosure: Long STU, PRI
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