The cheap and expensive places in American banking.

I woke up this morning to prepare breakfast and saw this interview with Derek Pilecki long/short financial investments, regional banks, non-banks and insurance by Value after office hours:

Derek runs Gator Capital and he focuses on value investing in banking, insurance and finance-related companies, so it’s interesting to hear his comments on different things.

A few quick takeaways from the video:

1. There is a lot of fear, but private lending is actually breaking away and helping the medium and small banks make the riskier loans.
2. Private lending is usually done by the larger banks and in a sense they have two levels of control. The private credit will vet the borrowers, while they vet the private credit companies they lend to.
3. Derek met ten banks at a conference and no one was concerned about credit quality. It makes Derek think that there would have been some concern last time, but credit quality has been top class in recent years. He had a conversation with an M&A person and it turned out that 1 in 3 potential banks have loan books that are well organized, clear and of good quality, making them an attractive target. But now almost all the banks he comes across are good because of standardization.
4. Derek says the quality is good, but despite that you would face the generally cyclical problems in the housing market, but it wouldn’t be as bad as 2006 due to much better credit conditions.
5. Track the growth of the tangible book value per share. If that rises over time, the stock price usually follows suit.
6. The big American banks are expensive.
7. There are mid and small banks trading at 8 times PE when they usually trade at 10-14 times. Derek discovers that medium and small banks were expensive in 2017/2018 and he doesn’t own any. He currently believes this space is mispriced.
8. Not all banks focus on ROE. Banks can expand mindlessly without worrying about how well their ROE is doing.
9. The smarter managers will reconfigure the banks by withdrawing capital from areas that are not worth focusing on areas where ROE would grow.
10. The best combination is when you have something trading significantly below book value and ROE is expected to grow 1-2%. It is even better if the company indicates that it will buy back shares. The growth in return on equity indicates that management has a plan, or at least a vision, that earnings/sales in a very traditional company can be improved in the near future. If your ROE is 10% and your bank stock is trading below book value, say 0.5 times, that means $1 invested in equity returns 20%. So if the bank uses their resources to buy back their shares, it’s like each share earns 20%, and will grow because management is leading. These companies can grow as SAAS companies if done right.
11. There may also be indications that management decides to enter asset management.
12. The two ends or line of the yield curve to pay attention to are the 3-month and the 5-year, because the former is what they borrow against and the latter is what they borrow against. If the plan includes two to four rate cuts, that would reduce the short position by 0.5% to 1%.
    • The current 3-month US interest rate is 3.68% and the 5-year interest rate is 3.52%.
    • If three-month rates move lower, the steep yield curve will help the net interest margin.
13. #12 actually indicates the tailwind for the short end, but since the term of the loans is 5 years, those loans from 5 years ago now need to be refinanced at a higher lending rate, so this also helps the NIM (but volume is a whole different matter.
    • The US five-year yield in March 2021 is 0.79%, so imagine it now resets to something closer to 3.5%.
14. On the insurance front, the cost of accident insurance has been a headwind and is proving to be a challenge.
15. Derek says that financial advice work at the right price is something that not many people notice. Names to watch in this space include LPL Financial (LPLA), Raymond James (RFJ), and Ameriprise (AMP). AMP looks really cheap.
16. Another money printing company in the spotlight is Jackson Financials, a spin-off of Prudential. It is a pure play on annuities with a fixed index that are attractive to retirees. It’s a play about the aging part of America.

I hope this is helpful.

Some graphs of what is mentioned.

Jackson Financial (JXN)

About $10 billion in enterprise value. Debt has remained constant over the last three years, but over the last three years they’ve added $1 billion and $2 billion in cash without much change in structure.

Ameriprise (AMP)

Approximately $38 billion in enterprise value with net cash of $4 billion. 13 times price-earnings ratio tends towards the lower limit of the historical price-earnings ratio of the past ten years.

The yield curve is currently comparable to 5 years ago:

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