Eagle Bancorp Montana, Inc. (EBMT)

Eagle Bancorp (EBMT) is the bank holding company for American Federal Savings Bank, a community bank based in Helena, MT. The company has 13 branches, primarily along the I-90 corridor in southern MT. As of Dec. 31, 2012, the company had ~$508 million in total footings and a market cap of roughly $40 million. 

EBMT has twice been written up on Value Investor’s Club, and the analysis put together by the two authors shames my feeble attempt, so I urge you to review those write-ups (both are available to “Guests” who register for a password). The most recent write-up from February 2013 does a nice job of explaining what’s happened recently with EBMT, specifically the acquisition of 7 branches from Sterling Financial in July 2012.

To recap, EBMT purchased: 

• 7 Branches (Missoula [2]; Hamilton, Bozeman, Livingston, Big Timber, Billings) 
• These complement the bank’s existing 6 branches (Helena [3], Townsend, Butte, Bozeman)
• $44 million in performing loans. 
• $182 million in deposits. 

Management paid a 4.3% deposit premium for the acquisition (EBMT paid Sterling $7.92 million for $182 million in deposits). The acquisition put to work excess capital that was raised with the second-step conversion back in 2010 (Equity/Assets dropped from 16.4% in June 2012 to 10.5% as of Dec. 31, 2012).

Beyond the branch acquisitions, another notable point regarding EBMT is its anniversary. On April 5, 2010, the bank completed its second-step conversion from a mutual holding company to a fully publicly-owned stock holding company structure. Without getting into the fascinating world of bank regulations (ZZZZzzzzzzzzzz), we can sum up to say that the OCC (savings bank regulator) severely limits a mutual company’s ability to be acquired in the three years following conversion. As of April 5, 2013 (what a coincidence – that's today!) those restrictions are eased (I say eased because this is still a bank, and the Federal Reserve Board (holding company regulator) / OCC (bank regulator) would still need to sign off on any acquisition). 

Now, my 2 cents: 

1. The Sterling acquisition is not the slam dunk it appears at first blush. The cost of the deposits acquired ($182 million) was 0.72%. Doesn't sound like much does it? Yet, ~57% of those deposits were money markets, DDA, NOW, and savings. Those should be yielding ~0%. The ~43% in CDs would then have an implied yield of 1.67% - not exactly cheap money (I know, I know, 1.67% is cheap money in a normal environment, but the Fed’s ZIRP is anything but normal). Consider that a quick internet search reveals that I have to go out 5 years to get in the 1.50 – 1.75% on a CD right now. The reason for the heightened cost of acquired deposits is due to Sterling Financials problems in the financial crisis. Sterling was literally trying to avoid a run on its banks, and jacked up deposit rates to avoid insolvency (go look at its stock chart). Although I think EBMT can hold on to many of these deposits, it might not be perfectly smooth/easy/cheap.
2. Although I like the idea of a potential acquisition catalyst, I’m not sure how high a probability we should assign such an outcome. From conversations with Montana bankers, there isn't a good in-state acquirer. Most of the other local institutions already have significant footprint overlap with EBMT. On top of this, the Sterling branches were shopped to everyone. EBMT didn't so much score a coup by grabbing them, but rather they were one of only a handful even interested in the branches (which makes the 4% deposit premium look a little expensive in my mind). Still, I'm not much good at identifying potential acquirers beforehand. Perhaps a mid-sized out of state institution wants into Montana, but I'm not building an investment thesis on it. 
3. EBMT held up remarkably well in the financial crisis. I love a bank with solid underwriting. Just look at the ratios: 

	Jun 05	Jun 06	Jun 07	Jun 08	Jun 09	Jun 10	Jun 11	Jun 12	Dec 12
NPL/Loans	0.47%	0.32%	0.13%	0.02%	0.75%	1.65%	1.57%	1.83%	0.70%
ALLL/Loans	0.53%	0.38%	0.33%	0.31%	0.31%	0.64%	0.96%	0.93%	0.85%
ALLL/NPL	114.4%	116.6%	244.3%	1641%	41.9%	32.1%	44.0%	29.1%	121.4%

NPL = Nonperformg Loans; ALLL = Allowance for loan and lease losses

Close (geographic) peers like GBIC and FIBK saw NPL/Loans spike to 4.5% to 7.8% in the 2009-2011 timeframe. 

Now some people are criticizing EBMT because they won’t be able to juice earnings with reserve releases as NPLs come down and the economy improves (FIBK/GBCI are now running ALLL/Loans at 2.5% - 3.85%, with ALLL/NPL of 100% - 130%). Although technically true, that’s just an accounting game. Games can influence short-term investors (a catalyst), but over the long-haul, I prefer the bank that never had to jump on the reserve/release roller coaster.

The stock looks moderately cheap if we think a number of things can go right:

• (A) Leverage improves. As noted above, EBMT has now deployed some of its excess capital. This should help improve ROE levels by up to 50% (Assets to Equity improvement from 6.1x to 9.5x = 56% improvement). 
• (B) The potential to write-new loans. Right now, EBMT is under-loaned at a loan/deposit ratio of 52%. Historically, the bank has run at ~75% loan/deposits. If they jumped up to a 75% ratio, this would be $97 million in new loans. I do not want them to do this quickly (I worry about underwriting standards), but even assuming a 5-10% increase in new loans annually that’s a $450,000 benefit to the bottom line and a 9bps boost to ROA annually (assumes $15 million in new loans annually, a 3% margin on new loans [consistent with most recent 10Q loan yield of 5.4% less securities yield give-up of 1.4% and a 1% hit for oversight costs = 3% yield increase] divided by $508 million in footings). 
• (C) Now the question of what is a normalized ROA confronts us. Over the last 10 years, the bank has averaged 0.83%. Over that same time, the bank has posted an average efficiency ratio of 72%. This is inexcusable – peers (no, not management cherry picked peers, but rather banks right across the street from EBMT) are sub 60%, with a number below 50%. Whether through its new larger size, or just better control of the purse strings, EBMT needs to get down to 60% (as a side note, this is where I think an acquirer might salivate – it should be feasible to buy EBMT and quickly improve the profitability). A drop from 72% to 60% in the efficiency ratio would foster a 40% increase in ROA. Using the 10 year average 0.83% ROA, a 40% increase would indicate an ROA of 1.16%. Let’s use 1.0% to be a little more conservative. 
• (D) Let’s put it all together. Now points B & C overlap somewhat (historically, EBMT has run at a loan/deposit ratio of 75%, so I can’t assume loan growth will increase ROA above the 10 year average). However, just looking at point A, which is an Asset/Equity ratio of 9.5x, and point C, which is an implied ROA of 1.0%, we get an ROE of 9.5%. If we want a 10% return on our investment, we can afford to pay 0.95x book value. At 0.8x right now, we’re buying EBMT at a near 20% discount.
• (E) If we look back at the good old days before the financial crisis (2002-2008), EBMT had an average ROA of 0.89%. A 40% efficiency ratio improvement would get this to 1.25%, ROE to 11.88%, and an implied P/B ratio of 1.2x, which is 50% above current. 

Bottomline, I think EBMT is undervalued trading at 0.8x book value. It’s not incredibly cheap on an absolute / right now basis, but it has solid long-term potential, as well as a number of catalysts (acquisition integration, efficiency ratio improvement, improving economy, etc.) that should help it improve operations. Most importantly, management has historically been a top notch underwriter, which provides downside protection (margin of safety).


The importance of solid underwriting brings to mind an old J.P. Morgan quote. In December, 1912 Morgan testified before congress and was asked how he decided whether to make a loan. He replied, “The first thing is character.” One of the esteemed congressman suggested that perhaps factors like collateral might be more important, but Morgan retorted, “A man I do not trust could not get money from me on all the bonds in Christendom.” 

Disclosure: Long EBMT

Harvest Investor © 2013. All rights reserved. The content and ideas contained in this blog represents only the opinions of the author. The content in no way constitutes investment advices, and should never be relied on in making an investment decision, ever. No content shall be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The author may hold positions in the securities and companies mentioned on this site. Any position disclosed on this site may be modified or reversed without notice to you. The content herein is intended solely for the entertainment of the reader, and the author.