The list of PICO holdings provided many examples of investments in banks. Through reverse-engineering, I was able to get a better understanding of their bank investing philosophy. In this article, we will focus on two PICO investments, Exchange bank of Santa Rosa (EXSR) and Farmers and Merchants Bank of Long Beach (FMBL). Between the two of them, we can see the important criteria in analyzing banks.
One of the first things that stands out in all of PICO's bank stocks is their high quality of deposits. EXSR has 400 million checking deposits out of its 1.38 billion total deposits. FMBL has 770 million checking out of 2 billion total deposits. Most banks can only dream of these deposit mixes. Checking deposits are non-interest bearing and less competitive- people have few reasons to switch checking accounts and it is usually not worth the hassle. Market share can be an important factor in attracting higher quality deposits; EXSR is currently number one in its county.
EXSR earns 7.7% on its loans. Judging by non-performing loans, EXSR seems to have good asset quality. Non-performing loans over total loans were .29% last year. Going back to 2001(the earliest I can find), the figure was at .15%. This compares with their allowance for loan losses of 1.6%.
Companies that can keep their expenses low have an advantage in deposit competition. My measure of expense ratio is (non-interest expense - non-interest income) / net interest income. EXSR has a respectable 51%. FMBL has an exceptionally low 31.5%. I'm not positive this calculation is the best way to measure it, but the important thing to take away is that FMBL has been able to run its business much more efficiently than most banks today.
Generally. a well-capitalized bank has a ratio of equity to assets of 1:10. A lower ratio means undercapitalization, and a higher ratio means the company has excess capital. EXSR has 128 million in equity for 1.5 billion in assets- it is slightly undercapitalized. FMBL, on the other hand, has 650 million in equity for 3 billion in assets. This is highly overcapitalized, and makes the company's return on equity look weak. (This is why when screening for banks, you should focus on Return on Assets, with greater than 1.3% generally being a very well-run bank) The company can dividend out 350 million and still easily be considered well-capitalized.
PICO must have been foaming at the mouth when they bought FMBL shares at a market cap of 550 million. The company could dividend out 350 million and leave a security with an adjusted 17.5% yield on a best-of-breed bank. Trading at over 1 billion today, the valuation for FMBL is much less compelling.
EXSR does not have excess equity it could dividend out, but the company does currently trade at only 10x earnings. This is cheap for a high quality bank, especially when compared to the valuations of other banks. But is it cheap on an absolute basis?
Additional Write-Up on 8/9/07