Friday, February 10, 2012

Guest Post: Rurban Financial



One of the things that I love about this blog is that I often get the chance to talk to other value investors and we get the chance to bounce ideas off of one another. Recently, I had the privilege to discuss a whole lot of ideas with one of the readers of Ragnar.

While talking one afternoon, I told him that if he ever wanted to do a guest post, that he would be more than welcome to send something my way. He obliged. Frankly, I was pleased with the results. As I have said in a previous post, I never have a problem with people emailing with me to share ideas (or, in certain instances, do guest posts). I will add though, that sometimes stuff gets buried in my inbox, so, If I don't respond to you, feel free to send a follow up email.

Unfortunately, in regard to this post, I was wanting unable to post it immediately, so, earnings have since come out, and the market price has improved significantly (I got the post a few days before the last earnings release)... However, it is still a great read, and potentially a great investment.

Without further ado, here is a fellow value investor's (under the pen name: DTEJD1997) write up on an interesting little bank called Ruban Financial.

Disclosure/Disclaimer: I have no financial position or interest in or against, in any regard, to any of the entities mentioned. This is not advice of any kind. Always do a ton of your own research before contemplating doing anything that I say, do, write, or so much as think about.


Rurban Financial (RBNF $3/share 1.27.12) 

I would propose that shares of Rurban Financial (RBNF $3/share), are an interesting example of a bank left for dead.  RBNF has been through difficult and turbulent times. Investor and analyst interest in this company is non-existant, and thus we have a good opportunity for superior investment returns.   RBNF is well capitalized and is quickly getting stronger, but this not reflected in the current market quote.
Rurban Financial is headquartered in NorthWest Ohio, Defiance Ohio specifically.  RBNF has operations in North West Ohio, Central Ohio, and Central Indianna.  Most of their locations are in rural communities, but they do some amount of business in the cities of Toledo, Columbus, and Fort Wayne. Rurban Financial is a holding company that consists of a bank division (The State Bank), Rurban Data Systems Inc., and some mortgage origination offices.

RBNF is a fairly small bank, with a market cap of about $15MM.  The average trading volume is about 2800 shares a day, so this investment is probably suitable for personal accounts only.  

RBNF has about $625MM of assets under management.  Book value per share is about $9.76.   TANGIBLE BOOK value is $5.91.  Tier 1 capital ratio is approximately 8.57% and thus puts them in the "well capitalized" category.  These figures are from September 2011.  I strongly suspect that all forms of book value, and Tier 1 capital levels are higher than this at the end of January 2012.  

Tier 1 capital is approximately 8.57%, 8% is the minimum requirement for a "well capitalized" bank.  The important thing is that the bank is "well capitalized". It is also important that earnings & capital levels are trending in the right direction.  

Rurban has actually been earning money this past year, it's loan book is getting better, not worse.  This is supported by the CEO Mark Klein's statements in the 2011 3rd quarter report: 
"Elevated costs associated with the administration of problem assets are fairly well behind us,  and we are focusing more intensively on improving efficiencies within the Bank."

The 3rd quarter earnings were not a one quarter temporary bump.  Here is what was said in the 2011 2nd Quarter report:
"Earnings, total  revenue, Tier 1 and total risk-based capital, as well as services-per-household, all  revealed positive movement while non-performing  assets, delinquencies, and non-interest  expenses were all down."

Finally, in the 1st Quarter of 2011 CEO Mark Klein wrote:
"The most compelling aspect of the improving trend, particularly in the current quarter, is that we  are seeing less deterioration with our loan portfolio, and as a consequence, fewer additions to  delinquent and nonperforming status."


The end result is that earnings and loan quality are improving for Rurban and have been trending that way for at least 3 quarters in a row.

Like most other banks, Rurban has not been without it's problems...


WHAT WENT WRONG WITH RBNF?

RBNF has had many problems these past four years.  Some of them were self-inflicted, some were not. The primary problem with RBNF was it's RDSI (Rurban Data Systems Inc.) division.  This division did transaction processing for small banks primarily in the Midwest.  This was a boring, but profitable sideline.  At some point in the distant past,  RDSI decided that they were going to develop their own software to compete with Fiserv.  This was most of the business going on in RDSI and was a major expense center.  

In their quest to get this software developed, RDSI merged with another small software company, New Core Systems (NCS).  This is a very long & complicated story.  The end result is that the software development burned through a lot of cash and failed in the end.  RBNF took a large charge to write down the value of this division in June 2010.  Most of the people associated with this division were let go.  As of late January 2011 there are about 32 people in this division vs. 110 when it doing software development.  It has been scaled back to it's original position of doing boring transactional processing, and is now mildly profitable.  RDSI is now a much smaller part of RBNF.  Management does not anticipate taking any further charges here in the future.

The other thing that went wrong with RBNF is that they had a lot of loans go bad.  This was a problem common to a lot of banks.  RBNF has taken charges to write down and disposed of these loans.

RBNF also got hit with a large FDIC insurance charge.

RBNF has also had to deal with a very difficult economy in Ohio and Indiana.

Fortunately RBNF had a VERY strong capital levels before all these problems started.  If RBNF did not have such strength and reserves, it would have enetered bankruptcy by now.

The end result is:

A). RDSI has been scaled back.  People have been let go (32 now vs. 110).  A charge was taken to write down the bad investments.  This division is stabilized and mildly profitable.
B). The bad loans have largely been charged off and addressed.
C). Barring the general economy relapsing into further recession/depression, most of RBNF's problems are behind it.

Well, all of this sounds great, but what are the future possiblities for this bank?

In order to get an idea of what RBNF is capable of producing, we can look at the financial returns of other banks.  I would propose that we look at the following:

A). Return on Assets
B). Return on equity & book value
C). Extrapolation of TTM results for RBNF

RETURN ON ASSETS:

Good & capable management of a bank can earn returns on their assets of about 1% in normal economic times.  That would equate to net earnings of about $6.25MM ($1.30share) for RBNF.  A very well run bank could earn a return of about 1.5% on it's assets, if RBNF could achieve that, earnings would be nearly $2/share.  I don't think RBNF is a currently a well run bank, but it certainly could be a decently run bank in a year or two.  This would indicated future earning potential of at least $1/share.

RETURN ON EQUITY & BOOK VALUE:

Rurban has a book value of almost $10/share.  A well run bank, in normal economic times, could earn 15% on it's equity.  That would put Rurban's earnings at close to $1.50/share.

Rurban has a lot of goodwill & intangibles on it's balance sheet as it has acquired smaller banks in the past and has a data processing division which has a lot of intangibles & goodwill associated with it.  You could mark down all goodwill & intangibles to ZERO and be left with a book value of about $6/share.  I am conservative investor and I don't much care for goodwill & intangibles, but I think marking it down to ZERO would be a bit too much.  How about marking intangibles down by 2/3?  That would give Rurban an "adjusted" book value of about $7.35/share.  I think that is probably pretty accurate and fairly reasonable.

You could say that Rurban is an average/mediocre bank...OK I might be willing to concede that point.  Average banks don't have 15% ROE.  Yes, that is quite right, how about a 10% ROE for an average bank?  I think that is probably a conservative estimate.  With that estimate, Rurban would be earning about $.73/share.

You could argue that Rurban is an average bank, that it is operating in a difficult economic climate in a economically depressed part of the country, and you would be right.  So maybe take that estimate of $.73/share and mark it down by 15%.  You will still have earnings of  $.62/share.
EXTRAPOLATION of TTM RESULTS:

In the latest 3 quarters, RBNF has earned $.29/share.  I think 4th quarter earnings will be at least as good as third quarter earnings, probably a bit better even.  That would equate to earnings of maybe $.14 or $.15/share.  I think RBNF will have earnings of about $.45 for the last 12 months.  That equates to a P/E ratio of about 6.5.  I think earnings in 2012 will be higher as RBNF has put a lot of it's problems behind it, I think 2012 earnings will be at least $.62/share.  That equates to a forward P/E of slightly less than 5.

Also note that RBNF is expensing about $180k a quarter in goodwill and intangibles resulting from the takeover of two smaller banks.  These banks were the Exchange Bank and National Bank of Montpelier.  These expenses will continue for another 4 to 5 years.  What is important to remember is that these expenses are non-cash.  If you add these back into earnings, RBNF is doing better than first glance.

I have spoken with top level management at RBNF and have found them to be receptive to shareholder questions and concerns.  They appear to be very shareholder friendly.


 FUTURE VALUE OF RBNF:

A bank that is well capitalized, earning money (probably $.62/share), has a loan book that is improving, is only trading for $3/share?  I think Rurban will trade for a discount to other banks, but a P/E of 5?  

I think an appropriate P/E for Rurban to trade at would be in the high single digits, maybe a 9 P/E.  That would put Rurban at a price of about $5.50 to $6/share.  I think that estimate is conservative, and at the low end of estimates.

In 3 years I think RBNF will easily be earning $1/share.  At that point, I think RBNF will reinstate a dividend.  RBNF has a history of paying dividends in normal economic times.  Management has stated that this is reviewed by the board of directors every quarter.  There is no intention to pay a dividend now, but that it will be seriously considered once regulatory capital levels have improved and business in general improves.

The end result is that RBNF is earning money NOW, growing it's business and is likely to earn more money in the near future.  After a year or so of good earnings, a dividend will almost certainly be reinitiated. A bank with characteristics such as this will be trading for a P/E ratio higher than 5.

*NOTE*  I personally own shares of Rurban in my investment accounts and may trade it at any time without  notice.  Please don't take my word as to the suitability of Rurban as an investment, please conduct your own research and due diligence.

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