This is a tough week to submit an idea!  EBML is touting an 8 dollar stock with the potential to earn $40 in eps, with a patented product that can trick your brain into liking diet soda.  Katana’s write up is getting traction in the WSJ for a product that can cut your phone bill by 90%.  I offer nothing quite as exciting, but remind myself that the world needs ditch diggers too.

I am recommending Anchor Bancorp as a long, symbol ANCB.  Anchor Bank, formerly Anchor Mutual Savings Bank, is a relatively small bank in Lacey, Washington with approximately 400 million in assets and a market cap of 42 million.  They file with the SEC, and their cert number with the FDIC is 28454.

The really short version is that there is some hidden value here in a bank that I think is an eventual takeover candidate.

Pricing:

With a last price of 18.25, the stock trades at approximately 85% of tangible book value.  Stock has crept up a little bit this week, likely the result of a American Banker article published early this week highlighting the two activists involved.

Credit Quality:

Non Performing Assets (NPAs) are elevated at around 5.5% of total assets.   This number includes Troubled Debt Restructurings or ”TDRs” (aka “performing non performing”).  TDRs represent loans where below market concessions are made to the borrower.  Most common types of concessions are lowering the rate or the LTV or making concession based on cash flow specific to the collateral or global cash flow.   There is some reason for optimism when considering the 5.5% NPAs: Roughly half of the NPAs are TDRs (Which the bank is likely making a profit on).  Roughly a quarter of the NPAs are OREO (which tends to be the final stage for an NPA, indicates a fresh appraisal, and typically means that the OREO will be sold sooner rather than later).  The loan loss reserve is about 25% of total NPAs, and 80% of non-performing loans.

Capital:

Tier 1 13.5%.  Tier 1 Risk-Based 17.7%.  Total Risk-Based Capital 18.5%.

Regulatory:

Anchor entered into a Cease and Desist  with the FDIC in 2009.  Order was terminated on 9-5-12 as a result of steps Anchor took in reducing the level of classified assets and improving the condition of the bank.

Activist Investors:

Two activist investors have voiced their opinions on the situation.  One wants Anchor to sell now.  One wants Anchor to sell later.  More on those guys later.  Anchor converted on January 25^th 2011, so it just celebrated the critical 3 year anniversary.  Converted thrifts can not sell until three years after a conversion.

Not so obvious hidden asset:

Due to prior losses, Anchor has a valuation allowance of 8.9 million against their Deferred Tax Asset.  If they can achieve and demonstrate consistent profitability their auditors will allow them to remove the valuation allowance, thus realizing the full value of the deferred tax asset.  This would add approximately 3.50 to the current book value of 21.16 for an eventual pro forma book value of 24.50.

Back to the activists.  One 13D filer, Joel Lawson, doesn’t want to wait to see if ANCB can get the DTA back.  The other, Joseph Stillwell, seems to think it might be worth waiting to see if the DTA can be recaptured.  Stillwell thinks the nation is overbanked and is quite willing to assist with this particular problem by strongly urging most of the banks he invests in to merge.  So it is somewhat rare that he is suggesting that it might be better to wait. 

I am in the Stillwell camp on this one.  There has been a steady resolution of problem assets and the bank is shrinking appropriately by running off high cost deposits, and closing some branches.  My educated guess is that profitability will be achieved in 2014, and the DTA will be “captured” in 2015.  By then book value will be close to 25.00, and I think a really clean Anchor Bank could get 120% of book value in a takeover, or approximately 30$ per share in mid 2016.  At current prices this equates to an IRR of 24%.  The conjecture on ANCB is that they will sell once cleaned up, and I think Stillwell will play this one like a fiddle.   Note that a bank with 400 million in assets is in a sweet spot for M&A.  Not too big and not too small, but just right to move the needle for a 1 or 2 billion dollar bank.  Especially attractive is a bank that has been slowly shrinking, as the higher cost deposits are weeded out in the deleveraging process.  So perhaps 120% of book value turns out to be conservative.

Now hypothetically they might continue to struggle with high NPAs and associated costs and might never recapture the DTA and then shareholders, including Stillwell, might force a sale.  In that case I think we can get 90% of book value, or around 19$. 

So heads we win, tails we have a still positive but undesirable IRR.

That is my idea.  I concede that I probably won’t get a check for $5,000 from VIC on this one, it won’t be referenced in the WSJ, and it won’t make a diet soda taste better - but I view it as a good risk reward nonetheless.  I’m partially hoping it generates a good thread on other banks on the verge of capturing their DTA, as I think this could be a good investment and trading theme in 2014 & 2015 as community and regional banking continues to recover.  Don’t all jump in at once (like I did with SNMX), it is a thinly traded stock perhaps only suitable for small funds and personal accounts.