Description

I had some trouble pasting in pictures and charts so I set up a scribd link for this write up:

http://www.scribd.com/doc/238655950/Blue-Hills-Bancorp-BHBK-VIC?secret_password=TDiaGm8Wn09ehmPuxkQa

Thesis

Background – Recent IPO Through Standard Demutualization

BHBK recently converted from a mutual-owned (MHC) company to a stock-owned (public) company via a standard thrift demutualization transaction.  The offering was completed on 7/21/14 at the adjusted maximum of the range, which resulted in gross proceeds of $278 million, pro forma TCE ratio of 22% and pro forma TBVPS of $13.67 per share.  Today’s stock price of $13/share therefore represents a pro forma entry valuation of 0.95x P/TBV.

Background – Franchise & Strategy

Organized in 1871 and reorganized into a mutual holding company structure in 2008, Blue Hills Bancorp is a $1.8B community banking institution with nine full-service branches in the attractive Greater Boston market (southern and eastern MA regions) as well as Nantucket Island (acquired footprint).

Source:  BHBK S-1 Filing.

The business mix is concentrated in Residential Mortgage and CRE lending, funded by a strong deposit footprint with 60% MMDA and 30% CDs.  According to the S-1 filing, since 2010:

the Bank has significantly revised its strategic direction and operating strategy, its executive management team and its board of directors. The Bank appointed William M. Parent as its Chief Executive Officer and President in mid-2010 and developed a strategic plan to transform the Bank into a full service community bank serving the needs of retail and business customers residing and operating in eastern Massachusetts. The Bank has appointed seven new directors since 2010, many of whom have direct experience with larger financial institutions or the local communities served by the Bank. In addition, the Bank has hired a new executive management team, with eight of its executive officers joining the Bank since 2011. All of the Bank’s new executive officers have experience with larger financial institutions and commercial lending organizations.

Source:  BHBK S-1 Filing.

The bank’s business strategy is focused on lending growth and diversification as it has added approximately 34 employees involved in loan origination, underwriting and servicing over the past few years.  In addition, BHBK is focused on improving its already solid deposit franchise, utilizing mobile products and expanding the franchise via M&A.  We expect share repurchases and dividends to be part of the shareholder value proposition to lever the bank’s excess capital, as is typical for recently demutualized thrifts.

Source:  BHBK IPO Pitchbook.

Source:  BHBK IPO Pitchbook.

Source:  BHBK IPO Pitchbook.

Source:  BHBK IPO Pitchbook.

Nantucket Branch Acquisition

On January 18, 2014, the bank completed its acquisition of three branches on Nantucket Island that operate under the name Nantucket Bank for a purchase price of $10.3 million.  This purchase price equates to a deposit premium of approximately 3.75% on acquired balances of $275M.  The total assets acquired were $285M.  All loans acquired were performing.  The majority of loans was 1-4 Family and CRE and had an all-in blended rate of 4.3%.  Deposits acquired were 90% non-CDs with all-in cost of 34bps.  The transaction is arguably a net positive for shareholders as it continues the bank’s growth plans in attractive markets at a reasonable cost, with attractive balance sheet economics.  According to the bank’s S-1 filing:

The Nantucket Branch Acquisition assisted in the implementation of our business strategy as it added a strong local market share of core deposits and reduced our dependence on wholesale funding and brokered deposits to fund loan growth. The acquisition provided net cash of $151.6 million, the majority of which was subsequently used to pay down Federal Home Loan Bank advances and brokered deposits.  The transaction also changed the interest rate sensitivity of the Bank through the addition of core deposits and the use of cash to reduce short-term wholesale funding and brokered deposits.

Source:  BHBK S-1 Filing.

A description of the acquired B/S:

Source:  BHBK S-1 Filing.

Loan Portfolio

New management aims to grow and diversify the lending portfolio.  Today the portfolio is predominantly real estate loans (84%) with the majority in 1-4 Family and CRE.  The all-in yield on earning assets is just over 3%, an opportunity for improvement as NIM sits slightly below industry averages.

Source:  BHBK S-1 Filing.

Credit Quality

The bank has a record of pristine credit quality.  Management aims to maintain this profile while growing and diversifying the balance sheet, drawing upon its extensive experience in the Greater Boston banking market.

Source:  Hyde Park Bancorp (MHC) per SNL Financial.

Source:  BHBK IPO Pitchbook.

Investment Securities Portfolio

Source:  BHBK IPO Pitchbook.

Deposit Base

The bank’s all-in cost of interest-bearing liabilities is a relatively strong 58 basis points, with potential for substantive improvement as the bank grows and diversifies its business banking relationships.  CDs account for approximately 1/3^rd of the deposit base.

Source:  Palmetto Bay Capital Management.

Preferred Equity Redemption

BHBK had $18.7 million in Small Business Lending Fund (SBLF) Preferred Equity as of March 2014.  This paper was issued in September 2011.  The bank redeemed its SBLF using proceeds from its recent IPO completed 7/21/14.

Sensitivity to Market Risk

The bank is liability sensitive.  According to the S-1 filing, a 200 basis point upward movement in rates would result in a (2.47%) change in NII over a one-year period.  For the same shock in rates, the bank’s EVE would decline (8.8%).  Recent initiatives, such as the Nantucket branch acquisition, coupled with management’s view to grow and diversify the balance sheet, will help rate risk positioning.

Management Team

Source:  BHBK S-1 Filing.

The management team is new and draws upon experienced professionals with commendable track records at larger banking institutions like Citizens (RBS) and Sovereign/Santander.  This level of experience should drive the bank’s growth and diversification strategy in its markets, particularly since banks like Citizens (RBS) have dominant market positions in the Boston markets.  Since 2011, eight new executive officers have been hired post the new CEO in 2010: Senior Commercial Officer, Chief Risk Officer, Chief Retail Officer, Chief Information Officer, Chief Marketing Officer and the CFO.  CEO Parent joined BHBK in 2010; prior, he was Partner and CIO of Grail Partners, a boutique merchant bank.  He has 27 years of experience in the banking industry, including 16 years at Bank of Boston, FleetBoston and Bank of America.  Thomas O’Learly, EVP Commercial Banking, joined in 2011, has 39 years of experience, and was previously at Citizens Bank (RBS).  Jim Kivlehan, CFO, joined in 2013 and was also previously at Citizens Bank (RBS).  Lauren Messmore, SVP Corporate Strategy, joined in 2012 and was previously an investment banker at Citigroup and founded her own boutique firm.  Scott Thimann, EVP and Chief Retail Officer, joined in 2011 and was previously at Sovereign/Santander Bank from 2000-2011.

Board of Directors

12 directors serving three-year staggered terms.

Source:  BHBK S-1 Filing.

The Board has many members with high level, senior leadership experience at large banking institutions.  Thomas Menino was former Mayor of Boston for five terms from 1993-2014.  Chairman David Houston Jr. has been on the BOD since 1977 and is a senior member of an independent insurance agency.  Ken D’Amato is Managing Director, Global Equity and Fixed Income at Manulife Asset Management of Boston, MA.  Peter J. Manning is former Vice Chairman of FleetBoston Financial Corporation and joined the BHBK BOD in 2010.

The exceptional caliber of local talent and experience represented on the Board and senior management team is highly uncommon for a community business bank and should drive outperformance in terms of gaining market share in the Greater Boston banking market and achieving sustainable profitability.

Markets

The bank operates in an attractive geography in and around the Boston market area.

Due to our proximity to Boston, our market area benefits from the presence of numerous institutions of higher learning, medical care and research centers and the corporate headquarters of several financial investment companies. Eastern Massachusetts also has many high technology companies employing personnel with specialized skills. As a result, healthcare, high-tech and financial services companies constitute major sources of employment in our regional market area, as well as the colleges and universities that populate the Boston Metropolitan Statistical Area (“MSA”). These factors affect the demand for residential homes, apartments, office buildings, shopping centers, industrial warehouses and other commercial properties. Tourism also is a prominent component of our market area’s economy, as Boston annually ranks as one of the nation’s top tourist destinations.

Source:  BHBK S-1 Filing.

Household income and population projections exceed the national averages, according to SNL Financial:

Source:  Hyde Park Bancorp (MHC) per SNL Financial.

Competitive Positioning

The bank ranks in the top 20 by deposit market share in all counties of operation, illustrating both its comparative scarcity value to a prospective acquirer as well as its potential for market share growth.  Total deposits in these counties amount to over $110 billion, illustrating the compelling growth opportunity.

Source:  Hyde Park Bancorp (MHC) per SNL Financial.

Precedent Demutualizations in Massachusetts

On average, thrifts demutualize in MA at 75% of TBV with 17.7% capital (TE/TA)…the mean pricing and capital ratio for the group “today” (or, for those institutions that have sold, the most recent time period before sale) is 160% of TBV and 9.7%, respectively.  These metrics suggest a compelling risk/reward for thrift investors in Massachusetts’ demutualization transactions.

Precedent Bank & Thrift M&A Transactions since 2010 in Massachusetts

Of most interest to BHBK investors, comparable institutions of size - United Financial Bancorp, Danvers Bancorp and Wainwright Bank & Trust Company - sold for P/TBV multiples of 140%, 184% and 200%, respectively.  All were clean banks with strong profitability (70-80 basis points ROA) and capital ratios (7-10%).  BHBK is similarly well poised to reach these metrics and become a compelling takeout candidate.

Model & Valuation

The model was developed independently based on a reading of the bank’s public filings.  The central questions underlying the model are the capacity to which the bank can lever its excess capital through organic growth, share repurchases and dividends, as well as achieve sustainable earnings through improved NIM and lower expenses.  Key model assumptions include:

1. Pro forma offering (IPO) adjustments in 2Q 2014
2. Annual balance sheet growth (loans and deposits) of 6%, in-line with historical trends
3. NIM rises to 3.0% driven by growth, mix improvement and rising rates
4. Credit profile remains solid as NPAs / Assets remains < 1%.  ALLL maintained at 1.12%
5. Fee income increases at rate of 4% per year
6. Operating leverage “right-sized” (i.e. decline in Expenses/Assets) in order to achieve positive earnings, and to reflect core run-rate after integration of Nantucket branches.  An acquirer is likely able to cut expenses more quickly and with greater value for shareholders than BHBK on a standalone basis
7. Dividends:  none modeled
8. Share repurchases:  10%/yr starting in June 2014 at market valuation
9. TCE levered from pro forma 22% in June 2014 to 17% by 2017 (three-year anniversary).  Model does not assume any acquisitions
10. TBVPS moves from $13.67 per share to $15.55 per share in 2017

Returns and Exit Considerations

We believe the franchise is well positioned to be an attractive takeout candidate given its growth profile, exceptional management team and Board and geographic/market positioning.  If BHBK can lever its excess capital through organic growth and disciplined M&A activity, proving to the market its growth strategy, while reducing expenses to achieve higher ROAs and ROEs, it could garner a higher P/TBV multiple more in-line with peers.  To illustrate the potential returns as based on the model, assuming the long-term average takeout multiple of 1.6x P/TBV, as seen in the MA thrift and M&A tables earlier, this would result in a 2017E nominal value per share of $24.88.  Discounted at 10% back to today, this equates to a $17.40 per share stock price.

Merits

1. Highly attractive entry valuation / margin of safety for bank of this size (already at critical mass > $1B in assets), caliber (growth trajectory, people talent) and geography (attractive Greater Boston market)
2. Strong management team and Board of Directors with uncommon talent and resources for a community bank
3. Strong credit quality
4. Earnings power upside through enhanced NIM as rates rise and opportunity to diversify lending niches (more commercial loans vs. real estate loans), plus reconfigure deposit mix
5. Good hedge against broader market, as mutual conversions are generally uncorrelated

Risks

1. Abundant excess capital (22% TCE ratio) – overcapitalized, dragging returns (ROA, ROE)
2. Acquisition philosophy and willingness to do deals (banks and branches)
3. Strategic philosophy – standalone or sell in three years
4. Growth philosophy – including de novo branching and syndicated loans (participations)
5. Securities portfolio risk – equity securities
6. Share repurchases
7. Dividends
8. Regulatory risk
9. Expense management
10. Credit risk with high growth – special mention loans, classic car portfolio

Catalyst