Description

Bank of Utica is a small, $1.4 billion asset bank that’s traded at a huge discount to book value since the financial crisis despite no asset quality issues. It trades OTC, no analysts cover it, and not many people care since it’s in a small town in upstate New York. It is family-controlled with a dual share class designed to entrench the status quo. There are 250,0000 shares outstanding, 200,000 non-voting (BKUTK) and 50,000 voting (BKUT). The stock has been a value trap for several years, and it may still be, but today you’re getting paid a healthy rate to hold an option on a steepening yield curve and to hope the Sinnott family finally does right by shareholders and repurchases some stock. 

BKUTK isn’t really a traditional bank, it’s more like a 5x levered hedge fund with a portfolio of safe, mostly fixed-income investments. Except, unlike a hedge fund or mortgage REIT, the bank’s source of funding is FDIC insured. The bank, a single branch in Utica, NY, prides itself on having a strong, safe deposit base from corporations and municipalities. It hardly makes any loans (just 8% of assets); instead it invests in a 10/90 stock/bond portfolio mostly composed of muni bonds and investment grade domestic and foreign corporate bonds, 75% of which mature in five or fewer years. 

The few loans that it has made have historically performed okay over time: NPAs to Assets peaked out at about 1.3% in Q1 2009, and have stayed at or below 0.5% pretty much ever since. This means that the bank’s net interest margin maps pretty closely to the spread between the U.S. 5 year treasury and 3 month paper. 

For Q1 2021, the bank posted a headline EPS of $65, which included about $15 million of unrealized holding gains on the equity portfolio which was up big in the first quarter. While this isn’t indicative of true earnings power, it still amounted to a very nice quarter. Backing out that equity security appreciation and applying a 25% tax rate, the bank earned over $17 in core EPS for Q1. This amounts to an annualized ROA of 1.25% and an annualized ROE of 6.6%. With the stock at $475, that amounts to an earnings yield of 15.7%. We like this as an upside option on a steepening yield curve. If we were to get back to 2013-15 levels of a yield spread and the bank decides to deploy more capital simply by decreasing their capital ratio to something like 17.5%, we think you could see a core ROA above 1.5%, which would make for EPS north of $95.

The company does pay a semi-annual dividend, prorating to $16.50 per year, and it gets raised every year like clockwork. 

Meanwhile the price-to-book is just about as low as it has ever been for both the voting and non-voting shares.

Running his bank as a hedge fund is ironic considering Tom Sinnott, the CEO, hates other investment managers, and has warned us, unprompted, that if we tried, we would surely lose a proxy fight. Most years, we don’t get the proxy materials and annual meeting information until a week or so before the meeting; sometimes they arrive after the meeting.

After the 2007-2008 financial crisis, CEO Tom Sinnott was apparently singled out by government officials responsible for banking oversight, who lauded him for Bank of Utica’s ability to maintain high asset quality throughout the mortgage crisis. Since then he’s taken pride in hoarding excessive amounts of capital.  He implied in this year’s annual letter, writing about covid-related tailwinds, that a 2.9% return on equity was what one could expect “in a typical year.” He’s the third generation Sinnott family CEO, and I’m betting his competence isn’t what won him the job. This attitude has alienated serious investors and left the stock for dead. We think eventually the family will grow tired of having their assets tied up in an investment that has returned about 4% annualized for the past 7 years (while S&P has compounded at about 14% over the same timeframe), and will look to make some more shareholder-friendly decisions in the future. 

Risks

The buyback never comes and the company is stuck earning a levered spread on short-medium maturity municipal and corporate bonds.

Yield curve flattens; ROA falls back to historic lows.

Catalyst

Any announced buyback or tender anywhere near book value would be an immediate windfall profit

Yield curve steepening