Description

Bay Community Bancorp (ticker: CBOBA), the parent company of Community Bank of the Bay, is the recent recipient of $119.4M in equity capital from the Treasury’s ECIP program. This has resulted in a staggering 168% current year increase in equity from 12/31/2021 EOY total shareholders’ equity of $68.0M.

CBOBA is a San Francisco Bay area commercial bank with full-service offices in Oakland, Danville, and San Mateo. It is California’s first FDIC-insured certified Community Development Financial Institution (CDFI) and one of only three operating in the Bay Area. This and related information have been gathered from its website at www.BankCBB.com.

For those following along, there have been several write-ups of ECIP banks, but other than some comments in the Associated Banc thread, not much on VIC. That thread, as well as several public commentaries and fund letters, point to this Twitter thread from @dirtcheapstocks for providing helpful background.

There has been some discussion on how the ECIP equity infusion should be regarded. Some banks have listed it on their balance sheet as preferred equity while elsewhere it has been included as paid-in capital. I intend to make the case that it should be regarded as nearly-free equity capital.

Let’s begin with the nature of the ECIP (Emergency Capital Investment Program) and what these awards from the U.S. Treasury mean. Let’s go straight to CBOBA’s own announcements:

In summary, under the interim final rule, MDI and CDFI banks in good standing were eligible to apply for an ECIP investment of up to 15% of Total Assets as of June 30, 2021.  Treasury’s investment will be in the form of Perpetual Preferred Stock with favorable terms, including a maximum dividend rate of 2.00%, that will be waived in the first two years and then may be “bought down” to 0.50% through additional impact lending and activities similar to what we have always done as a mission-driven institution.  Importantly, this preferred stock investment will not include the operating constraints or carry the negative stigma associated with Treasury’s TARP investments during the financial crisis. (2021 Annual Report)

Essentially, what would you call a non-cumulative perpetual preferred stock with 0% interest for the first two years, and then what will likely turn out to be 0.5% interest after that (given CBOBA’s typical impact lending activities)? In the worst case, it will be 2.0% interest.

In addition to that, the Treasury provides the recipient institutions a right of first refusal for buying back this ECIP capital. However, instead of being bought back at par, it will be bought back via auction. What would you pay for a 0.5% interest non-cumulative perpetual preferred? Maybe ten cents on the dollar?

Perhaps eventually, if the Treasury ever decides to get it off their balance sheet, this equity will fully reveal itself as nearly free capital when the recipients buy it back at such a bargain discount.

In the meantime, which of course, might well be forever, how should an investor think about these ECIP funds? I’d suggest that they should be regarded as essentially a shareholders’ equity increase with barely a whiff of offsetting dilution. Technically, in the case of a bank like CBOBA, let’s say it is twenty years from now and the Treasury wants to wind up the program. CBOBA buys it back for $0.15 on the dollar. Now let’s present value that back to today. What type of hit would you give the balance sheet for the current NPV of retiring this obligation?

Getting back to fun with numbers: at year-end 2021, there were 8.870 million shares outstanding which calculates as a tangible book value of $7.67 per share. Shareholders’ equity as of Q3 to $181.9M following the ECIP infusion is against 8.685 million shares for a new book value of $20.94 per share.

The shares are trading for $9.20 per share. ‘Nuff said.

Or not enough. There were over 200 lending institutions that received these funds. Again from CBOBA’s announcement:

On June 7, 2022, the Company announced that it had completed a $119.4 million investment from the US Treasury Department. Treasury’s investment, made under the Emergency Capital Investment Program (“ECIP”), is in the form of non-cumulative Senior Perpetual Preferred Stock. For the first two years from the date of issuance of the Senior Perpetual Preferred Stock the dividend rate shall be zero percent (0%) per annum, and thereafter dividend payments begin accruing with a maximum dividend rate of two percent (2%) and the dividend rate may be reduced to one half percent (0.5%) based on the level of increased qualified lending undertaken by the Bank. On October 18, 2021 Treasury announced that 204 credit unions, banks, and savings and loan holding companies applied for total investments of over $12.88 billion under the ECIP Program and that the demand exceeded the amount available by $4.13 billion.

On December 14, 2021, the US Treasury announced it would invest $8.7 billion in up to 186 Minority Depository Institutions (“MDI”) and CDFI banks and credit unions to accelerate the recovery of small businesses, minority-owned businesses and consumers, especially those in low-income and underserved communities that may have been disproportionately impacted by the economic effects of the COVID-19 pandemic. The Bank previously announced that it was one of the only five banks and six credit unions in California to be approved by the US Treasury for an ECIP investment.   

MDIs and CDFIs are not typically admired by investors for their profitability metrics. Many of these banks and credit unions have weak ROEs and as investors well understand, buying a bank at a significant discount to tangible book value is often mitigated by such banks rarely producing significant net income.

However, CBOBA is not a typical CDFI as it relates to profitability, efficiency, and loan quality. Note that Net Interest Margin is very strong near the 3.5% level (it weakened slightly last quarter due to the timing of deploying the ECIP funds). ROAs, ROEs, and the Efficiency Ratio are all quite healthy.

As to credit quality, they had zero nonperforming loans as of September 30, 2022.

EPS through Q3 this year has been $0.64. If they repeat Q3’s earnings for Q4, 2022 earnings would be $0.89. Against yesterday’s close of $9.10 that would be a P/E multiple of 10.2x.

However, I’d suggest that $0.25 per share might reflect more of a floor than a run-rate earnings pace. According to CBOBA’s third-quarter earnings press release:

“The third quarter began to reflect the earnings potential of June’s $119.4 million preferred capital raise. That capital immediately supported $60.8 million of loan growth and $95.6 million of investment security purchases, mostly short term Treasuries. Those earning assets, combined with the Federal Reserves’ rate increases, resulted in a quarter over quarter increase in total interest income of $1.4 million, or18 percent,”

And:

“Higher than typical liquidity levels, and the resulting effect on the mix of our earning assets, put pressure our net interest margin during the quarter. As we continue to deploy this new capital into loan production and other higher yielding assets, we should better recognize the full benefit of the Federal Reserve interest rate increases, and expect to see our net interest margin improve in future quarters,”

This all makes for a compelling combination: a 10% current earnings yield backed by a significant discount to book value. There is a lot of playbook that can be run from here beyond simply expanding the loan book. CBOBA recently bought back shares from an institutional investor and there is no reason that they can’t both expand their lending presence while reducing the common share count.

In addition, there has already been some activity by which ECIP recipients have acquired other ECIP recipients. This all makes for a fascinating area to watch over the coming years.

DISCLAIMER:

This is not meant to be a buy or sell recommendation. The author makes no representation as to its accuracy or completeness. Always do your own due diligence before taking a position in any securities mentioned.

Catalyst

Net income improvement from deploying significant ECIP capital.

Increasing awareness of the nature of the ECIP funds and their resulting impact on adjusted tangible book value.