Description

Community Bank of Santa Maria (CYSM) is nano-cap bank in California with only two branches and $250m in assets. Its focus is on lending to local small/medium sized businesses (mostly backed by real estate) and the bank seems to have carved out a successful niche for itself. Despite small size the bank manages to operate efficiently - generating good returns for shareholders while maintaining strong underwriting record. Recent actions by management suggest the bank might be getting positioned for sale. I would expect the bank to be sold at least at 50%-100% premium to current prices.

Average daily stock liquidity is under $50k so most likely this is suitable for PAs only.

CYSM is really cheap at only 1.18xTBV and TTM PE=11 with ROE of 11% and further profitability improvements projected for 2020 and 2021. The bank has doubled its assets and deposits since financial crisis. BV/share has compounded at 7.5% over the last 5 years and 11% over the last two. Loan loss provisions stand at zero since 2013 and totaled only 4.3% of assets (in aggregate) during the period of 2008-2012. To top it all off, insiders own 18% of stock and have been with the bank since it’s early founding days (1983 and 2001).

Aside from cheapness and strong historical track record I think CYSM is a timely investment now because:

• Bank is overcapitalized and has just launched a tender offer to buy back 12% of outstanding shares (at $15/share). Pro-forma for the tender offer valuation drops to PE=10;
• Insiders will tender only 2.5% out of 18% of their holdings. Only 3 out of 12 insiders are partially reducing their investments in the bank;
• New CEO Janet Silveria took helm in 2015 and since then CYSM profitability has improved significantly, one of the three branches was divested in 2018 (as it was under-performing bank’s goals), annual dividend was initiated (albeit at only 1% level) and current tender offer is the first time company is returning material amount of funds to shareholders;
• Most importantly, CYSM is a dark company with no regular SEC filings and with only limited disclosures on their website and FDIC. This is probably one the reasons why CYSM is so cheap relative to other banks. However, recently announced tender document has full dossier of disclosures about CYSM business, its credit portfolio and insiders. This new information when digested by investors might serve as a catalyst to propel the shares upwards.
• Also worth noting, that recent profitability improvements do not seem to be driven by higher credit risk, but rather by cost structure efficiencies – yield on assets only improved from 3.6% to 4.5% (since 2015) and this was driven by higher yields on securities portfolio (U.S. Government and MBS) rather than loan portfolio, for which the yield has remained stable (c. 5.8%-6.0%). At the same time cost efficiency ratio improved from c. 80% in 2012-2016 to current 63% on TTM basis.

Given all of this, it seems the company is getting positioned for sale or at the very least moving generate better returns for shareholders. Bank transaction multiples in the Western U.S. stand at 1.6x - 2.0x TBV. The multiple would be even higher for a tiny-and-yet-profitable two-branch bank like CYSM due to obvious and easily achievable synergies. Thus in M&A scenario I would expect 50%-100% upside.

Compensation of 4 principal officers alone amounts to $1.2m, director compensation adds further $0.4m – so in total that’s already 20% of the annual cost base. Elimination of these expenses would push net income up by 50% and pro-forma PE down to 6.5x. And while some of these execs and their relationships with local businesses might be vital to generate new lending (it’s still a community bank), expense synergies seem to be abundant.

All execs have entered into change of control agreements entitling them for 2 year pay in case of bank sale and termination. However, the tender offer filling does not make it clear whether this is a recent development.

Both CEO and chairman (who co-founded the bank) have been with the company and its predecessor already for 36 years. A further 5 directors (also co-founders) have been with the company at least since 2001 when the Community Bank of Santa Maria was established (it was called Bank of Santa Maria since 1983). Average age of long time directors / co-founders is 80 - seems like a good time to cash out of their holdings in the company. It might be confirmation bias speaking, but I think these circumstances are supportive of the thesis that some kind of strategic change is likely to be in the works.

Final point on tender offer. Unaffected price before the announcement stands at $12.5. If the tender offer is over-subscribed shares are likely to revert back to this level. So waiting waiting till after tender expiration before establishing the position might pay-off. Also there is an odd-lot provision for some 'risk free' $100.

Appendix: Historical financial data (mostly from FDIC):

Notes:

- Decline in assets and deposits during 2018 is due to sale of the third branch.

- Net income for 2018 has been adjusted downwards to exclude one-off items - gain on sale of branch and expense recovery from large vendor. 

Catalyst

- Expiration of tender offer, especially if it is undersubscribed (on the 6th of December)

- Company sale

- Continued compounding of BV/share