Description

In this 10^thyear of the Great Bull Market, I’ve been having a hard time finding stocks that fit the traditional definition of value.  The Exchange Bank of Santa Rosa (EXSR) is an off the radar micro-cap financial institution trading at a modest valuation:  

            ~ 8 times Earnings

            ~ 1.2 times Book

            ~ 15% Return on Equity

That’s the good news. The bad news is that this is a thinly traded microcap with a float of less than 1 million shares.  It’s also unlikely to be acquired.  If you have room in your personal account, here are some numbers:

I’ve adjusted 2017 to add back the expense related to the adjustment of the deferred tax assets caused by lower federal tax rates.  2018 and TTM are reduced for the $2.10 per share temporary benefit caused by excess deposits following the Tubbs fire. 2018 is also adjusted to eliminate a one-time gain of $1.30 per share from a sale of OREO.

In addition to being a thinly traded micro-cap, EXSR is controlled by a trust.  As a result, there is little chance that the bank will be sold at a premium. A bit of history:

The Exchange Bank of Santa Rosa was founded in 1890 by Manville Doyle.  The bank was run by Manville Doyle’s son Frank Doyle for several decades, surviving both the San Francisco earthquake of 1906 and the Great Depression.  When Frank Doyle died in 1948, he established a trust that controls 50.4% of the bank. The trust is operated for the benefit of students from the Santa Rosa area and funds scholarships at the Santa Rosa Community College.   The three trustees of the trust are all current or former directors of the bank, so there is little chance that the bank will be sold.

In October 2017 the Tubbs fire destroyed approximately 5,300 homes in Sonoma County – including 2,800 in Santa Rosa. While this was devastating for the Santa Rosa community, insurance recoveries and delays in reconstruction have been a boon for the bank.  The bank gained approximately $300 million of incremental deposits after the fire, which generated approximately $5 million of incremental interest income in 2018. ($2.10 per share.)  

Even before the fire, the bank was deposit rich.  Currently approximately $1 billion of the bank’s $2.6 billion of assets are cash, FRB deposits or available for sale securities.  The $1.5 billion of loans are roughly 2/3 real estate based and 1/3 consumer and commercial loans.  Higher interest rates are a plus for EXSR - $800 million of deposits are in non-interest bearing demand accounts.  Only $180 million are time deposits. (Interest on the interest-bearing deposits runs around 18 basis points.)

The bank operates 18 branches in Sonoma County.  A 19^thbranch is expected to open later this year.  Growth seems to be measured.  The loan book increased by just 3.5% in 2018, and actually declined by 0.5% YOY in Q1.  Management indicates that they passed on some refi opportunities where the rates were “too aggressive”. The bank has made a couple of small bolt on acquisitions to its trust department, but seems content with slow incremental growth.

Home prices in Santa Rosa softened in late 2018/early 2019, but seem to have picked up in March. Median prices are in the $500-$600k range, so high by national standards, but much lower than the prices in San Francisco or Silicon Valley. (There was a significant jump in local home prices after the Tubbs fire, so some of the softness may just be a reversion to normal.)

Management has been fairly aggressive in increasing the dividend each year since it was restored in 2012.  There have been 16 increases of $.05 each since 2013.   The dividend is currently $1.05 per quarter, or roughly a 20% payout ratio and a 2.5% yield.  Given the importance of a steady cash flow to the trust beneficiaries, steady increases are likely in the future.

Catalyst

Unfortunately, there’s no imminent catalyst here.  EXSR should earn another $20 or so this year, and pay a little over $4.50 in dividends. Book value should increase to over $150 at the end of 2019.