Hingham Institution for Savings: Buying When There’s Blood in the Streets
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Credit Where it's Due
In studying banking (which sounds thrilling, I know), I came across an exceptional conversation between Andrew Walker and John Maxfield. This conversation conducted on Andrew's podcast has been immensely insightful in helping me develop an understanding of the banking industry. John's Substack has also been a great resource for the same reasons. Both Andrew and John do exceptional work and are well worth following. For some more context, John is exclusively focused on banking, while Andrew covers a wide range of companies and sectors. I provided links to the interview and both of their Substacks below.
Context
Many investors love the timeless Nathan Rothschild quote, "The time to buy is when there's blood in the streets." Though many love to cite this classic, the same investors fail to apply this simple mental model. The important thing to keep in mind is that "when there's blood in the streets" the companies that are bleeding will not seem to be primed for a Goldilocks set up- or even a decent one. In reality, it will be the opposite. More than likely when you are presented with one of these opportunities there will be issues, and potentially big ones at that.
With this in mind, I believe that the recent string of regional bank failures has created one of these opportunities. Many stocks in the financial industry, specifically regional and community banks, have been severely and unjustly punished. This naturally creates opportunity for those willing to look through the rubble. I am certainly one of these people.
Understanding Banking
By now I am sure you are already thinking, "This conceptual stuff sounds great, but can you please get to the stock pitch?" To which my answer would be a firm "No." Before buying bank stock it is important to understand how to buy bank stocks (and no, this is not meant in a literal sense). This understanding is particularly important as banks are unable to sustain healthy growth above their return on equity (ROE) without running into issues- just ask your friends over at First Republic. As I mentioned earlier, a lot of my understanding of this very complex industry has come from the podcast conversation between Andrew and John. Specifically, there are three points that I believe are essential to understand at a high level: when to buy banks, what drives the business of these banks, and last but not least what major sea changes will come from the recent events.
When to Buy Bank Stocks
So when exactly should you buy bank stocks? The simple answer: right now. A well run bank will grow at the pace of its ROE, over the long term of course. That said, even the best banks will only be able to conjure up a 15% ROE. This is certainly not something to complain about, but personally I am looking for a little more alpha. As a side note for those wondering, "alpha" is a fancy finance way of saying "better returns." Now back to the point. This is where Mr. Market, as always, becomes the friend of a patient investor. As per John (and I am sure Buffett if asked), the best way to buy bank stocks is when a big event causes "just get it off my screen" syndrome, leading to indiscriminate selling. This indiscriminate selling is what allows investors to gain alpha above the bank's ROE.
What Drives the Business of Banking
In studying businesses broadly I have continuously come to the conclusion that in most situations the success or failure of a business, at least in its earlier days, comes down to one thing: people. I do not think this is better illustrated anywhere in the business world than in banking. Banking is a true people business, in which the culture, focus, and discipline of the organization from the top down are what drives results. These points are important to keep in mind as banking, contrary to most other businesses, is a business of abundance. In simple English: banking is a largely commoditized service in which the banks have virtually unlimited sources of funding. An unfortunate product of this is that some banks try to grow too aggressively, resulting in the need to raise capital (usually through preferred shares), and eventually, other issues as well- again, ask your friends over at First Republic.
(Not) A Changing Industry
The last aspect to look at before we get to the fun part is trying to understand, in live time, how the recent events will change the industry. Again deferring to my expert- it won't. The United States has had about a dozen "large" banking "crises" and more than 20 smaller banking "crises." As pointed out by John, every time one of these events occurs people tend to extrapolate major change in the industry. So far the result has always been minimal change if any. Though I am no longer a betting man, I would wager that history repeats itself again.
Hingham Institution for Savings
When listing the best people in banking, John immediately went to Patrick Gaughen, his father Robert, and Hingham Institution for Savings (Hingham). Hingham is a regional bank located in (you guessed it!) Hingham, Massachusetts. Hingham has seven branches across its primary markets of Massachusetts and Washington DC. 100% of its income in these markets comes from residential or commercial real estate lending. Though there is no physical branch, Hingham recently expanded into commercial real estate lending in San Francisco and plans to slowly grow into the market.
Though it was founded in 1834, the modern era of the bank is marked by the elder of the Gaugehns taking control of the company in 1993. As is always one of my favorite things to hear when studying management teams, the Gaughens put their money where their mouth is. Insiders own more than 30% of the company, many of which are Gaughen family members. In trying to find examples that best encapsulate the excellence of the Gaugahen-led management team you can very quickly become overwhelmed by the amount of green flags there are in every piece of communication they put out- and more importantly the lack of red flags. I think this can best be seen through the company's Annual Meeting Slides. After going through the first few pages of formalities, the presentation starts off every year with a Warren Buffett quote. The next slide is titled "What We Do," which is always followed by a much more extensive slide titled "What We Don't Do." This is music to my ears when studying a management team.
Valuation
This will almost undoubtedly be the shortest valuation section I ever write. As a company I plan to hold forever (which is always easier said than done), I expect Hingham to give me returns that are about the same as its ROE. Over the last 10 years, the company's median ROE is 15.5%. I expect to earn about this rate, with hopefully some extra alpha generated by buying in the current range of about 55% off its December 2021 highs.
Balance Sheet
Now to the most topical matter these days: the balance sheet. We'll start with the one negative. As of the end of its last quarter, the company saw deposit outflows of 11% year over year. You don't need to be a banking analyst to understand this is not a good thing. That said, the rest of the balance sheet is pristine. Barring a highly unlikely run on the bank there is not even the slightest concern of a liquidity issue. It is worth noting the reason a run is highly unlikely for two reasons: its long-term, deeply rooted, close ties to the communities it operates in and its participation in the Massachusetts Depositors Insurance Fund making all deposits insured up to any amount. It is also worth noting that the company also just raised its dividend- probably not something a company in a liquidity crunch would do.
Though the bank's deposits have decreased, its assets have still increased over the same time period. This is due to 16% year over year growth. As the 15.5% median ROE would tell you, this is a very healthy growth rate. Did I mention that 99.99%(!!!) of its loans are performing? Still, it is worth noting that the bank would have no problem meeting the capital obligations should it start to see defaults or more deposit outflows. The Gaughens have made sure to be conservative in capitalizing the bank, which, from my short time as a bank analyst, seems to have adequate Current Expected Credit Loss (CECL) reserves and is strong in its various tiers of capital ratios.
Summary
The best time to be greedy is when others are fearful. The current regional bank situation is no exception. There are various opportunities across the industry for those brave and careful enough to dig through the carnage. I believe Hingham is one of, if not the best way to play this. The company has steady and consistent growth, a strong franchise, a beautiful balance sheet, and aligned management with a long-term view. What else could you ever want in a bank?
Links
Podcast:
Andrew’s Substack:
John’s Substack:
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