Beating the Street (31 page)

An S&L with excess equity, excess lending capacity, and a loyal depositor base is a prize that commercial banks covet. Commercial banks can take in deposits only in their home states (this rule is changing, to some degree), but they can lend money anywhere. This is what makes taking over an S&L a very tempting proposition.

If I were the Bank of Boston, for instance, I'd be sending love notes to Home Port Bancorp of Nantucket, Massachusetts. Home
Port has a 20 percent equity-to-assets ratio, making it perhaps the strongest financial institution in the modern world. It also has a captive island market with crusty New England depositors, who aren't about to change their banking habits and run off to a newfangled money-market fund.

Maybe the Bank of Boston doesn't want to make loans on Nantucket, but once it acquires Home Port's equity and its deposit base, it can use the excess lending capacity to make loans in Boston, or anywhere else around the country.

During 1987–90, a terrible period for S&Ls, more than 100 were acquired by larger institutions that saw the same sort of potential the Bank of Boston ought to see in Home Port. Banks and thrifts will continue to consolidate at a rapid rate, and with good reason. Currently, the U.S. has more than 7,000 banks, thrifts, and other assorted deposit takers—which is about 6,500 too many.

There are 6 different deposit takers in my little town of Marblehead, half the number there are in all of England.

Table 12-1.

The casual stockpicker could stop here, pick five S&Ls that fit the Jimmy Stewart profile, invest an equal amount in each of them, and await the favorable returns. One S&L would do better than expected, three OK, and one worse, and the overall result would be superior to having invested in an overpriced Coca-Cola or a Merck.

But being an inquisitive sort, and not wishing to rely entirely on secondhand information, I usually try to improve my odds by calling companies before spending money on them. This increases the phone bill, but in the long run it pays off.

Usually I get to talk to the president or the CEO or some other top official. Either I'm trying to find out something specific or I'm fishing around for surprises that haven't yet come to the attention of Wall Street analysts. Glacier Bancorp, for instance, had done more commercial lending than I like to see from a strong thrift. I wouldn't have bought the stock, or recommended it, without exploring this matter with the company.

You don't have to be an expert to talk to an S&L, but you do have to have a basic idea of how the business works. An S&L needs loyal depositors to keep money in their savings and checking accounts. It needs to make money on that money by lending it out—but not to borrowers who default. And it needs low operating expenses in order to maximize its profits. Bankers like to live on threes and sixes: borrow money at 3, lend money at 6, play golf at 3.

Anyway, I made six phone calls to six S&Ls (four strong ones and the two born-agains) to gather relevant details. Eagle Financial I didn't bother to call. Because Eagle was on a September-September fiscal year, the annual report arrived on my desk in time for me to see the details in print. It read like a bank examiner's dream. The annuals for the other S&Ls wouldn't arrive until February or March. Here's what I discovered from my conversations:

I talked to Glacier the day after Christmas. I'd come into my office in Boston wearing plaid pants and a sweatshirt. The building was empty except for me and the security guard.

Holidays are an excellent time to do this sort of work. I'm always impressed when I find executives who are sitting at their desks on December 26.

Above the debris on mine, I'd opened my Glacier Bancorp file. The stock was selling for $12 a share, a 60 percent gain over the year before. This was a 12–15 percent grower selling at 10 times earnings—not a spectacular bargain, but there wasn't much risk in it either.

Glacier Bancorp used to be called the First Federal Savings and Loan of Kalispell, and I wish they'd kept the old name. It sounded antiquated and parochial, which to me is always reassuring. I'd rather have antiquated and parochial than trendy and sophisticated, which usually means a company is desperate to improve its image.

I like companies that stick to business and let the images take care of themselves. There is this unfortunate tendency among financial institutions to take the “bank” out of their names and replace it with “bancorp.” I know what a bank is, but “bancorp” makes me nervous.

Anyway, whoever answered the phone at Glacier Bancorp in Kalispell told me they were having a retirement party for one of the officers, but they'd inform chairman Charles Mercord that I called. They must have dragged him out of the party, because a few minutes later Mercord called me back.

Asking a president or a CEO about a company's earnings is a ticklish proposition. You're not going to get anywhere by blurting out, “What are you going to earn next year?” First you have to
establish rapport. We chatted about the mountains. I said that the entire Lynch family had been to all the Western states to see the national parks, and that we loved Montana. We chatted about the timber industry, the spotted owl, the Big Mountain ski area, and the big copper smelter owned by Anaconda, a company I often visited as an analyst.

Then I began to slip in more serious investment-type questions, such as “What's the population out there?” and “what's the elevation of the town?,” leading up to the more substantive “Are you adding any new branches or standing pat with what you've got?” I was trying to get a sense of the mood at Glacier.

“Anything unusual in the third quarter?” I continued. “You made thirty-eight cents, I see.” It's best to pepper these inquiries with bits of information, so that your source thinks you've done your homework.

The mood at Glacier Bancorp was upbeat. Nonperforming loans were almost nonexistent. In all of 1991, this bancorp had had to write off only $16,000 in bad loans. It had raised its dividend for the 15th year in a row. It had just bought out two other thrifts with wonderful names: the First National Banks of Whitefish and Eureka, respectively.

This is how many of the stronger S&Ls are going to speed up their growth in the next few years. They are acquiring the valuable deposits of troubled and defunct S&Ls. Glacier can fold the First National of Whitefish into its own system and make more loans with the additional Whitefish deposits. It can also do some administrative cost-cutting, since two S&Ls together can live more cheaply than one.

“You're building up a nice asset here,” I said, introducing the Whitefish subject. “I'm sure it's a good move, accountingwise.” My only worry was that Glacier may have overpaid for its acquisition, a topic I approached obliquely. “I assume you had to pay way over book value for this,” I said, inviting Glacier's president to admit the worst. But no, Glacier hadn't overpaid.

We talked about Glacier's 9.2 percent of commercial loans, the sole troubling statistic I'd gleaned from
The Thrift Digest.
If this had been a New England thrift, that high number would have scared me away, but Montana wasn't Massachusetts. The Glacier president assured me that his S&L wasn't loaning money to developers of empty office towers or unsalable vacation condos. Glacier's commercial
loans were mostly in multifamily housing, which was in great demand. Montana's population was growing. Every year, thousands of escapees from California smog and taxes were taking up residence in the Big Sky, small government state.

I never hang up on a source without asking: what other companies do you most admire? It doesn't mean much when the CEO of Bethlehem Steel tells me he admires Microsoft, but when the head of one S&L says he admires another S&L, it usually means that other S&L is doing something right. I've found many good stocks this way. So when Mercord mentioned United Savings and Security Federal, I cradled the phone in my neck and opened my handy S&P stock guide to get the symbols, UBMT and SFBM, and punched them up on the Quotron as he was describing them. Both were Montana thrifts with impressive equity-to-assets ratios (20 percent at Security Federal!). I put them on my “tune in later” list.

I called Germantown in January, the day before I flew to New York to meet with the Roundtable. This was another of my recommendations from the prior year. The stock was $10 then, $14 now. Germantown was earning $2 a share, giving it a p/e of less than 7. It had a book value of $26, equity-to-assets ratio of 7.5, and less than 1 percent nonperforming loans.

Germantown was located in the suburbs of Philadelphia. It had $1.4 billion in assets and a wonderful record, yet not a single brokerage firm bothered to cover the story. I prepared for my phone call by reading the latest annual report. Deposits were up, which meant the customers were keeping their money here, but loans were down. There was a decline on the asset side of the balance sheet. That meant the bankers were being conservative and holding back on making loans.

I found more evidence of the bankers' prudence in the “investment securities” category, which had increased by $50 million from the year before. Investment securities include Treasury bills, bonds, stocks, and cash. An S&L that's worried about the economy or the creditworthiness of borrowers parks its assets in bonds, just as individual investors do. When the economy improves and it's safe to
lend money, Germantown will sell its investment securities and make more loans, and this will cause a surge in the earnings.

On that subject, I examined the earnings report to see if any unusual factors might be giving investors a false impression. You don't want to be fooled into buying a stock after a company reports a gain in earnings, only to discover that the gain was an aberration, caused by some onetime event such as the sale of investment securities. Here I found the reverse—Germantown had taken a small loss from the sale of some of its securities, which had depressed its regular earnings, but not enough to make much difference.

“We have a very boring story,” said the CEO, Martin Kleppe, when I reached him by phone. This was just the kind of story he must have known I liked. “We also have a fortress balance sheet. When we get in trouble, other guys are walking the plank.”

Loan losses and defaults were scarce to begin with, and getting scarcer by the month. Nevertheless, Germantown had protected itself by adding to its loan-loss reserves, which punishes earnings in the short term but will boost earnings later, when the unused reserves are returned to the corporate kitty.

The area around Germantown is not what you'd call brimming with prosperity, but the people there have always been savers and loyal depositors. Germantown Savings was not going to fritter away this money. I figured this prudent S&L would outlive many of its wilder competitors and make big profits somewhere down the line.

In the November 25, 1991, issue of
Barron's
, I came across an article entitled “Hometown Lender to the Well-Heeled.” It described how Sovereign Bancorp serves a wealthy element in southeastern Pennsylvania from its headquarters in Reading. I liked the part about how a bell goes off in a Sovereign branch every time a mortgage loan is approved.

This was not the only time in my career I was introduced to a stock by a weekly magazine. I checked the annual and the quarterlies. In every important category, Sovereign got good marks. Nonperforming loans were 1 percent of assets. Commercial and construction lending was 4 percent. Sovereign had set aside sufficient reserves to cover 100 percent of its nonperformers.

Sovereign had acquired two New Jersey thrifts from the Resolution Trust Corporation, which boosted its deposits and eventually would boost its earnings. To review some of the details, I called Jay Sidhu, Sovereign's Indian-born president. We chatted about Bombay and Madras, which I'd visited the year before on a charity trip.

When we got around to serious subjects, Mr. Sidhu said that management was determined to “grow” the business by at least 12 percent a year. Meanwhile, based on the latest analysts' estimates for 1992, the stock was selling at a p/e ratio of 8.

The only negative detail was that Sovereign had sold an additional 2.5 million shares in 1991. We've already discussed how it's usually a good thing when a company buys back its shares, as long as it can afford to do so. Conversely, it's a bad thing when a company increases the number of shares. This has the same result as a government printing more money: it cheapens the currency.

At least Sovereign wasn't squandering the proceeds from its stock sale. It was using the proceeds to buy more troubled thrifts from the Resolution Trust.

Mr. Sidhu's model for success, I was pleased to discover, was Golden West. Basically, he wanted to copy the penurious Sandlers by increasing loan originations and cutting expenses. With the payroll that Sovereign inherited from its recent acquisitions, the overhead was 2.25 percent, much higher than Golden West's 1 percent, but Mr. Sidhu seemed devoted to bringing that down. The fact that he owned 4 percent of the stock gave him a considerable incentive to carry out this plan.