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Vol. VI, No. 21


Financial Services Insights and Intelligence

FIRST WORD: A lot Going on at BancorpSouth.  This week I got an update on what’s going on at Tupelo, Miss.-based BancorpSouth from CEO Dan Rollins. Here are some highlights:

Acquisitions completed. On May 1, the company completed its acquisition of $750 million National United Bancshares, which has seven branches in mid-Texas, and FNS Bancshares, with $800 million in assets in Alabama, Georgia, and Tennessee. The National United deal is primarily a cost-saving-driven transaction, while FNS moves the company into some new markets such as Chattanooga. Rollins joined BancorpSouth eight years ago from Prosperity Bancshares of Houston, where he was involved in a number of similar type add-on acquisitions.

Cadence, the big one, announced in April. In April, BancorpSouth, with $37 billion in assets at the time, announced it was acquiring $17 billion Cadence Bank, which was started by Paul Murphy and an impressive board of individuals with extensive banking industry knowledge. The new company will have an impressive footprint including Texas and the Southeast.

Of course, the financials look impressive, with the company expecting double-digit earnings per share accretion. However, if I didn’t know Dan Rollins and Paul Murphy so well, I’d be more concerned about issues included in the initial discussion of the merger. First, many tough decisions were simply not made. For example, the board will consist of the existing eleven board members of BancorpSouth and the nine from Cadence. I understand no one wants to let board members know they won’t be part of the new company, but that’s not a good reason to start out with an unwieldy number. Second, the combined management team will consist of three executives from BancorpSouth and two from Cadence, which suggests an “I’ll take one, you take one” approach. In addition, the company will operate with dual headquarters, in Tupelo and Houston. Finally, the business models are quite different with BancorpSouth run as a large community bank focused on small businesses, while Cadence is a commercial bank with a focus on larger, middle-market companies. For two other CEOs who didn’t know each other so well as Rollins and Murphy do, these might be challenges difficult to overcome, but I’m confident Rollins’s no-nonsense approach will cut right through any issues.

Loan growth is the primary operating issue. Ex mergers and the PPP loan program, the primary challenge for BancorpSouth currently, as it is for so many banks, is boosting its loan portfolio. Like others the company sees a growing pipeline of loans, but not much in overall growth, as consumers’ and businesses’ liquidity remain high. I told Rollins that with everyone’s inventory so low at this time that I expected to see more borrowing for plant expansion soon. He agreed with me on inventories, but borrowers remain scared. “We sold more lawn mowers in the U.S. in the last year than the previous three years combined. Who wants to build a lawn mower plant given demand uncertainty?” Even so, BancorpSouth is ready to lend.

PPP program.  In last year’s first round, the company made $1.2 billion in PPP loans, with one-third to customers new to the bank. So far, the company has done another $465 million in round II loans. BancorpSouth’s average PPP loan size was just $50,000.

The success of the loan deferrals. When the company reported its second-quarter earnings last year, some analysts were surprised and concerned that the deferrals reached 17% of total loans. Rollins said at the time, and repeated to me this week, that the bank’s strategy was to give out “deferrals like candy at Halloween.” By any objective measure, the deferrals strategy worked. Deferrals are now down to nearly zero.

It has been an active year for BancorpSouth already, and it’s likely to be more active as the company works on forgiveness for the other half of its PPP loans made last year that haven’t been forgiven, integrates the two banks closed in May, handles a gradual increase in loan demand, and then begins the integration of Cadence sometime in the fourth quarter. Just the type of banking activity that Dan Rollins enjoys.

TOO PEPPY: This makes me wonder, in a weird, upside-down-and-backwards way, whether something awful is about to happen: CEO confidence is at a record high—by a lot.

ZOOMING: I’m at a loss to understand why this isn’t a screaming signal—to the people at the Fed and anyone else who cares to pay attention—that things are about to overheat in a fairly major way: the last few months’ PMI reports have been absurdly strong.

AN ERA ENDS: Is there no respect for tradition on Wall Street anymore? I never thought I’d see the day when broker trainees at Merrill Lynch can’t make cold calls.

WAY TOO COMPLACENT: Good grief. I hate it when central bankers talk this way:

OUT OF TOUCH: Oh, and by the way, it really is possible for a Fed central banker to be clueless. Via ZeroHedge, Stephen Roach talks about his days working at the Fed in the 1960s, and recalls how Arthur Burns insisted on removing food and energy prices from the CPI calculation once those prices began to accelerate higher, which, Burns argued, was skewing the overall inflation number. Then when additional price categories started acting up, he ordered that they be taken out of the CPI calculation, too:

Over the next few years, he periodically uncovered similar idiosyncratic developments affecting the prices of mobile homes, used cars, children’s toys, even women’s jewelry (gold mania, he dubbed it); he also raised questions about homeownership costs, which accounted for another 16% of the CPI. Take them all out, he insisted!

By the time Burns was done, only about 35% of the CPI was left—and it was rising at a double-digit rate! [Emphasis added.]

Roach says that, at bottom, Burns simply had no idea about how inflation actually worked. Good thing no one like that is running the Fed now.

MIDDLE MARKET CFO SURVEY: Some notable results from s survey of CFOs of companies with fewer than 10,000 employees, conducted by Fortune and market researcher NewtonX:

  • 47% reported that revenues were back above pre-pandemic levels.  This is interesting because a survey of larger company CFOs in January reported over half their revenues were above pre-pandemic levels
  • The hybrid workplace environment could be permanent. Thirty-nine percent of CFOs expect to operate fully in-person going forward, 38% expect a policy requiring three or four days in-person, 19% one or two days in-person, and 4% expect to operate fully remote in the future.
  • Less space needed. While 12% of CFOs said their companies will need more office space in the future, 41% said they would need less, including 20% who said they will need more than 20% less space.

DIAMONDS IN THE ROUGH: You don’t say. Analysts at Richard Bernstein Advisors make the entirely sensible point that stocks that are covered by the fewest sell-side analysts—and which are thus likeliest to turn out to be undiscovered values—have outperformed the broader market for the past two decades.

TOP, AND THEN BOTTOM: Along that same line (sort of) here’s a reminder that past performance really is no guarantee of future results:

ON THE PROWL: This just in from the Dept. of Unintended Happy Consequences: researchers at the University of Wisconsin found that in areas where wolves have been reintroduced into the wild, deer vehicle collisions fell by so much—24%—that auto insurers cut their rates.

THE WOBBLING SPAC MARKET: While SPAC IPOs have slowed to a trickle, there is still a lot of SPAC-related events ahead, as 143 SPACs have announced but not yet closed on acquisitions and 240 have yet to announce an acquisition and must do so in the next 20 months or return their IPO proceeds to investors.

JIMMY DUNNE GREAT AS A PINCH HITTER: The commencement address at Notre Dame delivered this past Sunday by Piper Sandler vice chairman Jimmy Dunne—he was standing in for President Biden, who pulled out at the last minute—is very much worth watching.

GENERALLY RELIABLE INDICATOR: Well this is encouraging. The ratio of leading economic indicators to coincident indicators—one of the most reliable gauges of the economy’s health, in my experience—points to continuing and sustained economic growth.

STILL HOT: I take this as a sign that the housing market won’t be slowing down any time soon. Nationally, more than a third of homes going under contract have sold for more than their initial listing price, which is twice the rate of a year ago, and nearly half of homes are going under contract within a week of hitting the market, Zillow reports.

WAY, WAY DOWN: Oof. The bank investor in me is thinking that maybe keeping inflation in check isn’t the only reason the Fed should start raising rates sooner rather than later.

RISING HOPES: Enough already about the stock market’s valuation! I totally buy Ed Yardeni’s argument that stock market skeptics who point to current, historically high earnings multiples as a reason to doubt further market advances are, well, kind of full of it, since the market’s rise  over the last year has been entirely (and uncharacteristically) driven by rising earnings estimates rather than fattening valuations.

So in fact, once analysts finish raising their numbers—and no one knows for sure when that will be, after all—valuations could end up looking positively puny.

THROWING HIS WEIGHT: I see that Larry Fink’s plan to become the Prime Overlord of American industry is proceeding apace.

LESS MOBILITY: Don’t ask me why, but people just don’t move as often as they used to.

MISGUIDED SKEPTICISM: In an interview with interlocutors from Goldman Sachs last week, Nouriel Roubini explains why cryptocurrencies don’t really count as a real financial asset:

Assets have some cash flow or utility that can be used to determine their fundamental value. A stock provides dividends that can be discounted to arrive at a valuation. Bonds provide a coupon, loans provide interest, and real estate provides rent or housing services. Commodities like oil and copper can be used directly in different ways. And gold is used in industry, jewelry, and has historically been a stable store of value against a variety of tail risks , . . . Bitcoin and other cryptocurrencies have no income or utility, so there’s just no way to arrive at a fundamental value. {Emphasis added.]

Weak! For one thing, other than in jewelry manufacturing, which is a tiny use for it, gold has essentially no industrial value, either, so I don’t see why it gets a pass from Roubini while cryptos don’t. And there is too a way to “arrive at a fundamental value” for cryptos. It’s called a market! They’re pretty efficient, I hear. Also, don’t forget about what they’re using packaged mackerel—another non-cash-generating item—for in prisonsP.S. I’m no crypto evangelist, but never fail to be surprised by how the arguments against cryptocurrencies are so lame.

RECOVERY BECOMES AN EXPANSION: Well that was quick. GDP is already bigger than it was when the recession started—even though there are eight million fewer people in the workforce.

STATE ECONOMIES HELPED AND HURT BY THE PANDEMIC: At the same time, renewed economic growth doesn’t seem to be happening uniformly across the country.

WINE MYTH?: When I was in my 20s, a pal of mine told me my habit of ordering the second-cheapest bottle of wine on a restaurant’s wine list makes no sense because restaurants, knowing that a lot of their customers also use the second-cheapest strategy mark those bottles up by the most. I was skeptical, and it turns out I was right. Researchers at the London School of Economics analyzed the prices of 6,335 wines at 249 London restaurants, and found the markups to be the lowest at the extremes of the price range. At the low end, bottles are competing with individual glasses of wine, while the low markup at the high end are to encourage wine buyers to trade up. Moral of story: if you want the best wine deals at restaurants, don’t get stuck in the middle.

PLEASE SPELL OUT THE DEFINITION: During testimony last week before the House Financial Services Committee, acting OCC head Michael Hsu said the Fed, the FDIC, and the OCC are considering an “interagency sprint team” to deal with cryptocurrency regulation. Funny. Outside of Washington, even the time the three agencies will take just to consider the idea will fit no one’s definition of “sprint.”

GASBAGGING SENATORS: Why in the world were the big-bank CEOs raked over the coals by the Senate Banking Committee this week? If any industry helped consumers and small businesses—and the economy generally—get through the recession–it’s banking, notably through banks’ implementation of the PPP and the granting of relief through interest payment deferral programs. At some banks, people were working round the clock to set the needed infrastructure and process loan applications. Banks did indeed provide a great service to the country. And in return, bankers are being abused by elected officials. Shameful. Banks should be consoled by the fact that their customers see that they’re doing a great job—at least if their recent J.D. Power numbers are anything to go by.

LEAVING AT LAST: Anybody who’s been in an HSBC branch any time lately will not be surprised by this headline:

In branch tours we used to do in New York, HSBC’s branches consistently came off as being among the worst.

ONE MORE TIME: Is there really an eighth edition out of Charles Ellis’s Winning the Loser’s Game coming out? What for? It’s hard to believe there are that many different ways to explain that the typical investor has little chance of outperforming the market and so should just buy an index fund instead and at least save money on management fees.

ENOVA UPDATE:  Enova is a data-driven subprime consumer and small-business lender with a $1.4 billion market cap that is reminiscent of Capital One in its early days, if Capital One had just focused on subprime lending. Enova came through the recession without any bumps, saw some growth in the seasonally weak first quarter, and (I expect) will likely report strong growth in receivables through the remainder of the year, as well as better-than-normal credit quality. I talked with CEO David Fisher this week, and came away even more impressed with the company’s business model and management, and am even more encouraged about the company’s strong growth outlook for the remainder of the year. In particular, our conversation reinforced three points about subprime lending generally, and two distinguishing factors about Enova. Let’s start with subprime lending.

General misperception of “risk.” Investors frequently confuse the inherently higher risk of credit losses in subprime lending with the overall risk in lenders generally. Data from the Philadelphia Fed show that while the loss rate in super-prime lending quadrupled in the 2009 recession from the prior normalized level of loss rate and the prime loss rate rose 2.6 times, the loss rate in subprime lending rose by 1.4 times the prior normalized loss rate.

Even more important to maintaining the business’s profitability is the much higher revenue margin that subprime lending provides to absorb the higher loss rates. Subprime lenders can absorb incredibly high loss rates in a recession.

Subprime lending takes a different mindset. Virtually every aspect of subprime lending, from marketing to underwriting and collections, must be managed differently than prime or super prime lending. Seldom can one company do both types of lending well.

The biggest risk in subprime lending is a pen stroke away.  Regulatory risk at the Federal and state level can significantly alter or even shut down certain types of subprime lending. The only protection is diversification on both a geographic and product basis.

Enova has many attractive company-specific characteristics, but the two that distinguish it the most from other subprime lenders are its product diversification and its use of machine learning and artificial intelligence.

Product diversification. Thanks to last year’s acquisition of OnDeck, 25% of Enova’s loans are now to small businesses, compared with none in 2009. When I ask Fisher what he has learned from the OnDeck deal, he said, “I learned it was the best of the over 30 acquisitions I have done in my career.” Enova paid $110 million for the company last August, and will collect in excess of $200 million in cash from a portfolio of loans that it essentially assigned no value to when bidding for the company. And currently, the subprime small-business customers are coming back in search of loans faster and stronger than are subprime consumersI expect the growth rate of Enova’s small-business loans to exceed its growth in personal loans for at least the next six months.

The use of machine learning. Fisher wrote in his letter to shareholders this year that “machine learning models run across the customer lifecycle.”

Enova managed through another recession, and is poised to capitalize on the strengthening economic recovery. The company began to ramp up its marketing spending in the third quarter last year, and Fisher says it will continue to “lean into” the recovery with more marketing. Should be a fun remainder of the year to watch.

CAMBRIDGE BANCORP UPDATE: Cambridge Bancorp is one of the banking industry jewels sprinkled around the country that have unusually large trust departments. The company has $4.3 billion in banking assets, and the same level of client wealth assets. Its earnings per share have grown at an average annual rate of 11.9% over the past five years. In the first quarter, it earned 1.35% on its assets and 15.7% on its tangible common equity. Net chargeoff rate last quarter: of 0.0%.  However, the company is trading at under twelve times estimated 2022 earnings and 165% of tangible book value. I talked this week with CEO Denis Sheahan to get a business update. Highlights:

Wellesley Bank merger.  The merger was completed just less than a year ago and Sheahan says “all the easy work has been done and now it’s the hard stuff.” What’s that? Changing the culture so the Wellesley bankers think of selling the full range of Cambridge products, particularly wealth management in the fertile southern New Hampshire market. The Wellesley acquisition and the earlier one of Optima has reduced trust fees from 33% of total revenues to 25%, and Sheahan would like to see that percentage increase.

Employees returning to the office. Massachusetts has been one of the toughest lockdown states ,but restrictions will be lifted tomorrow. Sheahan believes it’s important that employees return to the office; that will happen over the month of June with many employees working in a hybrid model.

PPP.  Cambridge did $200 million in PPP loans in the first round, and 80% of the balance has been forgiven. The company then did another $95 million, and doesn’t expect the forgiveness process to begin on these loans until late this year or in 2022.

An example in diversity. Diversity on the board and in management is nothing new for Cambridge. The company’s 2020 annual report notes that its eight women board members (out of 16) is the most of any Nasdaq-listed company. In addition 20% of its employees are ethnically or racially diverse, as are 17% of its executive management.

Cambridge is a solid performer with a solid management team and trading at an earnings multiple less than 60% of the S&P 500 average. It’s a great example of the value that exists today in bank stocks.

NEXT WEEK: On Friday, the Labor Department will release the May Employment Report. The consensus looks for a change in nonfarm payrolls of +678,000 vs +266,000 in April and an unemployment rate of 5.9% vs 6.1%.

THE LAST WORD: Memorial Day weekend has always been one of my favorite holidays, as it combines both a solemn remembrance of those that made the ultimate sacrifice for us and the joy and excitement that it signifies the unofficial beginning of Summer. This year is a little different because of all the adjustments we’ve had to make to our normal way of living because of the pandemic. Most of the freedoms that we had temporarily given up a year ago have been restored this Memorial Day. Which gives us a special opportunity to truly reflect on why we made it a national holiday: others died so we could have our freedoms. Ronald Reagan said on Memorial Day in 1983:

We owe this freedom of choice and action to those men and women in uniform who have served the nation and its interests in the time of need. In particular, we are forever indebted to those who have given their lives so that we might be free.

What a year it has been. Enjoy the Memorial Day weekend with family and friends, and try not to overcook those ribs on the grill as my father did almost every year!

Edited by Matt Stichnoth.

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