Category: Columns

Time to Buy Berkshire Hathaway Stock $BRK

I’ve been watching Berskhire Hathaway stock this year — as many investors do. Berkshire’s annual meeting was timed well as it came during the heat of the COVID-19 crisis. Many felt disappointed to hear (or decipher) that Buffett wasn’t leaning in to the downturn. He wasn’t deploying his “war chest” of $125Bn+ in cash. In fact, he sold his airline stakes, sold some banks, and Charlie Munger even mentioned some businesses might be shutdown. Buffett also mentioned that the amount of cash they have isn’t really a lot to them in the grand scheme of a panic.

Now with the S&P back up to near highs, many are calling out Buffett and saying he’s lost his touch. “Maybe he’s too old now” and “maybe he doesn’t care anymore now that he’s approaching 90 and loaded” or “maybe the oracle has lost his touch”.

I don’t really think that’s the case and think the negative sentiment creates an opportunity in Berkshire Hathaway stock. People who argue that Buffett is too old and “lost it” could have easily argued the same thing when he was 65 going on 70, 75 going to 80… Buffett has that itch that can’t be scratched.

I do think some of his methods are too old fashioned. I can’t actually confirm this is true, but he has said he won’t participate in auctions. What board would actually be able to justify selling to him without a second bid? Especially when times are good and they are a good business.

Do we see Buffett do another elephant sized deal? Maybe. Maybe not. As I’ve written before, I think we could see deals that are smaller than what people expect.  But either way, I don’t think the option value of some deal being done is being appropriately valued today.

I’m taking Berkshire Hathaway’s current market cap and subtracting the market values of his equity holdings (note, I pulled this from Bloomberg, so it may not be 100% accurate). I then subtracted the cash to arrive at the value the market is ascribing to the “core Berkshire Hathaway” business.

I say core, but in reality there are so many subsidiaries within Berkshire Hathaway. You have GEICO, Berkshire Hathaway Energy, BNSF, Precision Castparts, just to name a few well known ones. If interested, I highly recommend perusing the list of subsidiaries on Wikipedia. I bet there are quite a few you didn’t realize he owned.

At the end of the day, you’re being asked to pay <8x earnings for the collection of businesses that Warren has acquired AND you have free upside from the cash if it is ever deployed.

Frankly, the real upside in the stock may be 5-10 years away when Berkshire Hathaway is broken up and people realize the sum of the parts is worth more than the whole.

Either way, look at the impact of Berkshire going out and deploying cash. Earnings could likely go up 30% from where they currently are and even deploying the cash at a worse multiple than where Berkshire trades today (i.e. dilutive), you’re still paying <9x earnings.

First 3 things I Do When I Read a 10-K

Reading a 10-K can be daunting for those without official training. It’s tough to figure out where to start. My goal of this post is to detail the first 5 things I do when I read a 10-K.

I’ll be using Fastenal as as an example given I recently used them as a case study in my Competitive Strategy series.

Unfortunately, if you want to read a 10-K to get better at investing or understanding how companies work, you can’t just read a 10-K in a vacuum. You must put the knowledge and information you glean into context.

If you were moving to a new city and needed to purchase a home, would you look at one home and determine you had enough information? Probably not. You’d probably want information on that home as well as several others and weigh the pros and cons of each (how are the schools, how much room am I getting for the price & is it a good trade off, do I need to pay city taxes, etc.).

Same is true for investing in companies. I want to read about this company, understand how it works, determine if I think it is good or not, and then go read about its competition. Is the competition even better? Maybe the customer is actually the better business or its supplier.

As you can probably tell, this creates a web of information you need to understand, but can be worth it in the end.

Also in the context of not reading a 10-K, I almost never open up a 10-K without opening up the company’s latest investor presentation (typically on their investor relations site), and then also typically plan on reading the latest earnings calls as I get more interested.

Ok – let’s dive into what I do when I first open a 10-K.


“How does this business actually make money” – Read the Business Overview Section and Understand How that Flows Through to the Income Statement

Nowadays, there are links upfront in a 10-K that can help you jump to the sections you want. First thing I do is click on the Business Overview section.

From there, I jump ahead to where the company has the opportunity to describe what it does.

I can’t tell you how much I respect companies that really take the time to help investors understand what they do. Sometimes companies leave it ambiguous which is super frustrating. Especially when covering small caps and I also look at private companies, the amount of times I’ve heard investors think an a company does one thing, when in reality they do not actually understand how they make money, is alarming.


As a quick aside, I once had a company describe themselves like this: “[Company’s] performance resins and surface overlays are ubiquitous in products used in residential and commercial applications and are increasingly displacing traditional building material through value-adding attributes. [Company] is a highly profitable, vertically integrated provider of these products.

Very hard to even determine what they were doing. Turned out, they would saturate paper with a formaldehyde-based resin and sell it into various building products. That’s the importance of diligence.


I have to commend Fastenal on how well they describe their business in 7 sentences. It gives some history, what customers they target, how many branches they have, and what their general strategy is.

So right off the bat, I can generally tell how Fastenal makes money. They sell fasteners. Their business description actually continues on for several pages, which I’ll let you read as opposed to pasting here. It’s a good read.

But as soon as I read this description, I start to have questions pop into my head. I’m trying to understand the value chain. Do manufacture themselves or buy from suppliers? What industries do they target? How do they differentiate themselves? The reason why I ask these is because the answers will start to tell me things about the business.

If they manufacture themselves, it’s probably a unique offering that they can charge a higher margin for, but it will be more capital intensive (need machines, plants as well as branches). If they just buy from China and sell in the US, maybe others can do the same so I’d expect their margins to be lower, but not much capital is really needed.

Turns out, Fastenal mostly buys from third-party suppliers, but as you’ll see later, its margins are surprisingly high. Fastenal is a rare company where it actually provides some detail on this. As I said in my competitive strategy series, looking just at the numbers doesn’t tell the whole story. We need to understand why a company may have high margins or not and if that is OK.

To understand a business and get better at investing, you have to know how a business works. If the above snippet doesn’t make a ton of sense to you, then you need to map it out.

Here is a quick snapshot of what I typically do. I first just try to make a made-up model of the company. I just say, “Hey, I understand selling fasteners, widgets, what-have-you, means buying fasteners in inventory and selling them for a profit. Let’s assume I sell 100k fasteners for $5 – how does that look here for Fastenal?” Note, these numbers are made-up, but the margins are about what Fastenal has.

Hopefully from the notes above, you can see I’ve also made attempts on how the cost structure of the business works. Is this a highly variable cost business or not? I would say it is highly variable. If my sales go down, I’m not just going to keep buying fasteners and keep paying bonuses to sales staff (I’m going to incentivize them to get sales up).

Contrast that to an automotive company like Ford or GM. They typically have unionized workforce, so I’m not sure how many people they can actually cut in a downturn. They also have huge manufacturing plants that are hard to just turn off and turn back on without expenses associated with it. Contrast that to Fastenal, whose branches are very basic stores with shelves. That’s one reason why automotive companies and airlines go bankrupt so often. They are highly competitive, highly cyclical, highly fixed cost businesses – demand going down hurts the bottom line a lot more.

I digress. Back to Fastenal.

Let’s now see an impact of what happens with more fasteners being sold – what impact does that have on the bottom line (using EBITDA here for now)?

As you can see, a 4% increase in fastener sales actually leads to a ~7% increase in EBITDA. The main reason is that, while COGS went up by a similar amount to sales, SG&A stayed relatively flat. This is important to understand because you may say, “Ok Fastenal is a mature business. Maybe it should only grow with growth in industrial production, manufacturing, or GDP in the long term. Well if that is 2-3% growth, earnings probably will grow at a faster clip than that, which is important for valuation.

This is a simplistic example and view (for example, more detailed models will have store branches modeled out, how many fasteners each branch sells, what the sales impact and cost impact will be of adding a new branch) but hopefully shows in more detail of how I examine a business and how it makes money.


“Show me the money!” or, uh, Free Cash Flow – Examine the Cash Flow Statement; Understand Drivers

 Ask any investment banker which financial statement is the most important and my guess is most will say the cash flow statement. It makes sense for many reasons.

First, the income statement doesn’t capture everything. Net income does not equal free cash flow that we use to value a business. It may capture depreciation which can be used as a proxy for capex in a mature business, but for a fast growing business, capex will likely exceed depreciation. The income statement doesn’t capture the working capital investment needed to grow the business. It also doesn’t tell us where the free cash flow is going (M&A, dividends, share buybacks, debt paydown, just sitting on the balance sheet?).

I also focus on the cash flow statement next because frankly I am trying to find good businesses. If after examining the business overview and parts of the income statement, I see that the cash flow statement is a mess, I may or may not decide whether or not it’s worth my time. Sometimes I like to dig into a messy cash flow statement because people who do simple stock screens will miss opportunities. Other times I’ll decide it’s best to drive on.

To find the cash flow statement, I typically search the document for “Operating activities” which will allow me to jump to “Cash Flow from Operating Activities” part of the cash flow statement.   If you don’t know, free cash flow = cash flow from ops minus capital expenditures. This is typically the cash leftover to the business that it can use for other discretionary items.

 So I do some quick math and try to determine FCF for Fastenal.

They generated around $600MM of FCF last year, which was a nice jump from $500MM the year before despite what clearly was a big increase in capex. You probably want to figure out why to see if it is sustainably higher. Very quickly, I can see that net income increased (+$39MM), depreciation & amortization increased slightly (+$11MM) which is non-cash so added back, and I have to do some math, but I can see changes in working capital also benefited them in that it looks like they didn’t need to invest as much there, as you can see the increases in inventory and accounts receivable are down a lot Y/Y (total W/C benefit +$141MM Y/Y).

After figuring this out, you need to understand why these occurred. Does the company say anything in its earnings calls about this? Investor presentations? Why is capex up so much? New branches? Is that what drove net income higher? But if they opened new branches, why didn’t working capital increase? Is it a new type of branch that doesn’t require as much of an upfront investment?

After figuring out FCF and whether the past few years look sustainable, I take a look at where the cash is going. It looks like from above Fastenal paid down some debt (as payments are larger than issuance of debt) and paid a big dividend, which has been consistent in size.

However, one red flag I immediately see is that 2019’s dividend is nearly identical to 2018’s FCF… do they have enough FCF to cover the dividend? Yet ANOTHER reason why focusing on net income and payout ratios that are thrown around never makes much sense to me.

Anyway, looking at the cash flow statement provides a lot of clues as to how good the business is. Frankly, I only really need to Income Statement and Cash Flow statement to get an idea if the business generates a good return on capital.


Management’s Discussion & Analysis

This section of the 10-K is when management teams can really explain what drove business results over the past few years. Look at how much detail Fastenal provides in just one section. This doesn’t even really get into cost of goods or operating expenses.

This section really should help an investor with the detective work needed to understand the business. It certainly helps me model companies and think about drivers for the future.


Obviously, there are many more things to study when evaluating an investment, but wanted to share my starting point for how I read a 10-K.

Bolster the Economy: Lower Bank Capital Requirements for the Foreseeable Future $XLF $WFC $BAC $JPM

I think the bank stocks look cheap, as I highlighted with a few in a recent post. But there are issues with lending right now — and I am not even including the wave of defaults & impairments people expect or forbearance.

In the article in the WSJ titled, The Day Coronavirus Nearly Broke the Financial Markets, there is this scoop on what was going on in the market. Essentially, banks held interest rate hedges on it books and when rates went down, the hedges swung in the banks favor and out of companies favor who decided to hedge.

What is funny is that this was seemingly good thing for banks — they had a gain on their books — but actually restricted their ability to deploy capital:

So when Mr. Rao called senior executives for an explanation on why they wouldn’t trade, they had the same refrain: There was no room to buy bonds and other assets and still remain in compliance with tougher guidelines imposed by regulators after the previous financial crisis. In other words, capital rules intended to make the financial system safer were, at least in this instance, draining liquidity from the markets.

One senior bank executive leveled with him: “We can’t bid on anything that adds to the balance sheet right now.

Matt Levine summed up the intricacies well in his recap on this. This scenario plus consumers depositing a bunch of cash at the bank (due to fear in the market) resulted in an increase in the bank balance sheet, but also required additional regulatory restrictions with the balance sheet growth.

The Fed stepped in and said that, temporarily, they would ease these restrictions through March 2021:

Liquidity conditions in Treasury markets have deteriorated rapidly, and financial institutions are receiving significant inflows of customer deposits along with increased reserve levels. The regulatory restrictions that accompany this balance sheet growth may constrain the firms’ ability to continue to serve as financial intermediaries and to provide credit to households and businesses. The change to the supplementary leverage ratio will mitigate the effects of those restrictions and better enable firms to support the economy.

This is good and as I showed in my last post on banks, the amount of capital banks hold now is insane compared to what they had going into the Great Financial Crisis. The Fed agrees:

Financial institutions have more than doubled their capital and liquidity levels over the past decade and are encouraged to use that strength to support households and businesses. The Board is providing the temporary exclusion in the interim final rule to allow banking organizations to expand their balance sheets as appropriate to continue to serve as financial intermediaries, rather than to allow banking organizations to increase capital distributions, and will administer the interim final rule accordingly

Why did we tell banks after the GFC that they needed to increase their reserve requirements? So that they would be able to provide support in a crisis, not be a source of weakness. That is what is happening now.

I think we need to go a step further and actually lower the capital requirements for the foreseeable future. When you crimp credit, you crimp the economy. Lowering reserve requirements for some time would unleash significant amounts of capital into the system. So far the Fed has just said certain assets won’t count against the risk-weighted assets. With the rule expiring in 2021, it doesn’t really help banks feel super confident.

Here is the chart again of what banks capital levels look like – exiting 2019 with a median level of 12.8%.

Tier 1 Capital represents core equity capital to risk weighted assets and essentially represents the capital not committed to meeting the banks liabilities. The reason you have excess capital is to prepare for unforeseen events, which is why regulators require a minimum of 4%, but higher (6%) for large banks. Investors typically want to see 150% above the minimum.  That foots to 6% and 9% respectively… And the big banks were near 13%. The excess capital allowed banks to invest, conduct share buybacks or dividends.

But its clear to me that banks learned their lesson from the last crisis – they did not want to buy the cause again so they carried significant amounts of capital.

I think the Fed / Govt should lower the reserve requirement to unleash more capital into the system from banks, not just central banks. They clearly have excess capital, they just need to be encouraged to deploy it. Imagine how much capital would be deployed if banks went from 12% or 10% to 6%? We then could say they have to get back to 9% in 5 years.

 

Google Should Take a Page from the IAC Playbook: Spin-Offs $IAC $GOOGL $GOOG

I’ve been thinking about Google recently… especially as concerns arose around COVID-19 and what it would do to the new era advertising giants. Everyone knows “search” is such a powerful business in advertising and benefits from the scale / platform benefits of everyone “googling” what they need. Though I can’t help but think that Google’s assets are underappreciated.

I think Google should take a page from IAC. For those of you unfamiliar with IAC, they essentially are a publicly traded venture capital firm. However, unlike VC the business is “home grown” and once it matures, they tend to spin-it out and maintain a stake or take a dividend from the business (like they have recently done with Match Group, the owner of Tinder and other dating apps).

IAC’s track record is impeccable. Recognize any of these names?

 

The point is, IAC understands that sometimes a company is worth more operating outside of a large corporate umbrella and with its own balance sheet, making its own strategic decisions, and having its own separate shareholders.

They also understand that a company may need to have a shareholder early on with a long-term view. I think Google’s assets could benefit from this treatment as many of them are mature at this point.

Imagine Google does the following spin-offs:

  • Google Nest, Google Home – Hardware play
  • Google Maps – logistics tolling play in the long run
  • Waymo – Driverless Cars
  • Google Cloud Business
  • Android, Chromebooks, other hardware etc.

Search, YouTube, & G-suite (Google Sheets, Gmail, Google Drive, Google Pay) is the “RemainCo” as the assets really do benefit from being combined.

Do you think the assets of the company are worth more than what Google currently trades at? I do.

I think YouTube and Google probably are worth where Google trades right now.

Facebook has roughly 50% EBITDA margins on its advertising-driven business. Let’s say Google’s is in a similar ballpark.  The company disclosed in 2019 that Google and YouTube generated around $135BN in revenue, so applying a 50% EBITDA margin to that implies $67.4BN in EBITDA. At the time of writing, Google’s entire Enterprise Value is $837BN, so that foots to ~12.5x EBITDA for a company that is a secular grower. That doesn’t seem excessive to me.

Next, lets look at Google Cloud, which is growing like a weed and competes with AWS.

Back when AWS was around this size in revenues, it had low 50% EBITDA margins.

Therefore, I can assume again around 50% EBITDA margins for the Google Cloud business, which foots to $4.5BN of EBITDA. This too is a secular grower, an oligopoly business between the tech giants, and likely going to double earnings in a couple years. Therefore, I do not think its is unreasonable to say this is worth $75BN (frankly, if earnings do double in 2 years, that’s only an 8-9x forward multiple).

The point is though that that one segment could add a lot of shareholder value if it operated outside of Google. We haven’t even touched “other bets” Google has, which seems to be a lot of cookey stuff like barges for some reason.

There are so many things within Google that I bet we don’t even know about. This list of acquisitions by Alphabet is insane and as a layperson, I don’t know what many of them do. Its also hard for me to actually see what value they bring to Google or to me as a shareholder — but if Google separated out its businesses, maybe that wouldn’t be the case!

4 Bank Stocks Worth Considering $WFC $DFS $BNPQY $SNV

Bank stocks have gotten hammered this year. In fact, they only trail energy in terms of worst-performing asset classes.

(thanks Callum Thomas for this chart)

This makes sense. If I were to boil it down in one sentence its “banks do not do well in recessions.”

Borrowers may default on loans and banks use leverage so those defaults add up quickly. In good times, banks also tend to reserve less and take less provisions for loan losses (i.e. losses they generally expect on their portfolios in the future) because its hard for them to see a recession on the horizon – and it also juices net income in the short term.

Then… a recession hits. Banks need to take further provisions and people realizes they may not be invested in a bank that can fully weather a business cycle like they thought.

That’s somewhat true today, but different in a lot of ways as well. Yes, banks so far have taken huge loan losses, major ones detailed below:

They took these provisions because we just so happen to be entering the worst economic crunch anyone reading this has ever seen. I mean, the global economy just ground to a halt. Unemployment has surged. And no one knows how long consumers’ trepidation of traveling, splurging, and so on will last.

At the same time, banks’ balance sheets were essentially forced to be in the strongest position we’ve seen for some time. The last crisis in 2008-2009 was a financial crisis. In response, governments attempted to impose “never again” policies to shore up our financial institutions (arguably, this lowered lending and caused our recovery to be much slower, longer and more painful than it otherwise would have been) and bank stocks were put into the penalty bin.

As you can see below, banks tier 1 capital ratios going into this recession far exceed what they were going into the last recession. While this is a health crisis and not a financial crisis, they still face pain, but should be able to withstand the impacts better.

I think this has created an opportunity in the bank stocks. We can now buy leading franchises below book value and collect meaningful dividends along the way.

Here is a list of banks and financials I am looking at:

You can read my comments for each one above, but I want to very briefly focus on some names I think are worth taking a deeper dive on (frankly, I think the banks in general look cheap and it was very hard to find 4 just to drill into – I think a basket of the above makes a lot of sense, excluding any you don’t want exposure to of course).


Wells Fargo:

This bank is absolutely in the penalty box right now. I mean literally – its in a penalty box. The “fake account” scandal resulted in a freeze on the banks assets as punishment so they could get a handle on what was going on in the firm and improve governance. They are a bank, which requires a lot of trust, and Wells Fargo broke that trust.

How quickly tides turn, though. I remember when Wells Fargo was what JP Morgan is today. The “good” bank. Led by a trustworthy team that wasn’t like those other greedy Wall Street banks. And for that, Wells used to trade at 0.5x-1.0x premium to the group (much like JP Morgan does now). You can clearly see a “changing of the guard” going on here. If you didn’t know when the scandal happened, I am sure you can now pick it out.

But Wells has a new CEO and if you have a long time horizon, I am sure they will figure it out. The CEO, Charles Scharf, has a very interesting pedigree.

  • CEO of Visa from November 2012 to December 2016
  • CEO of JP Morgan’s Retail Financial Services for 9 years (2004-2012)
  • Managing director at One Equity Partners, JPM’s private equity arm
  • CEO & CFO at Bank One in 2000-2002
  • CFO of Corporate and Investment bank at Citigroup (1999-2000)
  • 1995-1999 he was the CFO at Salomon Smith Barney

This guy gets banking. And he’s led some very large firms and divisions.

I understand why Wells Fargo trades at a discount to JPM. It can’t grow. Its brand may be irreparably harmed.

But I doubt that lasts forever. Just like Domino’s improving its pizza brand, a bank can improve too. Recall Soloman Brothers and Bank of America were once hated entities that came back considerably in terms of sentiment and trust.

Time heals all wounds as they say. We just need Wells to survive. Can they do it? Well, again, their capital structure is in healthy shape:

Wells does have exposure to high risk industries, like Oil & Gas and Retail that will be under pressure this year, but it is still very diversified. Also note, when they say retail, that breaks down to other exposures. For example, department stores are only 18% of their total retail exposure, so less than 1.5% of total commercial and industrial loans.

I like Wells Fargo here. I think the dividend is probably maintained so I’m collecting 8% per year to wait. Even if its cut in half, it still would be a 4% dividend (clearly, if they did that things would not be going swimmingly, but over the long run it should even out).


Discover:

It’s difficult to actually compare Discover to a name like Wells Fargo. Discover is mainly a credit card business (80% of loans), private student loans (~10% of loans) and personal loans (~10%). So if I were to sum up what makes Discover different than the other bank stocks, its that it is more of a bet on the consumer. And these are generally unsecured consumer loans, so they carry risk.

In Q1’2020, Discover increased its reserve ratio for its credit card portfolio to 7.2% (up from 5.9% at the end of 2019) and this is actually somewhat light compared to peers (Synchrony reserved 11%, Capital One reserved 9%, American Express reserved 7%). So there is a risk they need to have additional reserves in 2020. I would say that is the bulk of what people expect and that has people concerned.

On the call, management called out a few things to assuage reserve fears:

To give you a sense for how our card portfolio compares today, with how it looked at the end of 2007, our contingent liability, meaning the total open to buy for our card products has been reduced from roughly 5.7 times loans to around 2.7 times. And the percentage of the portfolio below a FICO score of 660 has gone from 26% at that time, down to 19% at the end of 2019. So, while we are not immune from the impacts of deterioration in the economy our portfolio is significantly better positioned than it was ahead of the last financial crisis.

So the open-to-buy has reduced by about $54 billion from the last recession to this recession. Average FICO scores in the portfolio have increased between 500 and 600 basis points, which is a material change. Our underwriting, frankly, is far more sophisticated than it was 10 years ago. And frankly, the actions that this business undertook when the pandemic started to actually drive some real difficult employment numbers was drastic and very, very quick.

Open-to-buy risk is when a consumer is under financial duress so they draw down on their credit cards. So one, they sap liquidity available and two, they increase the risk because the card lenders’ exposure to riskier credits grows.  It seems as though Discover is in a stronger position today.

Again, if you have a long time horizon, you’re buying a financials that earns a 22%+ ROE for only 1.5x TBV. That seems too cheap to me.


BNP Paribas

And now, for something different again. I actually looked up BNP Paribas, the french bank that is one of the largest in Europe, to see how negative rates would impact the US stocks. Clearly ROAs go down, but BNP’s 5-year average ROE isn’t that bad (the shape of the yield curve matters).

Look, a 8% ROE is not that great. But that is 8% return on book equity… and I can buy BNP right now for 0.4x that book value, so return on MY equity should be much higher in the long run.

Let me show a summary example. Assume a bank has $100 of beginning book value, earns 8% on equity and pays out 40% of its income. In year 10, I sell the bank to 0.4x book value, so I get no benefit from multiple expansion or ROEs improving.

The return on my equity is much more attractive.

Look BNP is like any other bank – it will have issues this year. But BNP is a highly diversified bank and I really like how thorough their management team is – their Q1’2020 investor deck was 84 pages!

BNP right now is planning to pay out 50% of its earnings as a dividend, which will be somewhere between a 9-10% yield on the stock. However, the ECB has told European banks that they need to shore up liquidity to support the economy and to cancel dividends for the time being. Even with the dividend, BNP expects to have a 12% CET1 ratio (about 300bps above the Basel III minimums) so I think that would be a huge boon to be able to pay out its earnings.


Synovus

Last one I am looking at is a small, southeast US bank called Synovus.  As shown in the table at the beginning of this post, it trades around 0.7x book and has OK, but not great capital buffers. The banks CET1 ratio is 8.7% compared to their goal of 9%. However, new bank accounting standards result in taking higher losses upfront (called CECL), so the management team relayed that CECL reduced CET1 ratios earlier in the cycle. 

As for the downturn, Synovus used to be heavily exposed to commercial real estate, land and 1-4 Family units, but since the crisis has been working to reduce that exposure and get more diversified. 

As  the company noted, because the loss rates of those sectors was so high, this significantly de-risked the company in a stressed scenario. 

We have significantly reduced our exposure to 1-4 family residential, land and investment properties as well as CRE in aggregate. By simply utilizing historical loss rates, the remix of our portfolio alone would result in a 50% reduction in losses. Combined with the improvements in underwriting and portfolio management, we would expect losses to decline even further when evaluating the impact of the severely adverse scenario

Part of the diversification was driven by the banks merger with Florida Community Bank back in 2018. Its funny to look at where Synovus trades now (0.7x BV) compared to when the deal was struck. 

But while merging with a Florida bank diversified the company away from being a mainly Georgian bank, Florida isn’t a great spot to be right now. Tourism drives their economy (Disney World!) and COVID-19 will surely wreak havoc. SNV noted 13% of loans were in deferment, which is pretty high compared to peers and the company noted it was in mostly at risk sectors, probably lining up with this slide:

The good news is that the company said “a lot came in, in the first week or 2. We’ve seen it trail off considerably to the point now where we’re really not adding many deferments to that book. And just want to make sure that we’re clear on it. It’s really just a 90-day program.” So seems like the worst is behind us and hopefully back up in running at quarter end (timing well with a re-opening, I would suspect).

Commercial & Industrial loans make up $17.7BN (or 47% of total exposure):

Within C&I, the specialty divisions such as senior housing and premium finance comprise about 14% of total loans and have been a significant contributor to our growth story while also possessing some of the best credit metrics over the last several years. The overall portfolio is well diversified by industry and geography and is extremely granular with almost 35,000 loans with an average original loan balance of approximately $770,000 

So clearly the bank is exposed to a bunch of smaller sized loans. 

Clearly, SNV is a riskier story, and I would size a position in a portfolio as such, but I think owning Synovus makes sense to buy for a few reasons: 

  • Dividend: Mgmt team seemed committed to the dividend, so we pocket ~7% to wait
  • The bar is already set low – company used to trade above 1.5x book value. I think BV by YE2021 could be ~$30/share, so trading at 1x would be nearly 60% upside plus a HSD dividend
  • Take-out candidate: Any bank that wants to increase its southeastern presence or market share could look to acquire SNV. Float a take-out for 1x TBV and I’m sure the synergies would be large and very accretive for the acquirer (branch consolidation, back office savings, etc).  

All that said, would I buy more Synovus or Wells Fargo or BNP? I’d probably choose the latter two.