A Special Situation With Banks

One of the most interesting situations I have ever seen in the world of community banks

Good morning. Today I am going to go over a special situation within the banking industry. This is a unique situation within the banking industry that has shored up significant cash on the balance sheet of a few select banks. Most of Wall Street hasn’t heard of this situation unless you closely follow the space. But before we get into this special situation, first a word from today’s sponsor…

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Special Situation In Banking

I like investing in weird obscure things. Companies trading under the cash on their balance sheet. Nano-cap liquidations that hedge funds can’t touch due to sizing issues. Off balance sheet assets that the market doesn’t fully appreciate. The search for obscure assets has led me down may weird paths in public markets. One of those has been in the banking industry.

There is a lot of weird situations in the banking industry. I think someone who spent their entire career studying the space and keeping up with regulatory changes could make a significant amount of money. From the strange preferred issues to the obscure mutual conversions. But, this regulatory change I am about to talk about tops them all. Meet the Emergency Capital Investment Program or ECIP for short.

Established by the Consolidated Appropriations Act in 2021, the ECIP was created to encourage low and moderate income community financial institutions to augment their efforts to support small businesses and consumers in their communities. Under the ECIP program the U.S. Treasury provided $9 billion in capital directly to depository institutions that are certified Community Development Financial Institutions (CDFIs). The funds are designed to support low to moderate income banks in providing loans, grants and forbearance to small businesses and minority owned businesses in underserved communities.

The Treasury department has put out a list of financial institutions that are approved to get ECIP funding which included 186 different institutions. To get the funding the U.S. Treasury department purchased senior preferred stock that is considered Tier 1 capital, the best kind of capital for a bank as it is equity capital and disclosed in reserves. In addition, the dividends on the preferred stock do not accrue and are not payable for the first two years of funding. Even better, the maximum dividend rate to be paid is only 2% and could be reduced to as low as 0.5%.

This effectively means that qualified banks will receive up to $250 million in capital from the government that they can use to expand. This capital is interest free for the first two years and when the dividends kicks in during year three it is capped at 2.0%. But it gets better, under the terms of the program the dividend or interest rate will decrease if the bank increases its loan originations to target markets meeting certain thresholds. Per the document:

The dividend or interest rate will be (1) 1.25% if the institution increases its qualified lending by 200% to 400% of the amount of Treasury’s investment, or (2) 0.5% if the institution increases its qualified lending by more than 400% of the amount of Treasury’s investment.

Even better, the preferred dividend does not accrue, meaning, if a bank decides they don’t want to pay the dividend it does not accrue and has no recourse on common shareholders. Worst case scenario the Treasury can elect two directors to a board if too many dividend payments are missed and it could prevent a common dividend or a share repurchase program. In a world of high interest rates and fleeing deposits, this is pretty much free capital for expansion.

Restrictions on what a bank can do with the capital include restricting the amount of dividends and buybacks to the sum of the prior two years net income. In addition, executive compensation now has a cap which prevents the executives from stealing the money outright.

To take advantage of this situation we need to figure out what banks on this list are public. Back in October, dirtcheapstocks sourced this list…

Some of the stocks from this list have all moved up meaningfully. Here is a new breakdown of the market cap to ECIP received. The stocks that are bolded are the ones who have seen their share prices fall since the original write-up on this situation was done.

• M&F Bancorp (MFBP): $51 million market cap and $80 million received

• Citizens Bancshares Corporation (CZBS): $83 million market cap and $95.7 million received

• BankFirst Capital Corporation (BFCC): $212 million market cap and $175 million received

• PCB Bancorp (PCB): $205 million market cap and $69.1 million received

• Security Federal Corp. (SFDL): $81 million market cap and $82.9 million received

• United Bancorporation of Alabama (UBAB): $137 million market cap and $123 million received

• Ponce Financial Group (PDLB): $180 million market cap and $225 million received

• Bay Community Bancorp (CBOBA): $67 million market cap and $119.4 million received

• Broadway Financial Corporation (BYFC): $77 million market cap and $150 million received

• Harbor Bankshares Corporation (HRBK): $17 million market cap and $75 million received.

These companies are all well capitalized, unknown to the market and should receive significant interest from investors during a period where banking deposits remain scarce. I personally own Ponce Financial and I am looking to add to other positions. Over the next few weeks I will provide in-depth analysis on these names.

As the entire banking sector gets demolished, these stocks could go down with them. They are well capitalized with a significant amount of cash on the balance sheet. The cheaper they get the more interested I become.

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