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StoneCastle Financial Corp. (Nasdaq:BANX) StoneCastle Partners, LLC. |
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April 3, 2017 Issue |
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CEOCFO MAGAZINE |
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A Publicly Traded Investment Company focused solely on Community Banks |
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Chairman & CEO StoneCastle Financial Corp.
StoneCastle Financial Corp. (Nasdaq:BANX) StoneCastle Partners, LLC.
Interview conducted by: Lynn Fosse, Senior Editor, CEOCFO Magazine, Published – April 3, 2017
CEOCFO: Mr. Siegel, what is the relationship between StoneCastle Financial Corp. and StoneCastle Partners?
Mr. Siegel:
StoneCastle Financial Corp. is a publicly traded company on Nasdaq under the ticker BANX.
StoneCastle Partners, LLC manages just under $13 billion of assets, and is a privately held company with approximately 70 employees. Our headquarters are in New York, NY and we have offices across the country. The firm has done about $5.8 billion of direct investments in over 450 community banks in 49 states, with the exception being Alaska.
A subsidiary of StoneCastle Partners,LLC, StoneCastle Asset Management, LLC is the advisor to StoneCastle Financial Corp. StoneCastle Partners and StoneCastle Asset Management, LLC own approximately 1% of the shares of StoneCastle Financial Corp. The balance of BANX is owned by outside investors.
CEOCFO: Would you tell us about StoneCastle Financial Corp. and your role as CEO?
Mr. Siegel:
The background of how StoneCastle Financial Corp. came about is quite fascinating. In part, it came about because of my professional network in Washington, DC.
One of the things that we do at the firm, and that I’ve spent quite a bit of time on, is consulting with financial regulators in Washington and at the state level. Whether it’s the FDIC, the Federal Reserve Bank, the U.S. Department of Treasury, the Controller of the Currency or 50 state bank commissioners, we spend time speaking with them and working on methods of stress testing banks, resolving troubled banks, as well as, discussing accounting standards and technology. We are not a paid consultant, so it is more of a hobby, that has allowed StoneCastle Partners to enter into many discussions about industry trends that concern regulators and government officials, whether it is credit or interest rate risk, or simply the lack of capital for smaller banks. That is what occurred starting after the peak of the crisis. The US Treasury and the American Bankers Association, which is the largest trade association for banks in America, were separately concerned about smaller banks being able to raise capital to grow and set out to find solutions. Those organizations called on me and our firm because back in the late 1990’s, I was the first in the country to find a way to bring large amounts of capital to banks from the capital markets, rather than through local community bank investors.
The Treasury and the ABA contacted us and said, “You figured it out once before, can you figure out a new way for capital to come into these banks?” With the Treasury, together we explored a number of ideas, such as a private stock market just for small banks, and others. All ideas were considered.
We came up with an idea of tapping into the public markets and executing on what became StoneCastle Financial Corp., the first publicly traded and what we believe is still the only publicly traded closed- end investment management company solely dedicated to investing in community banks. It took many years to get StoneCastle Financial Corp. to become a reality. StoneCastle Financial is a unique vehicle on the public markets. The Company’s investment objective is to provide income and to a lesser extent capital appreciation through investment in preferred stocks, subordinated and senior debt, and to a lesser extent common shares.
The best way to think about community banks is their size. Out of the 6,100 banks in the United States today, about 98% of those banks have less than $10 billion in assets, and are therefore, relatively small compared to a J. P. Morgan at $2 trillion. Most of those small banks do not have the ability to access capital or issue public stock. These institutions have been around on average for over 80 years and generate, on average, about a 9% return on equity year-after-year.
CEOCFO: Do banks need to get comfortable understanding what you can do for them, especially for those that have been around for a long time and do they reach out when perhaps they never had to before?
Mr. Siegel:
The most challenging time for me personally was in the 1990’s when the community banks typically raised capital through a local common equity investor, like members of their communities. During that time, there was a long educational process. When we came out with StoneCastle Financial Corp.as a permanent, living, breathing company that could hold investments in banks as a passive investor, we revisited this issue. The idea of making an investment in their banks, either through an income equity, preferred stock or subordinated debt, was not new, so the education process was not long. But it had been about 6 years since they had access to this specific type of capital. Therefore, it took a bit of time to reengage with us as new investors following an extended investment period that was rather dormant.
CEOCFO: Would you walk us through a typical engagement with a bank? Are you finding them or are they finding you? What are some of the negotiations and some of the outcomes?
Mr. Siegel:
Good question. I believe we are one of the largest investors in community banks in the country, which brings most banks and bank investors to know about us. In fact, StoneCastle Financial Corp. has an exclusive endorsement from the American Bankers Association, so we are the only entity that the American Bankers Association refers when a bank has expressed an interest in raising capital.
We have a strong professional network. We work with over 50 regional broker dealers, investment banks, law firms, and state bank associations of which when a CEO or CFO of a community bank has made a decision to raise capital, we tend to get the first call. Not just because we are only one of the largest investors, but because we are one of the few investors entirely dedicated to this space. Therefore, we do see quite a bit of activity.
Once we have an inbound inquiry, we do what we call a “pre-screening”, whereby we pull-up information on the bank. Banking is quite unique in this country relative to every other industry sector. Every single bank is required by the FDIC to file a perfectly standardized Call Report every single quarter and it is a large report-- an 80 plus pages. It is unlike a 10K and a 10Q for public company reporting that contains comparable information, but is not uniformly reported. A bank Call Report is a perfectly standardized document. Line 123 on one report is the same line 123 as in other report. Therefore, the availability of very granular data and transparency into banks is immense.
I also want to mention, we have a proprietary software product at StoneCastle called RAMPART™ that was built internally. RAMPART™ allows us to analyze call report data, so when a bank calls and has an interest in raising capital we can respond quickly. We review and verify all of the available data about the bank: it’s market and historical financials, information that we use to qualify the organization. If it does meet our investment objectives, then we have an in-depth call with the bank and we start asking very routine questions that help us to understand the nature of that bank within its community.
CEOCFO: What might you look at that less knowledgeable people in the industry do not recognize as relevant?
Mr. Siegel:
There are a number of things. One important thing to keep in mind is where we invest within the capital structure of a bank. StoneCastle tends to invest using preferred stock, or a form of debt. Very rarely do we invest in common equity. Therefore, the underlying bank’s profitability is very important, but it is not our first or only criteria. What we look for is financial stability and a very conservative approach to banking. Unlike others who may primarily focus on the fastest growing or most profitable banks, we tend to favor the long standing and stable companies within the industry. When we analyze a bank we proceed in the following order – management, market and balance sheet. It is in that order for a reason.
Let’s start with Management. We like to see if management is active in their communities. Let me tell you why that matters. Most local banks are locally owned by members of the community. If the shareholders of the bank are the management’s neighbors, family and social network, they are probably not going to go on a limb and take a great deal of risk. But, if that management team flies home every weekend, or is a professional CEO that has been transplanted from New York to Oregon, let’s say, it is too easy to move back to New York if it doesn’t work out. Not so with a community bank CEO that is a pillar of the community. Therefore, you want that local connection.
Most people, when they analyze a company as an investment, they look at the financials first. In terms of community banking, that is the last thing they should look at. Not that it is unimportant, but financials do not give the depth of information about the management and the market. For example, within a financial analysis, an investor would look at a bank’s loan book. A bank’s typical loan book is making loans that are on average about 5 years in duration. That means statistically every 5 years all of those loans will turn over, and there will be a new set of loans. We want to understand why the management is choosing to make those loans and how he arrived at the decision. So understanding how a management thinks is critical to understanding the future of that bank.
A community bank is not much more than a vessel to own what we call community risk. It is typically local business risk and local real estate risk with very little direct to consumer. Therefore, when we are looking at that community, which may consist of a town or a few towns or a county being the footprint of a bank, we first want to understand how management is aligned to their community; how they are trained. Are they aggressive lenders? Are they conservative lenders? And how is management compensated? You want a bank that is aligned with their community long-term. This allows us to invest in a broad range of banks.
Now, next is the market, and most people do not obviously look at it. Let me explain the importance of the market.
If you and I were analyzing a bank to invest in and we looked at management and they passed all the tests, convincing us that they were capable, experienced and conservative, let’s say. Then we looked at the financials next and found the bank to be well capitalized and very profitable. We might first come to the conclusion that this bank looks like a good investment.
However, that analysis doesn’t take into account the market. If I were to mention to you that all of the people who work in the town were employed at one auto parts manufacturing plant, there might be market risk if the plant closes. If we do not understand the underlying local market risk, we are not getting the full picture. So, along with how good management is or how robust the financials are, market risk needs to be taken into account. StoneCastle analyzes market risk by gathering information on the demographics of the community, like average age and average income level. We ask about the affordability of housing and what is the vacancy rate is in commercial real estate? We ask about the largest industries and the largest employer in the area. All of these factors about a local market give an enormous insight into the bank’s future prospects.
For example, imagine a market such as Michigan. You might think Michigan did not do well during the crisis. But certain parts of Michigan such as Ann Arbor did just fine. The reason Ann Arbor did well was because of government, healthcare and education jobs, i.e., jobs that tend to be recession resistant.
Therefore, asking management the right questions and looking at the right markets gives us a strong picture and puts a bank’s financials into context. Finally, we look at the financials to see if the amount of capital and the bank’s liquidity are consistent with the management’s description of their market.
To further answer your question of what we do differently from others is that StoneCastle Partners is focused entirely in one industry sector and specializes in that business. Our firm is doing $13 billion of business in one industry sector, community banks. It is easy to identify things that look completely out of whack compared to the other banks in the country. In contrast, if you invest and manage 30 different industries, it is hard to find those nuances.
CEOCFO: Is there a geographic component to the banks you choose?
Mr. Siegel:
We invest nationally and today, StoneCastle Financial has over 120 different banks in approximately 35 states. StoneCastle Partners, LLC, which has other products including a deposit business, has exposure in all 50 states, including Alaska.
But every single market, every micro-market, for example, has a certain demographic, affluence and nature to it. Take Winter Park, Florida, for example. If you drove 20 minutes north, south, east or west you could end up in a town that has a completely different profile. So, to say, I like North Florida or the Orlando area, does not mean anything. To invest in community banks, an investor has to get down to a community level and understand exactly where the branches of that bank are, and what communities they are serving, and the nature of that community, because it can be dramatically different, even 10 or 20 miles apart.
CEOCFO: Once you have invested in a bank, how do you keep track of what they are doing? Where does the human component come in when you are doing your review?
Mr. Siegel:
As I mentioned, the banks report their financials on the FDIC Call Reports every quarter. They are publically available on the FDIC website for every single bank in the country. The data is imported electronically into our RAMPART™ system, which makes the analysis efficient. Rampart™ does not do the analysis for us, but it assembles the information to be more easily handled by our analysts. What the analysts look for are quarter-to-quarter trends. Banks rarely become distressed overnight. They tend to decline over a period of time and with RAMPART™, we can be ahead of a trend.
We bring this kind of community bank information to our investors who cannot otherwise source it through their own research or advisors. That is the distinction here and the answer to your question about the human component. We are not simply buying securities available on the market. We directly originate deals. We make direct investments in a business based on relationships. And in our business, we take the time to meet with banks, go onsite, and go through loan books. We review board minutes and management biographies. We drive through their communities.
In order to monitor ongoing operations, StoneCastle will review the public information and look through government databases, for regulatory orders or any issues on the institution. We actively contact the banks and if it is a very healthy bank we will talk to them once a year. If they are trending below their peer group, we will probably call them every quarter for a discussion. If they are troubled, which we currently have none, we talk to them every week. Therefore, the human component is important and ongoing, because we constantly look at the data around the market.
I used the example of the local markets auto parts manufacturing plant earlier. Again, if we just focus on financials, you may be invested in a bank, of which the loan book looks fantastic with almost no non-performing loans. But in our analysis, if we learn that the largest employer, the auto parts plant is closing, we may know of the potential for a problem even earlier than the bank. If we are aware that the plant may be closing, we may decide to sell that investment or we may talk to the bank and make them aware of the situation. We will work with the bank since they may want to increase their liquidity or capital ahead of the closing, in the unfortunate event, that people may become un-employed and/or fall behind on their loans. This granular information also helps in having an active role in helping banks avoid any regulatory trouble. In the past, we have taken this course of action in order to protect our investment.
CEOCFO: You recently announced quarterly earnings. How is business?
Mr. Siegel:
Business is quite good. We have had three and a half years with no credit losses. We have nothing on watch right now that is declining in quality. We earned $0.39 in Q4 2016 and on March 10th declared a dividend of $0.37 for Q1 2017. The stock price returned approximately 24% for 2016 including the reinvestment of dividends. The trend in our performance relative to other income alternatives is quite strong. We are dealing with an investment grade quality set of securities, so it is a comparatively benign risk relative to other ways investors can achieve an approximate 7% dividend yield in an investment grade quality portfolio.
CEOCFO: Does the investment community understand what you are doing?
Mr. Siegel:
Yes. Investors are better at understanding the investment attributes in Stonecastle Financial Corp. When we launched, I like to say we were a purple chicken; no one ever saw anything like our company. They did not know how to compare us to other investments or how to think about our company. We believe the market is recognizing the performance of the management and how we approach the business. The yield used to be up in the 9% range and now we are down to the mid-7%s. Today, we believe that investors are attracted to StoneCastle because of the relative value we offer in the market. When you look at comparable credit risk BBB indices, some are yielding in the 3% or 4% range. We have a maintained a consistent stable income stream and quality of assets in the portfolio. We believe investors, over time, will value the predictability of an income stream given our current portfolio.
CEOCFO: Put it together for our readers in the business and investment community. Why pay attention to StoneCastle Financial Corp.?
Mr. Siegel:
Investors should pay attention to our common stock because we believe it is a way to earn mid 7% yields and current income with a more conservative risk reward profile than other comparable alternatives in the market.
More importantly In the current market, the community banking industry has interesting tailwinds with an inflection point in interest rates, the potential for changes in the regulatory environment, and industry consolidation. To make this point, in a market with increasing interest rates, banks can produce higher earnings and have a compounded rate of return on those earnings. Almost all other companies have lower earnings when interest rates go up because their debt costs go up. For banks, higher interest rates are counter cyclical to the market. Investment in community banks is a reasonably uncorrelated market because it is tied to small and rural communities, not to national issues. Irrespective of these tailwinds, small towns across the country continue their daily routines and just go on irrespective of the national environment and politics of Washington D.C. That is what is nice about this industry. There are no derivatives, no consumer lending, no mortgage production.
Therefore, investors who desire an income vehicle with a dividend yield in the mid-7%s, and a high quality investment grade portfolio of banks might want to pay attention to us. We believe StoneCastle Financial offers a stable and diversified income vehicle with a national geographic reach, without the banking exposure you usually have with large money center bank.
Community banking is a very old school model of banking, like the George Bailey “It’s a Wonderful Life” model of banking.
Disclaimer and Risk Factors: There is no assurance that StoneCastle Financial will achieve its investment objective. StoneCastle Financial is subject to numerous risks, including investment and market risks, management risk, income and interest rate risks, banking industry risks, preferred stock risk, convertible securities risk, debt securities risk, liquidity risk, valuation risk, leverage risk, non-diversification risk, credit and counterparty risks, market at a discount from net asset value risk and market disruption risk. Shares of closed-end investment companies may trade above (a premium) or below (a discount) their net asset value. Shares of StoneCastle Financial may not be appropriate for all investors. Investors should review and consider carefully StoneCastle Financial's investment objective, risks, charges and expenses. Past performance does not guarantee future results. Learn more at www.stonecastle-financial.com. |
“StoneCastle Financial Corp. is a unique vehicle on the public markets solely dedicated to investing in Community Banks. The Company’s investment objective is to provide income and to a lesser extent capital appreciation through investment in preferred stocks, subordinated and senior debt, and to a lesser extent common shares” - Josh Siegel, Managing Principal of StoneCastle Partners
StoneCastle Financial Corp. (Nasdaq:BANX) StoneCastle Partners, LLC.
Contact: Julie Muraco, Investor Relations 212-354-6500 x324
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StoneCastle Financial Corp., Nasdaq:BANX, StoneCastle Partners, LLC, US Banks Investments, Josh Siegel, Managing, A Publicly Traded Investment Company focused solely on Community Banks, Financial Companies, Capital Company, Treasury professionals, fixed income investors, Broker Dealers, closed end investment company, BANX: Nasdaq GS, investing in US community banks, invest in U.S. community Banks, bank funding strategies, depository institutions for institutional investors, cash management solutions, FISA, InterLink, strategies for institutional Investors, fixed income investors, community banks, StoneCastle Financial Corp., Press Releases, News, Bank Stock, Companies looking for venture capital, Angel Investors, private companies looking for investors, US bank investment companies seeking investors, fixed income investment companies needing investment capital |
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Josh
Siegel, Managing Principal of StoneCastle Partners