Been following BNK Bank ever since it was Goldfields Money. Was...

Been following BNK Bank ever since it was Goldfields Money. Was a holder until the sale of Finsure was announced and now given the recent low valuation, have gone back in again. My analysis on the investment below.

Summary
There is a large margin of safety given BNK’s low P/B valuation. While it isn’t currently profitable and is unlikely to pay a dividend in the near future, Firstmac is no doubt working in the background (and likely working with the board) to see how it can gain Treasurer approval to purchase the business.Meanwhile BNK has an extremely strong balance sheet; a loan book made up of almost entirely prime residential loans; and is slowly increasing its profitability, so see limited downside risk, while significant (150%+) upside risk, that could materialise overnight. BUY.

Bull points:

• Low P/B valuation – At 40c it is trading at 0.43x Tangible Book Value and by 30 June likely be closer to 0.44x TBV. This is well below peer values of more established banks of 1.0x. Its nearest peer, Auswide Bank, trades at 1.0x. At a book value of 0.43x, the market is pricing the stock as if it will be either forever loss making and/or is expecting a large writedown in the value of its assets (i.e. recoverability of its loans from customers). While all banks account for some level of bad debts, BNK’s loan book is made up of 96% prime residential loans, which are mortgaged against residential properties, around Australia. While there has been some much publicized recent reduction in house prices and the impact of recent interest rate rises may have of house values, prices have stabilised and most loans will have been made prior to a large runup in house prices. National unemployment also remains near all time lows, allowing people to service mortgages, and thus one would expect there to be very little write off of these loans. Will be interesting to see the provisions in the upcoming annual report, however as of last year these were very low. BNK’s higher margin, Commercial loans would be more risky, however these make up such a small proportion of the loan book.
• Share price lows – at 39c (and recently touching 35c), is now at/below the level when the Silicon Valley bank theatrics were taking place, where it was thought there would be onflow to smaller, regional banks, and thus a run on the banks.
• Growing profitability – the Bank has noted that it is approaching cash break even. Increasing interest rates by the RBA will also assist in the Net Interest Margin achieved by the BNK. The soon to come annual accounts will be telling, given Q4 performance.
• Strong balance sheet – extremely well capitalised with a Capital Adequacy Ratio above its peers, meaning it does not need to attract more funding in order to write additional loans.
• FirstMac’s 20% holding – clearly Firstmac are interested in purchasing an ADI. Their previous hostile approach in 2017 is an indicator of this (more on this below)

Bear points

• Peak of the Interest Rate cycle – lower profitability? We are however approaching the peak of the interest rate cycle, and as can be seen from some of the Big 4, record NIM’s are likely to peak, or have recently peaked.
• Potential Recession – would lead to a potential write down of its loan book, should unemployment increase materially, although recent ABS releases show that unemployment has barely increased across the nation, despite the quick run up in the RBA’s cash rate.
• Lack of scale – makes it harder to turn profitable given the high competition with the Big 4 and other banks, for writing mortgage loans. Therefore often having to provide cheaper loans, and offer higher deposit/term facility rates, squeezing Net Interest Margins.
• Question if will ever turn profitable – history of being loss making when a stand alone bank, factoring in the above points.

Takeover Potential

• Firstmac have popped up on the register a few months ago with the maximum allowed holding (per APRA Rules) of 19.9%. Paying 70c/share (at a c.60% premium), clearly indicates a willingness to buy the business, or at least achieve a blocking stake, and underwrites the value they would be looking to buy at (ie min 70c/sh). There is a Takeover Code rule that would mean they must pay this price as a minimum, if making a bid within 4 months of this purchase, in any case.
• No doubt Kim Cannon (Firstmac founder/owner) has learnt his lesson from a failed hostile takeover on BNK (when previously Goldfields Money), back in 2017. He would be absolutely kicking himself for not paying up for it, as he had Treasurer (Scott Morrison) approval for the deal at the time, and has since had a separate bid for an ADI credit union knocked back by Josh Frydenberg. It would have cost him an extra few millions dollars at the time, peanuts in the scheme of things looking back. The money he would have save on that, with access to cheaper bank deposit funding for his Firstmac lending business, would have been made multiple times over.
• As such, I would suspect any bid would come board recommended, and would thus need to be at a recommendable price, which would need to be at least 1 to 1.1x book value in order to be deemed Fair and Reasonable by any Independent Expert Report. Meaning a price of 92-100c / share, minimum. Firstmac is a huge business, and Nick Cannon’s net worth is estimated at >$1bn, so writing a cheque for $130m is not going to be an issue, especially for buying an asset at book value. The value to Firstmac is large, giving it access to cheaper ADI bank funding, rather than having to sell of securitized loan portfolios, the value of which has been reduced in a rising interest rate environment.
• The fact that the Board has given Firstmac a board seat, tells me they are willing to work with Firstmac to get this business sold. Management are incentivised to sell the business (more on this below), and thus this would help in getting any necessary approvals over the line.
• Treasurer signoff – this is the big question which it the only real prohibitor to an Offer, and is very hard to put a probability on and thus factor into BNK’s valuation. It was approved in 2017, however Firstmac was knocked back form a purchasing a Credit Union 3 years ago. Firstmac was recently fined by ASIC for unfair cross-selling tactics, so this has likely hurt its chances somewhat. The fact that the purchase of BNK Bank was previously signed off in 2017, bodes in Firstmac’s favour, however is impossible to tell from the outside. Its safe to say however, that the best consultants and lawyers are on the case. No doubt any approval will come with some APRA / Treasurer conditions, which can be worked in. There are no competition concerns (unlike ANZ / Suncorp) given the small size of BNK, and would think APRA/the govenerment would like larger, more consolidated banks, given what is happening to smaller regional banks in the US, and the increased risk of bank runs. The Treasury isn’t renowned for its speed of turning things around, and thus any approvals are likely to not come before Q4 calendar year.
• Other potential purchases – with a low valuation and a decent loan book, could be on the radar for a major like Bendigo Bank, who have a history of buying regional banks, and who would be more likely to get Treasurer approval. Although the Firstmac blocking stake would be an issue, but not off the table entirely, should Firstmac fail to get Treasurer approval.

Management

• Which brings onto if management would sell the business.
• Management would surely realise that, being such a sub-scale bank, generating profits and scaling up is going to be a hard slog, and thus the quickest and easiest way to attain value (getting P/B back to 1.0x) is through selling.
• Since the last takeover attempt in 2017, the board has almost entirely turned over. The previous board was against a takeover and found a white knight in Finsure. I don’t know what the current board are like, however the appointments seem to have more experience, with the exec team being more competent. The sale of Finsure demonstrates management recognise the value that can be attained through sales. Calvin Ng is still on the board, although I suspect will leave soon, given his reduced shareholding and relationship to Finsure.
• Looking at the annual report, a fair chunk of the mgmt. LTIP is tied to share price performance (total shareholder return – so including the recent dividend), and thus an easy way to gain value for these is through a takeover. A lot of the LTIPs have already vested, although would suspect a new LTIP will be put in place soon. The Annual Report released in August will give us a better view. Its likely they may remain in the role, if a takeover occurs, given the entities would need to be run somewhat separately (per APRA), but is hard to say. The CEO holds >1.8m shares, and holds the most on the board bar Calvin (who has already sold a chuck of his), so I image would be keen to liquidate those. With the low trading volumes in the stock and lack of institutional investors, there is not a viable option to sell 1.9m shares in the market. 1.9m shares at say a 100c/share = $1.9m payout, so he would be pushing for a sale, rather than slogging out over years trying to turn a sub-scale banking business profitable. As Charlie Munger says – “Show me the incentive, I'll show you the outcome”.
• The fact that Firstmac have been given a board seat and have been “welcomed” as substantial shareholder, is not language that was being rolled out in 2017, and demonstrates the new board’s differing mindset to that of 6 years ago re a sale.