Navigating financials: investing in banks with a difference

March 30, 2023

Federal Reserve Bank of Chicago.

It has been an extremely busy period as we navigated the banking environment. The risk of contagion is top of mind as well as the impact on our investments. The difficulty is that for a bank, added outsized risk can come in many shapes and forms. In 1907, the crisis came from overzealous bank owners attempting to corner the copper market. Today, for SVB, it came from duration misalignment of investments and even cryptocurrencies for Signature Bank. Elevated risk taken by banks often occurs when executives allow deposits and loans to grow faster than what their specific team of lenders and investment managers can handle in relation to risk.

Elevated risk can also come from other sources, such as too much government intervention in the case of the Baoshang bank in China in 2019 or severe mismanagement at all levels in the case of Credit Suisse. That’s the bad news. With 25,000 banks globally and 4,844 in the U.S. alone, let’s expect further difficulties to the system. Outflows are at 1.9%.

The good news is this is taken with extreme attention by government and banking associations. In the last two weeks, our team has travelled extensively, especially in Japan and the U.S. We were actually in California when we noticed the SVB debacle on the Friday. During a Monday morning presentation, a non-portfolio company commented that it had a US$80 million deposit with the California bank. All access to deposits was resolved by 11 a.m., certainly a sign of quick response.

Global Alpha holds larger exposure to financial services firms than bank stocks themselves. Its largest exposure is with Rothschild & Co (Roth FP), which provides global financial advisory (mergers and acquisitions and financing advisory). The company also has a wealth division and merchant bank that account for 24% and 16% of sales, respectively. Tracing back to 1760, the company now operates with 4,200 financial specialists across 40 countries. From its strong Europe-based foothold, the company is successfully growing its operations in North America. Rothschild & Co is presently subject to a takeover bid by the founding family’s financial holding.

Another important position for us in financial services is PRA Group (PRAA US). The U.S.-based company is a leading debt collection agency servicing mostly the financial industry, acquiring debt packages from banks and credit card companies. PRA is vertically integrated, from debt acquisition all the way down to call center-based collections, giving it a strong competitive edge. Increasing regulations implemented in the debt collection industry are certainly favouring PRA in the long term. The company has global footprint, with leading operations in North America and Europe.

Our positioning in regulated banks follows our general philosophy of investing in quality assets where we assess balance sheet strength, operational excellence, competitive standing and target markets. We generally tend to be underweight in banks, as most banks have low exposure to higher-growth investment themes and/or are constrained by increasing regulations. Our holdings include: 

Seven Bank Ltd. (8410 JP): The company provides banking services mainly through automated teller machines (ATM) across Japan. Culturally, the Japanese continue to rely on cash as their preferred payment method, mostly for security and identity theft reasons. Although licensed under a bank charter, Seven Bank majorly operates as a technology company through its 26,253 ATM outlets. Services are growing rapidly supplementing cash distribution, and novel and growing additions include credit and investment services. Its balance of deposits stands at ¥578 billion while its loan book conservatively stands at ¥32.7 billion.

With over 250 banks in our index, Global Alpha has low exposure to direct commercial real estate lending, an area that is being scrutinized with the increasing vacancies in commercial downtown centers. Our direct exposures are the following:

Wintrust Financial Corp. (WTFC US): Wintrust is a financial holding company with community bank locations in and around Chicago and northern Illinois, southern Wisconsin and northwest Indiana. Branded as Chicago’s bank, its lending book is highly diversified with a low exposure (6%) to residential real estate, all else mostly being small commercial (sub US$1.5 million) suburban business loans, with downtown office commercial real estate being a small part. An additional Wintrust differentiator is that it owns 15 bank charters, providing FDIC coverage 15 times over for every customer, or up to US$3.75 million in total guaranteed deposit coverage. We believe Wintrust will gain market share as it further commercializes this service.

UMB Financial Corp. (UMBF US): UMB is a U.S.-licensed bank operating nationwide, with main branches throughout Missouri, Illinois, Colorado, Kansas, Oklahoma, Nebraska, Arizona and Texas. Its US$31 billion in deposits is only 20% exposed to the consumer market. Deposits are otherwise commercial (46%) and financial services (17%). The majority (54%) of its US$17 billion loan book is in commercial and industrial lending. UMB maintains a low loan-to-value ratio (currently at 59%). With a 54% loan-to-deposit ratio, UMB also remains at the low end of the 74% peer median.

As you can see, our investment process has led us to financial services companies and banks with differentiated offerings, competitive advantages and defendable barriers to entry. These specialty-focused organizations tend to operate outside of the core banking space where increased risk (from volatile and unpredictable deposits and loans) is taken to achieve return targets. We will continue to monitor the bank environment as well as the health of our bank investments through direct engagement.

Global Alpha Capital Management Ltd.
March 30th, 2023