Back Up North...
If you have been following my articles, you will notice that I am very attracted to both regional banking and markets that have unique needs either by virtue of their geography or culture. For this reason, I have been very interested in Hawaiian and Alaskan regional banks. The economies of these two states are distinct from the mainland and require slightly different services than their counterparts in the "Lower 48." By virtue of these requirements, these markets are more difficult for competitors that are not well established to penetrate and thus provide significant opportunities for investors who know where to look.
In a previous article, I discussed one of the oldest and largest regional banks in Alaska, First National Alaska. In this article, I will discuss a smaller, more nimble bank that is both in the process of expanding, weathered the financial crisis in good form and is now performing exceptionally well in my mind. The company is Northrim BanCorp (NRIM).
What Northrim Does
Northrim's business is relatively uncomplicated as far as regional banking goes. It is a full service commercial bank that currently has ten branch locations. The company offers an array of commercial and consumer loan and deposit products, investment products and electronic banking services over the Internet. Given the enormous size of the state in which it operates, it is important for the bank to have a wide geographic footprint and robust internet banking apparatus.
The Bank also operates in the Washington and Oregon market areas through Northrim Funding Services (NFS), a division of the Bank. Northrim Funding is a factoring operation, which purchases the accounts recievable invoices of businesses at a slight discount in order to provide required needs for short-term liquidity.
The Numbers on Northrim
With a market capitalization of $167 million, the company is tiny. Currently priced at $25.72 per share against $21.89 of book value, the company is offered at a slight premium to book. The company also pays a dividend which is regularly increased, currently yielding 2.64% with a payout ratio of .32 - a very low number in my mind and something logical given the bank's high return on assets, or RoA, which stood at 1.2% for 2012. Any bank that has an RoA over 1% in my mind qualifies as a "best of breed" regional bank. The company has also paid stockholders an irregular stock dividend, amounting to 5%, most recently in 2007.
Assessing the Health of Regional Banks At A Glance: Using Performance During the Financial Crisis as a Stress Test
A method that II have developed to assess the health of regional banks quickly is what I call the "Glance Test." I highly recommend this due to both the speed and simplicity involved. Given the fact that there are many hundreds of regionals, it is important to exclude a vast majority and concentrate on the "best of breed" in the area: that is, banks which were able to survive and continue to prosper during the financial crisis.
Conducting this test takes very little effort. All one needs to do is find an interesting bank, pull up the chart on Google Finance and select the maximum time field. You will be able to visualize a record of the company's dividend history, share price performance and (if any) stock dividends paid to shareholders. If you see any gaps in dividend payment history (such as during the financial crisis) there is a significant possibility that the company either voluntarily accepted or was forcibly compelled to accept TARP money and thus had to restrict dividends due to poor loan quality, indicating a precarious financial position. While there are many reasons for dividend cessation and likely many good investments to be had in banks that elected to do this, I find it easier to skip banks that had to cease dividend payments in order to quickly locate the "best of breed" regionals.
Using the "glance test" on Northrim, a few things become apparent: While Northrim did reduce their dividend payments during the financial crisis from $0.17 to 0.10, it did not cease payments entirely - something I find very encouraging. The company also has increased dividend payments since 2009 and has returned to pre-crisis levels, something I find very encouraging when viewed in conjunction with the bank's low payout ratio and high return on assets.
An Acquisition In Progress: How To Get The Company At a Discount Through Merger Arbitrage
In late October, Northrim announced that it would be acquiring a small bank located in Alaska that I had been following for some time - Alaska Pacific Bancshares (OTCQB:AKPB). The company is extremely small, with a market capitalization of under $15 million dollars, and will be purchased in a stock and cash deal that values the equity of Alaska Pacific at $17.28 per share - that is to say, above the current price of the shares on the open market, which last closed $16.79.
Northrim is paying approximately $6 million in cash and approximately 304,000 shares of its own stock for Alaska Pacific.
Investors who are interested in establishing a position in Northrim and who are able to purchase shares of Alaska Pacific (traded over-the-counter and extremely illiquid) will be able to purchase the company at a slight discount through Alaska Pacific shares which will then be converted into Northrim shares (or cash, or a combination).
The deal is expected to close the first quarter of 2014, providing investors with an annualized return and an internal call option on the appreciation of shares of Northrim. The trade can also be hedged via short selling a proportional amount of Northrim Shares when purchasing Alaska Pacific shares, however until the precise conversion rate is announced, I would proceed with caution.
An important fact to take note of in the merger agreement is that if the price of Northrim Shares decline below a hurdle of $18.90 before the merger occurs, the merger will be renegotiated.
Potential Risks
By virtue of its remoteness, the Alaskan economy has historically been insulated from events that can plague the "Lower 48." Though the state's geographic isolation does afford some protection, the economy of Alaska comes with unique risks. The state's economy is deeply tied to the environment, and relies upon both tourism and ample natural resources including deposits of oil, gold and fisheries. In addition, Alaska is vulnerable to natural disasters including vicious storms and earthquakes which could cause significant economic damage to businesses and communities.
Another significant risk is competition. Though the market is isolated and specialized, the company does have significant competitors in the region. Per the company's most recent 10-K, two large national competitors, Wells Fargo and Keybank, retain an estimated 62% of the commercial banking deposit share in the region (51% and 11%, respectively). In the regional space, First National Bank of Alaska retains 23% of estimated market deposit share against Northrim's 15%.
While Northrim retains an estimated 15% of the total deposit share of the Alaska commercial banking market, it is important to note that the closest competitor First National is almost three times the size of the company and only retains an extra 8 percentage points of market share.
From a structural perspective, Northrim is a small bank and has stock that is thinly traded. While the company's stock does not trade "by appointment," the company trades at five digit volumes of shares per day - making it potentially vulnerable to a short term drawdown cause by the liquidation of a large block of shares on the open market.
Potential for Further Acquisitions Or Being Acquired?
I believe that given Northrim's low payout ratio and high return on assets that the company could potentially conduct further accretive acquisitions in the future. Given the high cost of regulations imposed on banks after the financial crisis, many smaller banking entities are finding it both difficult and costly to continue to operate and for that reason are selling out to larger commercial banks more able to absorb these regulatory costs.
Due to the fact that Northrim is the smallest of the commercial banks in Alaska, it will have to purchase smaller savings and loans or thrifts in order to increase market penetration in the state. These types of savings institutions are often very small in size and have a regional appeal as seen with the recent merger of Alaska Pacific.
Expansion in markets that are isolated (such as Alaska or Hawaii) is a difficult proposition, particularly given the fact that there are numerous entrenched competitors in the commercial bank space in Alaska (one extremely strong regional and two extremely large banks). As a result, I believe that investors should keep an eye out for the company increasing its factoring operations provided by Northrim Funding Services in the continental United States, or even potentially purchasing a smaller commercial bank located in the Pacific Northwest.
I believe that because of the "ossified" nature of the Alaska market, the most logical banking entities left to be purchased will be thrifts and savings and loans, which are very small and largely not publicly held. Over a longer horizon, I believe that once this growth dries up the bank will seek to expand its operations in the rest of the United States.
I also believe that Northrim itself could be acquired given its small size yet robust deposit share in the commercial banking market. Despite the fact that the acquisition of the company could furnish investors with a significant one-time gain, I am more than content to see the company continue to operate as an independent entity given its robust return on assets, acquisitions and increasing dividend.
Final Thoughts
For investors seeking a stable and well run bank that offers a healthy dividend yield with the potential to increase in the future, I believe that Northrim represents an excellent option. While the bank is currently not offered at a discount, I believe that it is a classic example of a "good company at a fair price," given that it is only trading slightly above its book value and has a high return on assets.
For smaller investors willing to exercise patience and make use of limit orders, purchasing the company through shares of Alaska Pacific will access to the company at a discount.
I think that it is very likely that the company could also engage in further accretive acquisitions in the coming years, as absorbing the deposits of smaller regionals will allow the company to both expand its geographic footprint and to exploit its high return on assets ratio.
By virtue of isolation, Alaska represents an advantageous state in my mind as it is partially insulated from the volatility that can impact the economy of the lower 48 states. The residents of the state also enjoy lower taxes and receive benefits through the Alaska Permanent fund, two things which I believe will help to provide growing deposit share and increase savings.
Disclosure: I am long OTCQB:AKPB. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)
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