A potential compounder picking low hanging fruits in Minneapolis
Bridgewater Bank ($BWB) was founded in 2005 to serve the Minneapolis/St. Paul market in Minnesota to target affluent business owners and middle-market customers. There are 7 service branches in the Minneapolis metropolitan area. 85% of its loan are to those within that metropolitan area, while 5-8% to those within the Minneapolis State, and the remainder to those outside the state. Even for the aforementioned loan outside the metropolitan area, it was typically for long-relationship existing clients who have previously operated within the metropolitan area but then branched out as their businesses expand.
Figure 1: On the left is the headquarter of Bridgewater Bank, while on the right is the compounded tangible book value per share of Bridgewater Bank. (Source: Corporate Website)
The management team came out of big banks, and they are well aware of the bureaucratic and inflexible aspects of big banks, and are willing to construct the institution in a way where individuals are encouraged to intelligently take risk and get paid for outperformance. This group of “outcasts” has built the business into a half-a-billion dollar market capitalization bank while compounding their tangible book value at a 19% CAGR (compounded annual growth rate) in the last five years. To give an example, there is a financial service company in the Minneapolis metropolitan area with more than a century of history, and has stayed with US Bancorp for 80 years. They have a $8-10 million deposit with US Bancorp, but has recently moved the deposit to Bridgewater Bank. Their CFO said it was simply impossible to get US Bancorp stop sending paper statements, and they frequently fail to find out who to talk to for a specific type of question. Bridgewater not only provides digitized solutions, but has high-touch, customized, and streamlined solutions. For instance, Bridgewater simply handed this financial service business two lines – if you have lending needs, call the first number, and if you have deposit needs, call the latter. The two lines respond to customer requirements on a 24/7 basis, making their service straightforward, competitive, and readily available.
The Minneapolis market has 65% of its deposit concentrated in two banks – US Bancorp and Wells Fargo. If you were a W-2 worker with basic needs, then US Bancorp and Wells Fargo cater your needs relatively easily. But if you are a relatively affluent business owner who is self-employed or has partnership returns, owning 60 entities, then it becomes a nightmare to get customized services from US Bancorp and Wells Fargo – and herein lies a vast set of opportunities for Bridgewater Bank. Minneapolis is also demographically attractive for a bank like Bridgewater, as it holds the highest number of Fortune 500 Headquarters per Capita of any city in the country, and the population trends are positive.
Figure 2. Population of the Minneapolis-St.Paul-Bloomington Metro Area in the US from 2010 to 2021. (Source: Statistica)
What makes things better, its two largest competitors are each having her problem. Wells Fargo has been struggling due to its well-known run-ins with regulators, while US Bancorp is focusing on solidifying its presence in California with its acquisition of MUFG Union Bank. Other competitors, TCF Financial for instance, was bought by Huntington Bancshare which is based in Ohio, while smaller competitors are being gobbled up by Old National Bancorp which has its base in Indiana. These dynamics allow Bridgewater Bank to expand through picking low-hanging fruits left by these competitors, while also attracting veteran bankers who came out of these competitor banking institutions to join the vibrant Bridgewater family.
A bank gets deposits from customers and loan the money out, so it would be instructive for us to get a glimpse of the type of deposits and loans associated with Bridgewater Bank.
Table 1: The type of loans made by Bridgewater Bank based on its 2021 Annual Report.
Table 2: The type of deposits for Bridgewater Bank. (Source: 2021 10K)
Figure 3: YTD and 5-year price performance for Bridgewater Bank, respectively.
By December 31st, 2022, the bank has a tangible book value of $11.69/share, more than double its tangible book value 5 years ago. However, the stock is up only 16.1% for the last five years. A growth regional bank with a talented management team trading at less than 9x earnings certainly seems cheap. The mismatch between high growth and incrementally compressed valuation represents opportunity, in my view.
However, we want to adequately listen to Mr. Market’s concern and see if we have a sufficient number of reasons to rebuttal its pessimism.
I believe these are the primary reasons that Mr. Market is concerned:
1.CET 1 ratio was 8.47% at the end of Q3 22 which is 100 bps lower YoY, and inched down a bit more by the end of Q4 22 at 8.40%.
2.Net interest margin was 3.45% for YE 2022, compared to 3.54% for YE 2021. A lower NIM indicates lower profitability on the bank’s assets relative to the costs of its liabilities.
3.Adjusted efficiency ratio, a non-GAAP financial measure which excludes the impact of certain non-routine income and expenses from noninterest expense, was 43.5%, compared to 39.4% for the third quarter of 2022.
4.The management team stated it will be cautious, moderate loan growth, upgrade loan quality. However, by YE 2022, gross loan increased $189.4 million, or 22% annualized, from the third quarter; deposits increased $111.5 million, or 13.4% annualized, from the third quarter of 2022. The loan to deposit ratio has increase from 98.4% at the end of Q1 2021 to 104.4% at YE 2022. This ratio’s going up seems to fly in the face of management team’s purportedly cautious bent in navigating the uncertainties ahead, and market was justifiably concerned.
The following are my take on the aforementioned concerns:
1.In 2021, Bridgewater Bank issued $60 million worth of baby preferred shares with a coupon yield of 5.875% (ticker: BWBBP), which raises its CET 1 ratio. Coming off a high base and 20%+ loan growth, CET 1 ratio naturally comes down compared to a year ago. When loan growth slows down, CET 1 ratio will automatically revert higher. Through conversation with the management, Bridgewater does feel business has overall slowed down, and the bank itself has, to some degree, deliberately slowed loan growth to manage the balance sheet. However, things have momentum. During 3Q and 4Q 2022, clients with long term relationship whose credit worthiness are known to the management come for business, and Bridgewater opened the door to them given their loan quality and yield. This seems to me to be long-term thinking. The pipeline of loan, however, has shrunken considerably, and currently is only about 1/3 of where it stood in June, 2022. In addition, there was a notable amount of construction loans that have risk weighting of 100%, and as a good chunk of the construction draws to conclusion in the first half of 2023, the loans become multifamily loan and the risk weighting declines to 50%. In sum, the transition of construction loan to multifamily loan coupled with slower growth rate will lead to higher CET 1 ratio over time.
2.Given that ~2/3 of the loan book is fixed rate, Bridgewater is relatively asset insensitive. Although the NIM adjusts a bit slower than some of its more asset sensitive peers, it is also more resilient to sustain a higher NIM when rate goes back down. Given the quick loan growth and elapse of time, one should expect NIM to meaningfully expand over the next year or two, leading to strengthened earnings.
3.To illustrate how impressive a 43% efficiency ratio is, we compare Bridgewater’s efficiency ratio with the other well known banks. In general, a sub-50% efficiency ratio is considered first-class.
Table 3: Efficiency ratio for some well-run, and well-known banks. (Source: bankregdata.com)
As a matter fact, based on a WestMonroe interview revealed, only 40% of banks will even target a sub-50% efficiency ratio, not to mention achieve it.
Figure 4: The desired target efficiency ratio for banks through a WestMonroe interview conducted in 2019.
Bridgewater Bank has reaffirmed that it aims to maintain a 40-45% efficiency ratio, allowing it to be a lot more capital efficient than its peers. The sequentially higher efficiency ratio is a direct result of compressed NIM leading to a lower denominator. Historically, the efficiency ratio of Bridgewater has been driven by loan growth rather than penny-pinching, leaving the company with room to further optimize its expenses with a cost-cognizant mindset under an uncertain macro-setting.
Last but not least, the historical average of adjusted efficiency ratio of the company is ~42%, inline with the results in the fourth quarter of 2022. (Source: 2021 10K)
4.The increasing loan to deposit ratio has been partially addressed above. Apart from construction loans transitioning into multifamily loans, and a cognizant effort to moderate loan growth and preserve the balance sheet, there are a couple of items that should offer investors relief. Firstly, the credit metric, namely LTV Ratio (loan-to-value ratio) is low, approximately 65% across the entire portfolio. What this means, is that if there is a 2008-2009 level drop of real estate price of ~20%, their loans, on a statistical average basis, should remain intact. Insider ownership is ~ 15-20%, aligning management interests with shareholders. If one adds the private equity ownership of Bridgewater, then insider ownership is higher than 25%. Coverage ratio is also strong. Thirdly, Bridgewater tends to make loans with personal recourse to individuals behind the transaction, and such individuals have typically developed a long-term core relationship with Bridgewater. Last but not least, Bridgewater actively monitors its loans, and will reach out to its customers in advance to cope with interest rate hikes rather than passively waiting for rate hikes to affect its clients, forming symbiotic and deeply connected ties with its clients.
Given the above reasons, I believe the market’s worry about this under-covered bank with limited liquidity is unwarranted.
What is fair value for this growth regional bank?
The annualized return on average tangible common equity is 15.86% for Q4 2022. Tangible book value per share increased 0.36% to $11.69/share by YE 2022. Price to tangible book ratio is 1.28x. ROTCE/PTBV is therefore 12.39% based on a conservative run-rate ROTCE (the ROTCE for Q3 was 17.07%). For a large, slow-growth bank such as JP Morgan, the current ROTCE/PTBV is roughly 9%, and although valuation is part art and part science, I believe a 8% figure is not aggressive for a double digit growth bank with significant growth potential to penetrate the underserved middle-market clients segment in one of the most prosperous metropolitan area of the US, leading to a fair value of 54.8% upside, valuing the stock at $23.5/share, and after the stock duly appreciated, it should keep growing at 10-15% out of the compounding of its tangible book value.
Risk Factor: Given the relatively higher leverage of banks (loans/equity~9x for Bridgewater, which actually is in decent shape), it is critical to monitor the health of its loan book. Despite every precautionary measure of Bridgewater, one should be alerted if its historically negative to 0% charge-off ratio substantially climbs up within a short period of time. Other than that, this company seems like a misunderstood, under-covered compounder barely starting its journey on a long slope with sticky snow.
Disclosure: Our fund holds a small toe position of BWB 0.00%↑ , and have no intention of selling within the next 7 days.
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