A Deep Value Chat With Former Bryn Mawr CEO Ted Peters

This piece contains the opinions of deep value investor Tim Melvin that do not reflect the opinions of Benzinga.com.

Deep value investor Tim Melvin had the chance to speak to former CEO of Bryn Mawr Bank Corporation BMTC Ted Peters earlier this year. Under the leadership of Ted Peters, Bryn Mawr has been a consistently high performing bank and even in the financial crisis the stock more than held its own. He made his shareholders a ton of money over the years and now he is turning his eyes towards making investors a bunch of money. Mr. Peters has just opened a new hedge fund, Bluestone Financial Institutions Fund, which will invest in community banks.

Below is a full transcript of their conversation ahead of that event.

Tim:   Okay.  We’re on today with Ted Peters, a former banking executive.  He’s moving into a new career as a hedge fund manager.  And Ted, I want to thank you for taking some time to talk with us today.

Ted:  Well, it’s great for you to include me and look forward to chatting for next ten to fifteen minutes.

Tim:   Right.  You’re retiring from Bryn Mawr Trust after 14 years.  Is that correct?

Ted:   Yes.  I was the CEO of Bryn Mawr Trust, Chairman/CEO for fourteen years and it’s a great institution that’s BMTC. BMTC is a tech-republic company and we’re very fortunate we’ve had a lot of success and it was time for me to move on and to try something different so it worked out very well.

Tim:   Okay.  Now your new venture is the Blue Stone Financial Institutions Fund.  Now it’s going to be a hedge fund investing in community bank, is that correct?

Ted:    That’s correct.  Yeah.

Tim:   Okay.  What attracts you other than obviously your long experience in banking?  What attracts you to the community banks space right now?

Ted:   Well, we really like the community banks space for a number of reasons.  One, it’s very well capitalized now, maybe over-capitalized, the credit quality is good, rising interest rates are certainly going to help this space, part of it, on the stock of community banks and community banks, we will just say for our purpose of it, are micro and small cap banks in that space. And then, so rise in interest rates are going to help community banks in general because almost all of them are very asset sensitive and the last thing is really a pretty big thing, it’s because of mergers and acquisitions, there are now 6700 banks in the country and there’s probably going to be 4500 banks in five or six years. So then, you’re going to see a lot of consolidation in the industry and primarily in community bank space.  Last year there are 272 acquisitions in the United States bank acquisitions. I think this year most people are thinking that this year’s going to approach 350, so you’re starting to see a real acceleration in bank consolidation.

Tim:  Now, do you attribute this to the rising cost of regulatory compliance because that’s something we talk about a lot that some of these smaller banks just can’t really afford to be independent anymore?

Ted:   Well, it’s really a couple of things.  Certainly the regulatory is the biggest part of it and the regulators have being, I hate to say, out of control but I’ve been, once again, I was a bank CEO for 28 years and every year it gets worst and worst and worst and I keep saying they’re going to ease up on community banks.  They never do. And part of the problem is, they’re trying to punish the large banks but they’re really catching everybody in it. Because the regulators are all over these compliance kind of stuff whether it’s AML, Any Money Laundering Act or Bank Secrecy Act or share lending or whatever, they’re all over, so you’re actually right. There’s going to be a lot of cost there that banks are adding and of course there’s no revenue with those costs. The other things although even though that gets the most attention, really technology is really one of the things that’s going to really start to affect the smaller banks.  They’re just not going to have the ability to invest in what they need to invest in. Prime example was Bryn Mawr Trust.  At Bryn Mawr Trust we’re pretty good size regional community bank.  We had three billion of bank assets in over, and probably almost eight billion of wealth assets, so we’re pretty good size, pretty good revenue and we are spending about a million to a year just on cyber security, nothing but cyber security, no fore proceed, just cyber security.  Well, it’s pretty tough to be a small bank.  You know, 500 million dollar bank, 600 million dollar bank, and you invest that kind of money in cyber security. So, I think it’s really not only the compliance put on by the regulators but, I think it’s also the technology spending that’s going to affect community banks.

Tim:   Okay.  Now, last fall you gave an interview that I read.  You talked about a certain characteristics involving things like CEO age and regulatory orders, can you expound on that a little bit, because that’s fascinating?

Ted:   Well, if you look at what we call, a takeover category, so the bank is in a takeover category for certain things.  So if you have a CEO and here she is 62, 63, 64, if you look that they’re under regulatory order maybe they’re struggling a little bit. They’re under a regulatory order, so usually board fatigue and management fatigue.  If you can have a couple of those things together that’s probably somebody you might want to look as a takeover, as a takeover target and if there’s activist in there, if there’s Mr. Stone Hagel or Mr. Steel-walls in the bank that’s probably even better from a takeover view point.

Tim:   Yeah.  That was a great study by Stone Hagel showing what happens to these community bank stocks when they get an activist in there and it’s pretty pleasant resolve for individual investors.  Now…

Ted: Yeah.

Tim:   --in addition to takeovers, you also look for turn around and gross stocks?  I read that in an interview you did with money show last week.  Is that pretty much how you characterize…

Ted:   Well pretty much, anybody is investing stocks at that different stock option, a growth stories is one, takeover stories is another, and a turnaround story would be a third for anybody investing in community bank stocks. You know, growth is probably the best area to be in, is the one that really rely a lot on management strategy.  You know, my belief has always been to invest in banks that have great management.  I’ve seen over my career, great managers takeover mediocre banks and turn them into really good banks. I see really lousy management takeover over a good bank and run it to ground in five or six years. So, to us management, to me personally, management is really the key when investing in any company but beware of the bank stock. 

Tim:   Okay.  Do you use any particular evaluation metrics, book value, or earnings, or any of those measures?

Ted: Well, I believe, you know, in fundamental analysis coming up in the management so we did fundamental analysis and let that percolate off and then evaluate management.  I’m not a technical person, I believe in technical analysis.  We believe in fundamental analysis and the names we know, the names that I like certainly will fall into these (inaudible 00:06:20)

Tim:   Okay.  Now at the bank director acquire or be acquire conference earlier this year, one of the topics was this. Some of the sellers out there have really unrealistic expectations about what their bank is worth right now.  Do you see that kind of starting to come to a close where seller expectations are more reasonable?

Ted:   Yeah.  I was at that conference.  That’s always one of the best conferences that’s out there and I’ve been doing that for fourteen years.  Yeah, I think they’re starting to come a little bit closer. You’ve seen prices go up and at Bryn Mawr Trust we did a lot of acquisitions before I left and I think we saw over the last few years, prices going up something that would have sold 130% of tangible book values now selling probably at 150 and 160% so there’s absolutely no doubt.  I think sellers are realizing that maybe they have to moderate a little bit and I think they also have to look at what are the alternatives.  The alternatives now would you become what some people call a zombie bank that is a bank that’s not going to have any caterers in three or four years or five years because you’re too small and the acquirer’s  going to bypass you and other people join them.  So, yeah, I think once again, we’re going to continue to see real close in the acquisition area.

Tim:   Okay.  Now are you interested in the stocks of the banks that are doing the acquiring?  I mean is that a valid, solid growth strategy for our community banks right now?

Ted: Well, yeah.  Absolutely!  I mean it’s one of the stories that we really like is First National Bank Corp in Pennsylvania, FNB Corp.  Its ticket symbol is FNB.  There’s a real growth story mainly a large acquisition and they’re really good acquisitions based on many, many acquisitions over the years probably done just in the last five or six years. When they do acquisitions their (inaudible 00:08:17) their earnings, their tangible book value, they’re really careful about not deleting their tangible book value, so they’re very good acquirer. In addition, FNB is really good at organic growth, you know, their organic growth is increasing as well.  So, we see this as a growth story of an acquirer who really knows how to acquire and there are other banks out there who have really hurt themselves not so much recently but in past years by being serial acquirers and not being very good at it. One, its overpaying, and then at the end not being very good integrators of putting the two banks together.  But, FNB is once again an acquired growth story that we like.

Tim:   Okay. You touched real quick, on what everybody’s calling exhausted board syndrome, how real and how widespread is that in the community bank space right now?

Ted:   Well, you know, if you’ve been under an order for three or four years and you have to report to the FDIC or the regulators every quarter and sometimes, going through meetings, and you know, you’re getting threatening letters from the regulators, you know, that can be real motivator for a director.  I think most people know that when a bank failed, that bank’s under them, I mean these directors very often, they go after those directors and they have up to five years to go after them.  So, when people look at personal liability regardless of the, you know, insurance and everything else. I think that’s something that, you know, certainly motivates them.

Tim:   Okay.  Now, you and I have experienced bank investors.  We understand that rates are rising, is actually really good for banks, especially smaller banks, but that’s sort of counter-intuitive for most investors. Can you just kind of touch on why rising interest rates is going to be great for these small community banks?

Ted: Yeah.  Most community banks are what we call are gap positively that is they will re-price assets after they re-price liabilities. So when rates go up they would increase their rates on their loans and some of their short term securities will be priced faster than the re-price of the deposits.  They’re generally a real lag (inaudible 00:10:22) when rates go up on deposits, if rates go up a hundred points maybe deposit rates go 35 or 40 dips and then they catch up over  a few years. So rising interest rates are going to be good, first of all, for the entire industry but I think especially for community banks that have really good core deposits, real relationships, you know, don’t have a heavy reliance on CB money retails, CB export, really have a lot of good core savings, money market, personal checking, and business checking. Those are the kind of banks that are going to do very well when rates go up. And rate is going to go up, I mean, I think whether they go up in June or they go up afterwards, and how much they go up with. You know, most of my banking career, you know, prime was usually 5, 6, 7, 8, something like that but all in my career, my prime was 21 and a half.  So, you know, right now rates are being artificially held down low by Fed, I know that, I was on the Fed board for about six years I just went off that.  So the Fed has purposely kept rates low and they have to go up naturally at some point. The economy is doing much better as you notice with gradual improvement over the last three or four years and employment is looking a lot better, so I’m pretty good on the economy of the United States and resolving interest rate rise. 

Tim:   It really sounds and I believe that right now a community bank stocks are, they’re pretty much in a win-win position. They’re either going to do well on grow or their taken over to premium to current price.  Is that kind of consistent with what you’re seeing out there?

Ted:   Well, yes and that’s one of the reasons we like the space because your downside are somewhat protected unlike the technology company which we go to zero that comes up with a new technology that’s better than ours.  Banking is a pretty basic kind of industry and so the worst case analysis of a bank kind of struggles is we’re going to be taken over.  So, one of the reasons we, you know, we like the banking space other than, obviously, we know it very well.

Tim:   Right.  Now in previous (inaudible 12:29) the ‘90s and post internet bubble bursting, I take it they went from about where they are now 7, 8 years got up over two and a half times book.  Do you think that happens again as this trend continues?

Ted: Well, pricing, as I mentioned earlier is going up, are they going to ever get up to two and a half or three and a half.  I sold my first bank I think at 3 and a half bank fold.

Tim:   Wow!

Ted:   I don’t think they’re ever going to get back up there.  I mean its part of the reasons people are much smarter acquirers right now, and it makes a little more sense and they realize that the analyst are following it closely. And if you do a deal that is over reach, you’re going to get tangible book value per share delusion and you’re earn back stock are not going to be rapid enough and the analysts are going to kill you.  So, you know, I think people are realizing, if you’re going to do acquisition, you know, smartly and I know that Bryn Mawr, when I was there we did seven acquisition in seven years, every single one was a creative.  There’s very little if any delusion of casual book value per share on each one and everyone has worked very well and, you know, if you look at BMTC, that stock was rewarded and that stock now sells at 225% of the casual book value. So I think doing smart acquisition works well.  Doing bad acquisitions is not good.

Tim:   -- is not good.  Okay.  Now, is your fund going to have any particular regional focus or are you going to be national in scope?

Ted: Yeah.  I really can’t talk too much about the fund, as you know.

Tim:   Right.  Sure.

Ted:   I’m sorry I can’t really talk too much about that.  I can talk about my personal interest in earlier banks that we know and my personal interest is I’m really sort of regional, mid-Atlantic, that kind of bank even though certainly I look outside those areas for things I might be attracted.

Tim:   Okay.  And how long do you see the community bank industry staying kind of in this sweet spot that ran right now for investors?

Ted: I think it’s a good five or six years easily and maybe even ten years or twelve, yeah, without a doubt.  It’s going to continue and it’s going to continue the industry to do well.  Those city banks that do survive and are not taken over, I think are going to thrive and those executive investment technologies will be able to compete with the big banks, and will compete very effectively.  I mean I just know from my, once again, I’ve been a community banker most of my career.  You know, most business people will always rather deal with regional community bankers, community banks than big banks because of the personal service and the relationships.  So as long as these community banks have their proper technology systems and so forth they’re going to be getting business.

Tim:   Okay, alright, one last question.  Tell us about the 'Animal House' poster.

Ted:  Well, that was just kind of a joke. I always loved the movie 'Animal House,' I grew up in Pittsburgh, (inaudible 00:15:19) in 72 and so I’ve kind of always loved that movie which is about that time, same time period.  So, I had a great big animal house picture-poster in my bathroom in my last bank and people will always love going to the bathroom and seeing them.

Tim:   Okay.  Any final thoughts for investors who might be looking into community bank space?

Ted:   Well, it’s a great space to be in but you’ve got to do your homework.  I mean you’ve got to know what you’re doing.  There are a lot of choices out there and you want to make the right choices.