On TCF Financial Corporation

TCF Financial Corporation (TCB) operates branches in Illinois, Minnesota, Michigan, Wisconsin, Colorado, and Indiana. The majority of the bank’s branches are located in Illinois, Minnesota, and Michigan. The bank, founded as a mutual thrift in 1923 with $500, now has almost $14 billion in assets and more than 1.6 million checking accounts.

Over the last ten years, TCF has averaged a 1.77% return on assets and a 21.93% return on equity.

Strategy

TCF collects low cost deposits by banking to the common man. Fee income accounts for an unusually large portion of the bank’s earnings. These fees greatly reduce TCF’s cost of funds, because they offset much of the interest paid on the deposits. To the extent that loans are made from deposits, this greatly increases profitability.

Unfortunately, TCF has a very high loan/deposit ratio (more than 110%), so not all of the bank’s loans are made from low cost deposits. However, TCF continues to grow, so the loan/deposit ratio should come down in the natural course of future expansion.

TCF’s growth strategy is simple and unorthodox. William Cooper, TCF’s Chairman and then CEO, outlined the bank’s strategy in a March 15th, 2004 interview with The Wall Street Transcript:

We are different because we tend to bank to the everyday person. We don’t have an emphasis on banking the rich. We have a product structure and a service convenience level. We’re open seven days a week, 364 days a year.

(Interview)

Supermarkets

TCF has one of the country’s largest supermarket branch systems. These tend to be the bank’s most profitable branches. One of the differences between TCF and other banks is the nature of their supermarket branches.

TCF actively seeks small deposits and structures their supermarket branches so that they can act as full service branches. In effect, TCF brings the bank to its customers. It’s a different approach entirely, as Mr. Cooper explained in the same interview:

In the supermarket you have to get out there and sell things to people who weren’t there particularly to buy a banking service. So you need people, for instance, who have worked at The Limited or sold shoes or whatever who can get out and really sell in a much more aggressive manner.

(Interview)

Expansion

While many other banks have been closing their branches in favor of doing more online banking, TCF has been growing its bricks and mortar presence. Much of that growth has come in urban areas like Detroit, where some of TCF’s competitors have been less interested in doing business.

Many of the company’s competitors look to the suburbs – where the greatest concentration of wealth is. TCF looks for population density first. The company aims to make a small amount of money on each customer and multiply that over a huge number of customers.

TCF’s approach to expansion is essentially the same as many retailers. The company goes where potential customers already are (including supermarkets), fosters a recognizable image, and …

On Valley National Bancorp

Valley National Bancorp (VLY) is a conservative bank with a strong position in northern New Jersey and a presence in Manhattan. The bank, founded in 1927, has about $12 billion in assets.

Valley has consistently earned extraordinary returns on assets and equity. Over the last twenty years, Valley has averaged a 1.74% return on assets and a 21.12% return on equity.

Valley’s worst two-year performance occurred in 1990 and 1991. During that period, Valley’s return on equity dropped as low as 14.54% and its ROA dropped as low as 1.29%. Even in Valley’s worst year (1991), the company still managed to roughly match the average long-term performance of most of its peers. In other words, Valley’s worst year was a close to typical year for many other banks.

It was at this low-point in 1991 that the board of directors decided not to increase the cash dividend. That was the only year in the last 37 that Valley did not increase its dividend.

The company has 79 consecutive years of profitable operations. That’s over 300 quarters (Valley has yet to post a quarterly loss). More importantly, Valley has a record of earning great returns on both assets and equity over long periods of time. So, what’s the company’s secret?

Location

Northern New Jersey is about the best place in the world to situate a bank. This isn’t hyperbole; if there’s a better location, I’ve yet to hear of it. As you know, American banks are unusually profitable. The market is large and highly fragmented. So, naturally the best place to situate a bank would be in the United States. But, why north Jersey in particular?

In a September 20th, 2001 interview with The Wall Street Transcript, Valley’s chairman, Gerald Lipkin, explained why northern New Jersey is such an attractive market:

Northern New Jersey is the single most densely populated area on earth. There are more people per square mile in northern New Jersey than there are in India, China, Japan or anyplace else. We have the highest median family income in the United States in that area. So, we serve a very densely populated and affluent area, which is not dominated by any single industry.

(Interview)

Focus

Valley maintains a narrow focus both in terms of geography and services. The company’s offices are kept within one hour of the bank’s headquarters in Wayne, NJ. In the same interview, Mr. Lipkin explained why this geographic concentration is important: “We like to make it very convenient for our client base to meet with senior management as well as the other members of our staff.” (Interview)

Valley focuses on relationship banking. The company has residency requirements for its directors. The majority of directors are to live within 100 miles of the corporate headquarters. Furthermore, each board member is required to use Valley for both business and personal accounts. Theoretically, these two requirements ensure board members are familiar with the bank’s services and are best able to …

Cedar Fair to Buy Paramount Parks

Publicly traded limited partnership Cedar Fair (FUN) will acquire the Paramount Parks business of CBS Corp (CBS) for approximately $1.25 billion. The five parks involved in the deal are located near Cincinnati (OH), Richmond (VA), Charlotte (NC), Santa Clara (CA), and Toronto.

Cedar Fair already operates seven amusement parks and five water parks, including the company’s flagship Cedar Point property on Lake Erie. The company intends to keep all five properties. The deal will be financed by a $2 billion loan from Bear Stearns (BSC). The interest rate charged will be determined once Cedar Fair’s debt has been rated.

The acquisition is quite large relative to the size of Cedar Fair’s existing business. Cedar Fair generated $569 million in revenues during 2005. During the same time period, the Paramount Parks properties generated $423 million in revenues.

In addition to the five parks, Cedar Fair will receive Star Trek: The Experience (at the Las Vegas Hilton) and the Nickelodeon license at the five Paramount Parks.

The Paramount Parks properties encompass about 1,250 owned acres and 180 leased acres. Based on past attendance, the five acquired properties will likely be some of the most visited parks in the new Cedar Fair portfolio. However, none of the new properties is likely to eclipse Cedar Fair’s two most visited properties: Cedar Point and Knott’s Berry Farm.

By far the two largest parks being acquired are Canada’s Wonderland (located near Toronto) and Kings Island (located near Cincinnati).

Cedar Fair’s chairman Dick Kinzel said:

This acquisition will provide exciting new growth opportunities and the potential for meaningful incremental free cash flow as we realize $20-$30 million in annual cash flow synergies over the next 3-5 years. It will also add significant geographic diversity to our portfolio of parks and improve our position as one of the largest regional amusement park operators in the world.

The acquisition will require significant debt financing. However, the amusement park business generally has a very high free cash flow margin. Cedar Fair’s existing properties are excellent generators of free cash flow. The company makes large cash distributions to unitholders; the current yield is somewhere around 6.85% (reminder: Cedar Fair is a Limited Partnership). Returns on both assets and equity have generally been quite high.

The deal is expected to close in the third quarter of 2006. Most analysts believe CBS will use the roughly $1 billion in after-tax proceeds to buy back shares.

Over the last ten years, Cedar Fair has compounded its book value per share at an annual rate of 8.11% and earnings per share at an annual rate of 6.30%.…

On Microsoft

As a result of recent price declines, shares of Microsoft (MSFT) look more attractive now than they have in years. I hope to write more about the company and the stock in the weeks ahead. For now, however, I am simply going to reprint my response to an email asking for my take on Microsoft.

At the time I wrote the response I did not intend to post it. Therefore, a few clarifications are in order. Throughout the response I am focusing on long-term trends. Viewed as a discussion about the next few years, my response could be badly misinterpreted. I took a longer view of Microsoft’s prospects than just the next few years.

It’s also worth noting that I omitted a few relevant points, because I was writing to a single individual, not a large audience. For instance, my remark that Microsoft did not use its cash pile to buy up an established player in the games business seems out of place. The company has, in fact, acquired a few developers (most recently, Peter Molyneux’s Lionhead Studios). These were small deals. I was thinking about something much larger.

My comments regarding the PlayStation 3 may also be confusing, because they seem to indicate I believe PS3 sales will be weak. Actually, I only meant to suggest that Sony’s competitive position would be considerably weaker at the end of this round than it had been at the time of the PS2’s dominance.

This email has been edited. Irrelevant passages have been omitted, and the text has been reformatted to match the appearance of other posts to this blog:

Microsoft is a difficult situation for me to evaluate. I think the company still has a lot of growth ahead in some areas. But, that depends on where management wants to take it.

There are three core businesses that are already well developed: Windows, Office, and Servers.

The moat in the first two are wide. The Windows moat is huge.

The business model in operating systems is great. You keep upgrading every few years; the hardware needn’t progress for you to find things to tweak and get people to buy the next step up. It’s insanely profitable.

I think the new launch (Vista) will be bigger than people expect (eventually) in how it allows for cross selling other Microsoft products (but we’ll see about that). I expect the press to be very negative at least until well after the launch, because there will always be some bugs and delays.

Games

Eventually, video games will be a big business for Microsoft. I hate the economics of the console business, but love the economics of the publishing (and development) side of things.

I’m sorry to see that Microsoft didn’t use its cash pile to buy up an established business here (publishers were cheap in the market a few years ago; an all cash deal would have worked well. Now, everyone thinks video games will be the next big thing).

The console wars …

On Yesterday’s Selling

Yesterday, the Dow suffered its biggest point loss in some time. You’d think that amid all that pessimism, some bargains might appear. Unfortunately, there was a method to yesterday’s madness. Many of the stocks that had run up gains earlier in the year suffered the most. As I looked over the list of stocks I’d like to buy at slightly lower levels, very few were down in a big way and a fair number were up slightly.

There were some exceptions. Earlier this week, The New Wall Street mentioned three tech giants worth considering at these prices: Microsoft (MSFT), Intel (INTC), and Dell (DELL).

Bill of Absolutely No DooDahs felt these stocks have farther to fall. As you may remember from an earlier discussion, I recognize the logical validity of technical analysis, but don’t believe it has serious practical applications, because an investor can perform very well by simply focusing on the fundamentals (if he has the stomach for large paper losses).

I’m probably somewhat tech averse, because it’s difficult to get a clear view of the future competitive landscape in these businesses. I wouldn’t be buying Microsoft, Intel, or Dell myself.

However, you may remember I set up a few simulated funds at Marketocracy to test out various limiting factors in portfolio construction. One of the funds I created (the Goliath Fund) is limited to investing only in companies with a market cap of more than $10 billion. It’s worth noting that a full one-third of the Goliath Fund’s assets are now in the three aforementioned tech giants. Since I know next to nothing about tech, you might want to take the implied endorsements with a grain of salt.

Yesterday, Rick of Value Discipline mentioned two international stocks that got hit hard during the selling. One of the stocks he mentioned seems like a good choice to me. Aegon (AEG) is a cheap life insurance stock. You may want to check it out.

Visit The New Wall Street

Visit Absolutely No DooDahs

Visit Value Discipline…

Value Investing Directory: New Additions

Visit the Value Investing Directory

The directory now includes 8 new listings.

New Additions

Personal Favorites: Every Little Bit Helps, Dah Hui Lau, Value Investing Forum

Worth a Look: The Dividend Guy, The Peridot Capitalist, Investing Intelligently

All new additions by category:

Blogs

Blogs > Investing Blogs > Value Investing Blogs > Graham and Doddsville

Blogs > Investing Blogs > Value Investing Blogs > Every Little Bit Helps

Blogs > Investing Blogs > Value Investing Blogs > Dah Hui Lau

Blogs > Investing Blogs > Investing Intelligently

Blogs > Investing Blogs > The Peridot Capitalist

Blogs > Investing Blogs > Investorial

Blogs > Investing Blogs > The Dividend Guy

Blogs > Investing Blogs > Rana’s Thoughts

Resources

Online Resources > Investing Communities > Value Investing Forum

Visit the Value Investing Directory…

Value Investing Directory: Submissions

The Value Investing Directory is always looking for new submissions. If you know of any good sites you would like to see included please follow the directions below:

To submit a site for inclusion in the Value Investing Directory please send an email to geoff@gannononinvesting.com with the site’s URL. All submissions will be evaluated within 48 hours.

Prospective sites are evaluated on the basis of utility alone; neither reciprocal links nor payment is required. Linking to the Value Investing Directory (or any other part of the Gannon On Investing website) will not affect the evaluation process.

If you would like to propose a new category, request a change to your site’s listing, or request the removal of any site, please send an email to geoff@gannononinvesting.com. All reasonable requests will be considered; however, I reserve the right to list and describe sites in whatever manner I deem to be most useful.…

Berkshire Hathaway Discloses New Investments

Berkshire Hathaway (BRK.B) recently disclosed stakes in ConocoPhillips (COP), General Electric (GE), and United Parcel Service (UPS).

The GE and UPS purchases were made during the first quarter of 2006. Berkshire acquired the first half of its $1 billion stake in ConocoPhillips during the fourth quarter of 2005 and the second half in the first quarter of this year.

The company reduced its stake in H&R; Block (HRB), Home Depot (HD), Iron Mountain (IRM), Lexmark (LXK), Sealed Air (SEE), and ServiceMaster (SVM).

During the first quarter of 2006, Berkshire increased its holdings in Wells Fargo (WFC) and American Standard (ASD).

Most reports in the financial news media will probably focus on the ConocoPhillips stake and engage in speculation over what it says about Buffett’s short-term view of the energy sector in general and the price of crude oil in particular. The purchase is also likely to lead to confusion, because Buffett had said he would like to put more of Berkshire’s cash to use in the energy sector. It’s unlikely he meant big oil.

GuruFocus always provides the best coverage of Berkshire’s buying and selling. You can read their reporting here.…

On Banks

About two weeks ago, Morningstar analyst Jim Callahan wrote an article entitled “Do All Banks Have Moats?”. It’s a good question.

Superficially, banking appears to be a commodity business. In fact, it appears to be a particularly poor commodity business, because capacity is not constrained by the need to invest in a substantial physical infrastructure. True, whatever investments are made in tangible assets are usually intended as a means to acquire more intangible assets; however, a branch is hardly comparable to an oil well.

A bank’s ability to lend money (and thus produce income) is not completely and inextricably linked to the size of its deposits. In other words, loans are the result of both a bank’s capacity to lend money and its willingness to lend money.

It’s hard to find a parallel in tangible commodity businesses. Theoretically, this should make little difference in the long run. However, the lack of physical supply constraints in the market for loans creates the possibility for large, industry-wide mistakes. Pricing in such an industry can get very weak at times.

There’s one catch here. The underlying assumption whenever the commodity business label is used is that both the demand for a product and the supply of that product are general in nature. They can’t be specific, because that would destroy the involuntary nature of pricing within the industry.

For example, if all pineapples were unbranded, identically tasting fruits the demand side of the business would meet the requirement for a commodity business. However, if most pineapples take eighteen months to grow, but there is one magical plantation where the fruit develops fully in just three months, the supply side of the business does not meet the requirement for a true commodity business. The magical pineapple plantation would produce six times as much fruit per acre and thus the plantation owner would be able to undercut his competitor’s prices. He would earn extraordinary profits, because the return on capital in his business would be much higher than that of the industry as a whole.

What does this fairy tale have to do with banking? It suggests extraordinary profits can come from having “sticky” customers or lower costs. The lower costs needn’t be the result of lower marginal inputs. The magical pineapple plantation turned the crop over faster; it didn’t need access to below market prices for any of its inputs.

The same is true of a grocery store. Two stores that buy and sell cans of soup at the same exact prices may have very different returns on capital, if one of the stores turns over its inventory more quickly, because the fixed costs will be spread over a larger number of sales.

How does this relate to banking? While a quick turnover (or some other form of operational efficiency) is the most common reason for one firm’s unusual profitability in a commodity type business, there are other ways to earn extraordinary profits. Some of them are conceptually quite similar to …

Book Review: Warren Buffet Wealth

Gannon On Investing’s contributing writer, Mike Price, reviews Robert P. Miles’ Warren Buffett Wealth. Mike also outlines his own still evolving, Buffett-inspired investment philosophy. The juxtaposition of the investment philosophies of Warren Buffett and Lou Simpson (along with Mike’s own philosophy) provides food for thought. The common thread is a principled, qualitative, and (above all else) focused approach to investing.

Read Review…