Hingham Institution for Savings (HIFS): A Cheap, Fast Growing Boston-Based Mortgage Bank with a P/E of 9 and a Growth Rate of 10%
This is the one “higher quality, more expensive” bank I mentioned in the podcast Andrew and I did where we talked about like eight or so different U.S. banks. Hingham’s price-to-book (1.7x) is very high compared to most U.S. banks. It is, however, quite cheap when compared to U.S. stocks generally. This is typical for bank stocks in the U.S. They all look very cheap when compared to non-bank stocks. There are many different ways to calculate price multiples: P/B, P/E, dividend yield, etc. The easiest way to calculate a high quality, stable, growing bank’s cheapness or pricey-ness is simply to take the most recent quarterly EPS and multiple it by 4. You then divide the stock price into EPS that is 4 times the most recent quarterly result. The reason for this is that bank’s aren’t very seasonal. But, sometimes events – like COVID – and normal growth (HIFS is a fast grower) can cause the full past twelve month earnings figure to be out of date So, how cheap is HIFS?
“Core” earnings per share in the most recent quarter – I’ll discuss what “core” means at Hingham later, but for now trust me this is the right number to use – was $5.68. Multiply this by 4. We get $22.72 a share. That’s our 12-month look ahead “core” earnings. The stock now trades at $206 a share. So, $206 divided by $22.72 equals 9. Hingham is trading at a “forward” P/E of 9. The “PEG” ratio (price-to-earnings / growth) here may be around 1 or lower. Hingham compounded book value per share by 15% a year over the last 5 years. Growth rates in the 10-15% range have been common since this bank’s management changed about 30 years ago. A lot of balance sheet items – like total assets, loans, and deposits – all grew about 10%+ over the last 12 months. So, a growth rate of about 10% and a P/E of about 9 seems likely here. One thing to point out is the high return on equity. Core return on equity is running at about 18% here. If ROE is about 15-18% while growth in loans and deposits and so on is in the 10-12% range, then the bank will eventually need to pay out one-third of its earnings as dividends and buybacks. Historically, it has not done this. It has found ways to grow much faster than the area (Boston) in which it operates and much faster than the balance sheets of its existing clients. Usually, that kind of thing can’t be kept up forever. Once that kind of growth can’t be kept up, the bank either becomes overcapitalized or it pays out a lot more in dividends and in buybacks. This brings up the other way we can look at a bank like Hingham. We can think in terms of dividend yield and growth. So, let’s say the dividend yield is 1%. The question then becomes how much do we think that dividend will grow? If we think the bank will grow earnings by 10% a year – the dividend will need to grow faster than 10% a year. So, your total return looking at dividends plus growth (and buying at a 1% dividend yield today) would be higher than 11%. However, this return would be skewed almost entirely to growth (like 90% or more of your return would come from the rate at which your dividend stream was growing, not from the initial dividends you received). It’s worth mentioning that I suspect Hingham will pay more out in dividends (some will be special dividends) than is suggested by the regular dividend yield you’ll see if you look up this stock. So, I’m not sure the dividend yield you’ll get to start is really as low as 1%.
Okay. So, Hingham is cheap versus its annualized forward looking “core” earnings. But, what are these core earnings?
Hingham has a stock portfolio. “Core earnings” are simply earnings excluding the quarterly mark-to-market unrealized gains and losses that occur in the bank’s stock portfolio. Hingham keeps about 20% of its book value in stocks. These are almost all individual stocks chosen by the bank’s top management. Technically, the company holds a mutual fund. However, I believe this is done because of how this mutual fund’s activities qualify and how that helps a bank. It’s a point not worth getting into here. All you need to know is that the presence of that one mutual fund is non-economic. It’s not on the books because the bank’s management likes it as an investment. So, 100% of the bank’s stock portfolio (which is 20% of the bank’s equity) is invested in specific stocks the management likes. We’re told these stocks are concentrated in financial services, information technology, etc. and are thought of as long-term investments. In particular, the investments seem to be in stocks where Hingham’s management likes the capital allocation decisions of the management at the stocks they’ve invested in. This is because Hingham mentions an added benefit of their equity portfolio is the ability to observe the capital allocation decisions of the management teams at the companies they’re invested in. We don’t have much information on whether Hingham’s portfolio is “Buffett like”. But, it’s possible it is.
How important is Hingham’s stock portfolio?
Not very. Hingham’s core banking business is 80% of book value. Furthermore, Hingham’s core business is so profitable it’ll blow away returns in the stock portfolio. The bank can sometimes make 18% a year. A stock portfolio can’t do that. So, assume the bank does 18% ROE and is 80% of book value. That’s 18% * 0.8 = 14.4% book value growth contribution. Then assume the stock portfolio has a 10% CAGR and is 20% of book value. That’s 10% times 0.2 equals 2% contribution to book value growth. Over time, book value – before dividends – could be capable of growing like 16% here. However, only 2% of that growth would come from the stock portfolio. In other words, Hingham is probably like 85% a bank and 15% a stock portfolio as far as an investor in the company is concerned. Therefore, it’s fine to just ignore the stock portfolio entirely.
What kind of bank is Hingham?
It’s not much of a deposit gathering operation. It’s basically a mortgage lender. And this is where my discussion of the stock portfolio might be relevant. I think the presence of that portfolio is a potential marker of how management thinks about capital allocation, compounding, etc. I don’t think the portfolio itself matters much. But, it does fit the overall mix of assets we have here at Hingham.
Hingham is a very efficient mortgage lender. It has an incredibly low – just about the lowest you’ll see – efficiency ratio. The industry calculates the efficiency ratio as operating expenses relative to revenue. I don’t like that measure so much (it is hard for most banks to control revenue). I prefer operating expenses divided by earning assets. So does Hingham’s management. For example, they’ll say something like operating expenses are now 0.8-0.9% of our loans. At Hingham, loans make up almost all earning assets (the company really doesn’t own debt instruments of any kind except to manage liquidity). For a bank, the “spread” they need to earn is not the net interest margin quoted everywhere on financial websites. It is the yield (after charge-offs) on the loans (and securities – which don’t matter at HIFS) vs. the total cost of funding which is the non-interest expense (the 0.8-0.9% I mentioned earlier) plus the amount paid in interest. So, imagine the bank is paying you 1.2% a year on your CD or whatever and then it has an added 0.8% in operating expenses. It is digging the commodity called money out of the ground at a price of 2%. If it then turns around and lends at 4%, it is making 2% a year.
Hingham really has just 3 advantages I can see in terms of how it achieves its higher ROE than other banks.
One, Hingham has a lower non-interest expense (it’s more efficient) than other banks. So, excepting interest, Hingham is a “low cost producer” of money.
Two, Hingham makes loans in two categories – mortgages on houses and mortgages on apartment buildings – that have lower charge-offs than other forms of lending. This means the yield on these loans NET of charge-offs is likely to be higher than it appears. For example, if you make construction loans at 5% a year interest and mortgage loans at 4% a year interest – the outcome is likely to be pretty similar (maybe 3.8% a year in both cases) net of how much you’d need to charge-off each year. In fact, the relative position of mortgages versus construction loans may be better than I just described. It’s likely construction loans default at a rate of like 5-6 times mortgage loans. But, it may also be the case that defaulted mortgage loans can be collected on – once the foreclosed property is sold, etc. – at a better rate than defaulted construction loans.
Three, Hingham’s mix of loans and securities is skewed almost completely to loans.
We can simplify these 3 points down to: 1) Hingham is a low cost producer of money (excepting interest costs), 2) Hingham has lower charge-offs than other banks, 3) Hingham has a better “asset mix” than other banks. Loans have higher yields than securities.
But, is what Hingham is doing dangerous?
It’s a highly, highly, highly non-diversified bank. I ran some estimates and came up with the overall guess that between half and two-thirds of Hingham’s entire balance sheet is made up of mortgages on housing in the Boston area. That’s it. Now, some of this housing is single-family owner’s primary residence. Some of it is a vacation home. Some of it is a speculative investment property. Some are small multi-family investment buildings. Some are bigger apartment buildings. But, we are talking about a majority of this bank’s balance sheet being in a small section of Massachusetts and being entirely tied to mortgages on buildings people live in.
The good news is that houses and apartment buildings are not correlated assets. They’re a little correlated (almost everything in banking is a little correlated). But, if you were told that losses on home mortgages jumped 6 times in a given period – this might only suggest that losses on apartment building backed mortgages jumped 2-3 times. If you were looking for just two asset groups that both have low full-cycle charge-offs and yet also are not that correlated with each other – I can’t think of a better 50/50 mix to choose than mortgages on houses and mortgages on apartment buildings.
Having said that, Hingham is not quite that evenly diversified. Over the last 5 years, they’ve moved more and more into commercial (what I’m calling “apartment buildings”) and less and less into houses. Recently, they reached 60% commercial and 30% residential. Also, you have to throw in about 8% construction. Some of that construction is really of a residential nature. But, for risk purposes it really belongs more with commercial in the sense it’s not a very good diversifier in times of trouble.
So, it’s kind of like Hingham has let itself shift from a 50/50 mix to more like a 60/40 or even 70/30 mix.
It’s important to keep an eye on this, because Hingham is basically 100% loans. In fact, loans are higher than deposits because the company is willing to borrow to fund loans.
An easy way to explain this is to look at construction lending at Hingham vs. energy lending at Frost. A lot of investors got concerned when Frost was at around 16% energy as a loan category. However, the bank was 50/50 between loans and securities. So, 16% of 50% is only 8% of the balance sheet. Hingham may be only 8% construction. But, if that is 8% of 100% – that’s still 8% of the balance sheet. Hingham is also a tad more leveraged now than Frost was then (in terms of assets/equity). So, I’d say the actual risk Hingham is taking in construction loans is a tiny bit higher than Frost was taking in energy loans when that bubble burst. I don’t expect construction in Massachusetts to burst. I’m just pointing out the fact that it is important for Hingham to maintain adequate diversification among its two fairly low correlation types of loans. The bank would become much riskier if it was ever 80% commercial and 20% residential or 20% commercial and 80% residential. This is because it doesn’t mix securities with loans. It just does loans.
Finally, although construction loans are often one-fifth or so the size of the next biggest loan category – construction loans may account for a similar dollar amount of charge-offs at HIFS vs. the other categories. Let’s say residential is 30% and construction is 8%. Well, if construction loans have 4 times the charge-offs as a percent of principal as the residential mortgages (which is very possible), then losses from construction and residential will be equal.
For these reasons, I think it’s important to watch Hingham’s construction lending percentage (will it stay below 10%) and watch the difference between its commercial and residential lending. The safest mix would probably be construction less than 10% and residential and construction lending within about 10% of each other. For example: commercial (50%), residential (40%), construction (10%).
There is a lot more to talk about with Hingham. For example, is the high ROE of this most recent quarter sustainable? Short-term rates dropped to nothing while a lot of long-term loans are more fixed for now. If rates stay this low for a long time – will Hingham’s margins and thus ROE eventually come back down to Earth?
But, this is a long enough initial interest article as it is. So, I’ll re-visit Hingham another time.
For now, I haven’t learned enough about the bank to buy it. It is a cheap, fast grower though.
Geoff’s Initial Interest: 80%
Geoff’s Re-visit Price: $180/share