As I was doing my "ready for the weekend pizza and vino" run last Friday, I got a ring and checked my phone to find a very interesting email. John Allison, CEO of Home Bancorp (HOMB), let me know that he thought I was unfair to his company when I suggested the stock was too rich to buy at current levels. He is the founder and largest shareholder of the bank and he reminded me that it has been the fastest-growing community bank since 1996. Allison is one of the best bankers on the planet if you measure his performance by return on assets, efficiency ratio and growth rates, so I agreed to talk to him the next day and hear his side of the story.
It's a really good story. Allison got his start in banking when he was appointed to the board of a small local bank, First National Bank of Conway, in the 1980s. Shortly after joining the board, he teamed up with some fellow shareholders and bought the bank and was named chairman. A few weeks later, the bank got a memorandum of understanding from Federal Deposit Insurance Corp. (FDIC) regulators for poor policies and credit issues. He told me that he rolled up his sleeves and dove in head-first to fix the issues and it was the best thing that ever happened to him. He learned the ins and outs of the banking business in the process, and the rest, as they say, is history. In 1985 the bank was sold to First Commercial at a decent profit and he joined the board at the new bank.
While at the First Commercial, he led a team that worked to buy Texas banks and assets during the late 1980s oil bust. They were very successful in working with the Resolution Trust Corporation to do profitable deals and they grew the bank by hundreds of millions of dollars. First Commercial eventually was sold to Regions Bank in 1998 for a staggering 4.11x book value. Later that year he joined with Robert H. "Bunny" Adcock, Jr., to buy a bank in the booming metropolis of Holly Grove, Arkansas, that had about $25 million in assets. They moved the charter to Conway, Arkansas, and today the bank now known has Home Bancorp is a $9.6 billion banking organization.
Mr. Allison explained the process to me. He said he was not looking to buy healthy banks as they expanded. They wanted to buy broken or poorly performing banks and fix them. The opportunity to make big money, he said, was in buying bank with a 0.5 return on assets and getting it up to a 1.5% or 1.75% ROA. He will not and has never done a dilutive deal. If a deal does not have the potential to significantly move his earnings-per-share needle, he simply won't do it. If the target bank won't do the deal on his terms, he moves onto the next one. He is openly scornful of banks that do dilutive deals and overpay for target banks.
As we talked it occurred to me that John Allison and I were doing he exact same thing with community banks. We are looking for underperforming banks that really need to sell and then invest in them in hopes of a high rate of return. I am looking to get there first and then hopefully sell them to Allison and other acquisitive bankers, but out approach is basically the same.
Then he said something eye-opening. Allison said as banks move up to and over the $5-billion asset mark, the price-to-earnings ratio and EPS growth rates are far more important than price to tangible book value. I can tell you that I really wish he hadn't said that because John Allison is a very successful banker and knows more about banking than I ever will. I can't just dismiss his remarks out of hand and cling to my "book value only" beliefs. I am going to have to clear some time on my schedule and test banks of a certain size based on growth rates and P/E ratios. I suspect that I will find he is right and I need to adjust how I look at the larger banks in the future.
He then rattled off a long list of banks that trade at higher P/E ratios than his but have much lower ROAs and higher efficiency ratios. Based on that list he thinks his shares are undervalued relative to the rest of the industry. He backed his opinion up with cash, as his earlier this year he exercised his option on more than 100,000 shares and simply kept the stock.
He thinks the future remains bright. His company is looking to do more deals in Florida and he says he has a team on the ground there ready to go when he finds a new acquisition and comes to terms. He told me his ROA right now is about 1.7% and he sees no reason he cannot work that up to 2% before too much longer. The already-efficient operation is looking to improve further and he is targeting a 35% efficiency ratio compared to the industry average of right around 60%. He told me that everything he does will be in shareholders' best interest and I believe him, because he and his family own 11 million shares of Home Bancshares and are the largest shareholder.
Did he convert me? Almost, but not entirely. I would break out in hives if I paid 3.8x and 18.9x earnings for a bank. However, his bank is priced at a discount to peers that do not perform as well as his does and could be considered cheap compared to similar institutions. I also think his size and valuation argument makes a lot of sense, and if we see a sector and/or market decline that brings the stock to a P/E of 15 or so I might get hives if I don't buy it at that level.
