Eureka Homestead Bancorp (ERKH)

The good, the bad, and the ugly

I maintain a spreadsheet that helps me follow along with the standard and second-step thrift conversions of recent years (I’ll get into why I typically avoid first-step conversions in a future post when I discuss the actual mechanics of thrift conversions). In it, I track a couple high level metrics relevant to banks such as valuation and capitalization, among other things.

You can probably imagine the excitement I had then when I noticed a nano-cap bank outside of New Orleans, Louisiana called Eureka Homestead Bancorp (ERKH) that had completed a standard conversion in July of 2019. It had all the makings of an under-the-radar community bank with potential for mispricing:

• Market capitalization of only $16 million so it’s too small for almost any institution to look at, check.

• Over-the-Counter (OTC) traded (as opposed to listed on a national exchange like NYSE or NASDAQ) so even fewer eyes on it, check.

• Illiquid with a 30 day average volume of only 44 shares, check.

• Optically cheap trading at around 75% of TBV, check.

• Overcapitalized and therefore safer with a TCE ratio of 21%, check.

The Good

Like most companies and banks in particular, ERKH was taken for a ride in the early stages of the Covid-19 crisis. It’s share price dropped as low as $9.00 in April, 2020 which would’ve put them at ~53% of TBV based on the 2019 annual report (the last filing that was available at the time of the price decline).

Better yet, beginning in Summer of 2020 ERKH began to repurchase shares in a major way. Remember, bank regulations only allow a thrift to repurchase shares after the one year anniversary of the conversion (which in ERKH’s case would be August 2020). This is exactly what ERKH did. And as many of you know, buybacks at a meaningful discount to book value accrete nicely to remaining shareholders. We’ll walk through the math in a second.

• August 2020 - 5% repurchase authorized

• September 2020 - incremental 8% repurchase authorized

• December 2020 - incremental 10% repurchase authorized

All told, ERKH bought back a total of 241,000 shares (or nearly 17% of the total shares outstanding at commencement of the repurchase plan!) through 1Q21 for an average price of approximately $10.90. Well done! Let’s demonstrate why by taking a look at the impact of such a move on TBV before and after the repurchases:

Now of course, the figures will be slightly different because over the course of that time, ERKH’s net income (or losses) would also change equity, but you can see despite an 11% decline in equity, shareholders who remain enjoy a 7% increase to tangible book on a per share basis. This is the benefit of repurchasing shares of a bank at a discount to book value. Thrifts can be kind of cool, right?

In addition to that, I want you to recall ERKH’s initial conversion date of July 19, 2019. Thrift conversions must wait at least three years from the date of their conversion before they can be acquired/sold. That meant ERKH would be eligible to sell itself in Summer of 2022, meaning another catalyst potentially on the horizon. Unfortunately, this essentially became the last of what I found truly compelling about Eureka Homestead.

The Bad

Eureka Homestead is a single branch bank in Metairie, LA with 90%+ of the loan book in 1-4 residential mortgages. They comprise about 71% of total assets. So far, nothing out of the norm for a very small community bank.

What I didn’t like was the deposits. The table below is from the 2020 annual report since it’s more visually appealing than what’s available in the 10-Qs, but suffice to say the composition hasn’t moved much in the last three quarters.

A few things jump out at you:

1. Certificates of deposit (CDs) comprise 95% of total deposits!

2. Consequently, the weighted average cost of all deposits at 1.75% is high. Recall Northeastern Community Bank (NECB), which I profiled in November did not have the best deposit mix on paper, yet they paid less than half that rate over the same time period largely due to an exceptionally high proportion of non-interest bearing deposits.

3. As of 3Q21, ERKH has a loan to deposit (LTD) ratio of 120%, again backed by CDs which are higher cost and are often more fleeting (chasing yield). In the worst case scenario, ERKH could have a liquidity crunch if those deposits went elsewhere quickly.

At a high level, I think it’s fair to conclude that customers don’t have a ton of reason to do business with ERKH unless they’re getting a great deal on deposit yields. As you can see, ERKH actively enlists an online listing service to help them gather deposits. The high cost paid for funding will impact their ability to ever generate any kind of reasonable income/returns. I don’t understand why the business model doesn’t at least try to have the already low-yielding loan book funded by core deposits, but ERKH doesn’t even offer checking accounts. Worse yet, without a meaningful deposit franchise, I think a big part of the value proposition for a potential acquirer goes out the window.

The Ugly

Readers can let me know whether the think this section should be ‘the bad’ and the deposits section labeled as ‘the ugly’, but I wasn’t too impressed with my conversation with management or the corporate governance of ERKH either. And yes I know, that simply might be asking for too much in an OTC nano-cap bank stock.

ERKH is incorporated in Maryland which I thought was strange for a one branch bank in Louisiana. Don’t most companies incorporate either in their state of operation or in Delaware? I don’t know enough here, so if you’re knowledgeable on this topic, please leave a comment below. As I understand it from management however, Maryland was advised because it offers better insider protections and can be more difficult for activists to force corporate actions. Again, not my area of expertise, but that doesn’t sound great from an investor’s perspective, does it?

The board is classified on three year terms and a couple of the directors don’t appear to have a background that is relevant to banking (not uncommon in small community banking unfortunately). As a whole, insiders/directors own 4.6% of shares outstanding according to the 2021 proxy which isn’t horrible I suppose. The directors skew to the older side which can be a good indicator of their willingness to sell a bank. Five of the seven are 73 or over and the youngest is President and CFO Cecil Haskins Jr at 65.

Cecil and I spoke back in October. Cecil explained ERKH thought it would be tough to compete and grow the bottom line without access to decent capital which is why they converted. He then outlined the business plan to use excess capital from the conversion via CRE participations. Despite their intention to stay local, Cecil stating NOLA area participations are conservative, and ERKH underwrites them individually, I can’t say I care for this approach. I asked what the LTVs and/or coverage ratios on these conservative deals were and he didn’t know off the top of his head. Now I wouldn’t say one has to memorize everything, but a ballpark estimate would’ve sufficed and by not knowing, it kind of made me doubt whether they really were conservatively and/or independently underwritten. Overall, I just got the sense management wasn’t on top of anything the way I’d like them to be.

Here are a couple other tidbits I took away from the conversation:

• Share repurchases were done because they are accretive and the bank has excess capital. Nailed it! However, they were going to pause them because they weren’t sure it’s the right thing to do for the bank going forward. Wait, what? Reminder: ERKH trades at 75% of TBV and has a TCE ratio over 20%.

• Cecil hates compliance (LOL). Understandable in my opinion, but probably not the best attitude for a President of a bank to have or mention.

• CEO and Chairman Alan Heintzen works about 2.5 days/week, or “as much as he needs to”

  • Heintzen apparently wanted to step back from President awhile back, but was kept in the mix because Cecil didn’t want to run the place by himself

• Cecil would be bored to death in retirement so he thinks he’ll be at the bank for foreseeable future

• Not much thought has been given to what a fair price for the bank would be and not sure how to evaluate a hypothetical acquisition either because they never have before

To their credit, Haskins Jr. and Heintzen did both participate in the conversion at the maximum amount allowed. Combine this with the significant accretive buybacks they executed in 2020 and maybe these guys are hustling me, will sell immediately, and just don’t want outsiders snooping around and buying up their shares!

Conclusion

Now I didn’t spend a ton of time on valuation for ERKH because 1) I’m a lot less interested in owning it for the reasons I’ve outlined above and 2) it’s less clear to me that ERKH has much value to a potential suitor unless it’s bought on the cheap, which would eat into potential returns for investors. If you want to play around with it yourself, just remember the formula from my NECB writeup; IRRs are simply a function of the price you pay, the value you realize, and time it takes for said value to be realized.

If August rolls around and they can immediately sell for close to book value, buyers at today’s prices will do well (~33% return in less than a year). I’m just not sure the probabilities are in the investors favor with ERKH. Two quotes from famous thrift investors Joe Stilwell and Rich Lashley in Jim Royal’s awesome book, The Zen of Thrift Conversions keep jousting each other in my head:

Somebody wants every bank. There’s not a bank I’ve ever run across, no matter what anybody said, that didn’t have someone else who wants to play suitor. People say no one wants it. There’s always somebody who it would make sense for. Somebody in-market can get some synergies. Maybe someone out of market wants to grow their empire.

- Joe Stilwell

Look for fewer CDs. Old-line mutual thrifts invest in one-to-four family mortgages and fund it with high-cost CDs. It’s a terrible business model. Look for fewer one to fours and CDs.

- Rich Lashley

Given my thoughts on management and the quality of the bank, I think that somebody will have to be someone other than me. I side more with Lashley’s quote and ERKH is a pass for me as things stand today. However, if the price drops to the Covid-19 low again, which would be less than 50% of TBV, the math would change and I’d probably revisit it.

That’s it for Conversion Confidential this week folks. If you know someone who might like this article, please share and spread the good word!

Disclaimer: No position. This is not investment advice nor a formal recommendation to buy or sell the security. Everything written is for general educational purposes and I have not considered your specific financial situation.