Ponce Financial Group (PDLB)

A NYC based bank that recently completed its second-step conversion

Greetings! Conversion Confidential is back after a nice tropical vacation. In this week’s issue, I’m reviewing Ponce Financial Group (PDLB). PDLB completed its second step conversion on January 27th and began trading on the NASDAQ the following day. In typical thrift conversion fashion shares are up from the $10 offering price - a modest ~7%. Let’s dig in and see what we’ve got under the hood.

The High Level Stats (Pro Forma for Conversion Proceeds)

Total Assets: $1.67 billion

Market Cap: $263 million

Dividend Yield: 0%

Loans/Deposits 3yr Growth Rates: 13.4% / 17.8%

9M21 ROA: 0.71% (0.32% in 2020)

3Q21 NPL Ratio: 0.77%

5yr Avg. NCO Rate: 0.00%

PF TCE Ratio: 16.9%

PF TBV/Share: $11.40

3Q21 LTD Ratio: 105.9%

The Transaction

If interested, you can flip through the prospectus to see the mechanics of a mutual holding company (MHC) and the exchange ratio involved with a second-step conversion. I’ll be doing a write-up in the coming weeks to go over first and second-step conversions.

PDLB’s offering is another conversion that occurred right after fiscal year end. That means the proceeds of the conversion won’t be reflected in the upcoming 10-K. Instead, we’ll have to wait until the 1Q22 SEC filing is published. As a result, here’s my estimate of the proceeds from the prospectus as well as the pro-forma situation based off the 3Q21 10-Q.

The Market

Ponce Bank is headquartered in the Bronx and operates in the competitive New York metro area and Hudson County via 13 banking branches. PDLB was originally chartered in 1960 and is designated as a minority depository institution (MDI) and a community development financial institution (CDFI). In July 2020, PDLB completed the acquisition of local residential mortgage lender, Mortgage World. At $1.7 billion in total assets, PDLB is a lot bigger than many of the thrift conversions we typically review. As a result, the bank has more ability to invest in modernizing itself. In 2020, the bank rolled out a partnership with Grain Technologies, a start-up that focuses on the underbanked community using non-traditional underwriting techniques. The company is also in the final stages of rolling out automated lending technology in partnership with LendingFront Technologies. Investigating these in depth is beyond the scope of this profile, but the app for Grain does seem to have good reviews in the App Store.

The bank calls out two primary customer cohorts in its market, which I believe is largely geared toward the Latin community. The first is locally employed, middle aged, blue-collar employees with limited investment funds. The second is older, white-collar, high income individuals who are largely self-employed or real estate investors/developers. I want to point out that you can see a stark contrast in the demographic statistics of the two neighboring counties, complements of Hometown Locator.

Given all the headlines about an NYC exodus, I was pleased to at least see positive population growth anticipated over the next five years. It is well below the expected US average however, but that’s probably also a reflection of having a large starting point too. I imagine as gateway city, New York still does well attracting new immigrants.

PDLB notes how deposit market share figures in the New York City area can be distorted by the mega banks which may include deposits from around the world. In Bronx County, where they are headquartered and have four branches, 2021 market share is listed as 1.8%, down from 1.95% five years ago. Market shares in the other nearby counties are negligible.

Capital

The 3Q21 TCE ratio pre-conversion stood at 11.1% and increases to 16.9% post-conversion. Over the past five years, TCE ratios have been maintained well over 10%, a quick rule of thumb for adequate capitalization. On a regulatory basis, PDLB is also estimated to have a CET1 ratio approaching 19.5%. Like most thrift conversions, PDLB is well capitalized. No signs that the conversion was undertaken to solve a capital deficiency issue, as has been done in the past for other thrifts.

Asset Quality

Mortgage loans make up the overwhelming majority of loans on PDLB’s books. The mix is even higher than it looks too because business loans are mostly PPP loans. These are somewhat illusory on a longer timeframe. Prior to 2020, business loans only comprised 1-2% of loans.

The residential mortgage loans should be lower risk in general although this will also depend on the underlying customer/tenant base. Notably, investor-owned and multi-family properties are also a larger proportion than owner-occupied properties. The bank underwrites them to maximum 70% LTVs (65% on refinances), and minimum 1.2x property-level and 1.0x global (inclusive of personal obligations) debt service coverage ratios. PDLB also discloses an overall portfolio weighted average LTV ratio of 56.5%, which is pretty conservative.

Non-performing loans over the past five years have ran higher (especially if you consider past due loans) than one would probably imagine given the relative economic strength prior to 2020. NPL ratios over 1% are certainly manageable, but have bounced around the past few years and probably contribute to the the lack of earnings power. However, at 0.77% as of 3Q21, PDLB has done a nice job nearly halving the NPL ratio from a peak of 1.4% in 2017. Moreover, the bank seems to typically hold adequate reserves with the allowance for loan losses usually around 1.3% of total loans. And most importantly, it doesn’t appear a whole lot of these NPLs are ultimately required to be charged-off, so perhaps management is conservative in their classifications of problem loans.

Deposits

At $816 million as of 3Q21, I peg core deposits at 65% of total deposits. Not bad. Meanwhile, non-interest bearing deposits are about 25% of the total. Again, relatively reasonable. And as management states, the mix has been improving on the back of money market and non-interest bearing deposits. Back in 2018, only 55% of total deposits were core deposits while non-interest bearing deposits represented 13% of the total. Hopefully this trend will continue so PDLB doesn’t have to rely on higher cost FHLBNY advances, of which the bank currently uses over $100 million.

Deposit growth has been strong at nearly 18% the past three years as noted in the high level stats. Perhaps some of this was drawn by anticipation of the bank completing its second-step conversion. If interested in learning more about PDLB, I’d suggest touching base with management on what they’ve done to attract deposits so successfully and whether it’s sustainable.

Management / Corporate Governance

PDLB is managed by CEO Carlos Naudon. He has been with the bank since 2015 and prior to that was a partner at a law firm and also ran a banking consulting/publishing firm called Banking Spectrum (which he owns to this day). I’m not sure what is meant by a bank publishing firm. Naudon is also a retired CPA and holds an MBA from the University of Rochester. The description of him in the prospectus also says he previously “was a frequent lecturer and speaker on banking issues, corporate governance, quality assurance and performance incentives”. I find that ironic.

PDLB’s board of directors is comprised of seven members, five of which are “independent”. Seeing as how three of them have been around since the 1990’s, I have my doubts as to that independence and their ability to hold the management team accountable. Prior to the second-step conversion, all directors and insiders cumulatively owned ~3.4% of PDLB shares. Based on the participation in the offering, this will increase to ~4.1%. The Chairman and CEO are participating to the maximum amount allowed which is good, but unless your bank is in real trouble, it’s also a bit of a no-brainer.

The board is classified on three year terms like many thrifts we look at here at Conversion Confidential. Most directors seems to have ties to real estate or banking operations. The newest director, Maria Alvarez, doesn’t appear to have a background in either however. Six of the seven directors, including CEO Carlos Naudon, are at least 70 years old. I would assume this bodes well for a potential sale of the bank a few years down the road.

However, Executive Chairman Steven Tsavaris and CEO Carlos Naudon each take down over $1 million in compensation per year! That bodes less well for a sale since they make more in comp in under two years than they hold in total stock. Seems like a good gig if you can get it!

I know, I know, you could argue it’s a larger, NYC bank and I’m sure there are compensation consultant studies that show higher peer wages yada yada yada…but I see nothing from the results of this bank that suggest anyone should earn that level of compensation on an absolute basis. This is also why I’ll probably never be nominated to a board of any kind! Maybe someday I’ll have the scale to introduce change at small banks myself, but for now, that’s a long way out unfortunately. Side PSA: I’m accepting all small bank director nominations and I can almost guarantee I’ll be far more engaged and shareholder focused than most directors I see in this space. Please inquire within :)

I’ve decided that unless I’m seriously interested in investing in a thrift conversion for myself, I won’t be arranging calls with each of their management teams. There are simply too many thrifts for it to be an effective use of my time.

Lastly, the prospectus did state that management will request permission from the Federal Reserve to pay quarterly dividends after the conversion is completed so there is some form of capital return planned for shareholders. It is not yet clear at what rate.

Earnings Power

PDLB has very little earnings power to note. Results are kind of all over the place. This is a big concern for me and the primary reason for my lack of interest in the bank. Just a quick look at the recent five year operating history reveals inconsistent returns, and in many years, net losses. Meanwhile, the efficiency ratio is extremely high, as is non-interest expense to average assets.

To give management the benefit of the doubt, perhaps some of expense base is driven by investment in the fintech area, but regardless, it’s too high. As they state in the prospectus:

We have made significant investments over the last several years in adding experienced bankers, expanding our lending and relationship staff, absorbing the costs of being a public company, upgrading technology and facilities and acquiring Mortgage World.

It has come down year to date in 2021 at ~72% so perhaps some of the costs are finally scaling although the prospectus notes the efficiency ratio will remain high. This would be another area for someone more interested in investing in PDLB to bring up in questions with management. PDLB also notes their anticipated “liability-sensitivity”. Their interest-bearing liabilities reprice or mature more quickly than interest-earning assets, which can result in interest expenses increasing more rapidly than increases in interest income as interest rates increase.

Valuation

Because I’m not very interested in investing in PDLB from a qualitative standpoint and this post already feels like it’s getting long, I won’t rob you off your own valuation work. I will say that with a recent share price at 93% of the pro-forma tangible book value, I’m not interested in the valuation either. I suppose it’s another to watch and see if the price drops materially or it becomes clear some of management’s investments are paying off in the form of better cost control going forward.

Risks

• Complexity - There’s a lot here compared to most conversions such as the potential emergency capital investment program (ECIP) investment by Treasury of up to $185.6 million in exchange for the issuance of senior perpetual noncumulative preferred stock. In the world of thrifts, that’s a bit of a turn off for me personally. From the larger size to the the fintech investments, it’s a bit more difficult for me to quickly follow what PDL is doing. That’s not to say they aren’t making the right decisions with these efforts to modernize or carve out a niche. I don’t want to pretend this is the most thorough analysis of this bank. If you know more about the bank or its management, don’t let my ignorance dissuade you.

• Quality - PDLB doesn’t appear to have stable earnings power. While it’s not a requirement that a thrift generate impressive returns for me to invest in it, I prefer to at least see consistent and positive net income. If not that, there should be a clear trend that at least gives the impression of improvement. I don’t really see any discernible pattern here yet.

• Management / Corporate Governance - Like many thrifts, the management team and board of directors look too comfy for my taste. We have a combination of weak operating performance and management/directors who don’t look super aligned with, or accountable to shareholders.

Disclaimer: No position. This is not investment advice nor a recommendation to buy or sell the security. Everything written is for general educational/entertainment purposes and I have not considered your specific financial situation. Always do your own research before making any kind of an investment.