U & I Financial Corp (UNIF): Another Decently Run K-Bank Trading at a P/E of 6, and at 55% TBV with Considerable Upside.
An Above Average Operating Bank with Decent Returns, Lottery Ticket and Great Margin of Safety
U & I Financial Corp the parent for Unibank is a one of the main publicly traded Korean-American focused banks in the US alongside of names such as $HOPE, $HAFC, $PCB, $CBBI and $OPBK. They are the main player in the Korean-American communities right outside of Seattle, WA sharing the market with Bank of Hope not far behind them. The bank seems to have a similar history to CBB Bancorp that I wrote about in a previous post, Unibank was started in the mid-2000s by a local group of Korean-American business owners who pooled together capital to start the bank. Unibank is certainly cheap, prices for the K-Banks as a group have been fairly depressed recently with general CRE and urban market concerns by investors.
Based on prices as of 2/16/2024
Key Business Figures & Ratios:
P/E: 6x
P/Pre-Tax Earnings: 4.68x
P/TBV: 0.55x
Dividend Yield: 2.5% (10-20% Payout Ratio)
Net Interest Margin: 4.45%
Return on Earning Assets: 2.68%
Return on Average Tangible Equity: 16.01% (Normalized around 11-13%)
Efficiency Ratio: 48%
Branches: 4 (Full service)
I’m not going to lie here, Unibank is definitely a low-information stock, finding every small piece of information on this bank is both incredibly helpful and difficult to do. They aren’t a dark stock, but unlike some of the other OTC and even NASDAQ bank you won’t get a lot of the other supplemental documents such as investor presentations that contain detail on the loan quality, loan detail, deposit and branch level figures. In short, they do the bare minimum to satisfy listing requirements on the OTC, so you will have to dig around FDIC call reports and regulatory filings if you want to know a bit more than what’s in the annual reports.
Unibank is an illiquid stock, they have around a 20% share turnover, they are liquid enough for a lot of individuals to enter a position but it could take a long time for a fund to open a large position. At a minimum 50% of the shares being a mix of the insiders and some of the funds who were able to buy into the bank are held and may not be traded in any given year. It could be more than that but it is at least 50%. Insiders own a considerable amount of the bank, they own around 35% of the bank, mostly held by the Chang family. There’s also AllianceBernstein and Stilwell who may have considerable influence on the board as activists who own 10.52% and 9.91% respectively.
Form FR Y-6 12/31/2021
So why is the stock cheap and what is interesting about it? Well, the stock declined on a poor Q4 earnings report where they had to provision $3.2 million for potential loan losses on some deteriorating loans. This essentially wiped all of the earnings for the quarter, the CEO got fired and the bank is on the search for a new CEO. That’s a lot for a small bank like this but not really unusual, going dumpster diving for stocks like this you have to determine most of the time how bad it needs to be to pass on an investment and if the margin of safety/upside potential is worth whatever problems the business may have. A K-Bank firing their CEO, CFO, or whoever is not really uncommon with these banks. Bank of Hope, CBB, RBB would be lucky to keep an executive for more than a few years. The deterioration in one of the lending relationships can be concerning and something to monitor in the coming months but as it sits currently, I’m not as concerned as the bank is very well capitalized at 17.29% Total RBC Ratio. The bank has a strong earning power and decent expense controls at place to be able to absorb those losses and then some without having to raise any capital.
I think this bank is particularly attractive where it has earned a strong return on tangible equity where on average in the last 10 years it earned around 11%, never dipping lower than 8.37%. There’s some level of decent expense control leveraged at the bank where it continued to lower its efficiency ratio over time especially as it continues to increase its earning assets over time without increasing more branches. It’s hard to go back earlier than 2018 Annual Report on these details but it seems like they’ve been operating with just 4 branches for quite a while. It’s very attractive to see a bank that can scale its lending in this matter without increasing branches which comes with additional operating costs and scale-up time to earn the bank’s average type returns.
Source: Own Calculations/Annual Report/TIKR
The bank’s loan book is kind of a black box since they don’t give out much detail on what’s contained outside of what you find on the annual report and FDIC Call Reports. If you’re familiar with some of these K-Banks they tend to mirror each other on the type of lending they tend to do. For many of them Commercial Real Estate makes up anywhere from 50%-80% of the loan book and that is neither good or bad without knowing the stratification of those loans. I got comfort on the loan book just reading what the other K-Banks are doing as well as knowing the interest that some other banks/funds have in buying the bank. What’s interesting for Unibank is that they’ve reduced their CRE exposure dramatically by lending out to Residential Real Estate just in the past two years as the interest rates have increased. Which I particular like where they make a lot of small dollar value loans in RRE vs in CRE where one loan relationship can cause a considerable issue relative to the size of the bank.
Source: Own Calculations/FDIC Call Reports
In summary you have a few things in play here if you decide to buy these shares. You are buying a very cheap bank at 55% of TBV that is improving its operations over time by just lending more and growing its deposits without growing its branches and ultimately its fixed costs. The bank is very attractive as it maintains its 40% to low 50% efficiency ratio. The bank will earn anywhere from 8-11% returns on tangible equity, they can earn more than this if acquired by another bank as they can cut out director salaries and other costs by consolidation. You also have activists such as Stilwell who are known in the banking industry as being a great activist on behalf of outside long-term investors. Within a year of their investment in Unibank the board announced a stock buyback program and bought back $2.64 million of stock (a bit less with stock based comp dilution) that represents 6.18% of the market cap in 2021. They paid $1.10 million in dividends representing a 2.5% yield. Stilwell has some influence on the board and has reported having discussions with the board. Which makes this a very compelling investment as the bank is very well capitalized, they either will return large amounts of capital over to shareholders if they end up slowing down lending or they go out and make loans that compound at 8-11% ROE. They represent margin of safety in price, but also a margin of time safety where you can wait a long time for this investment to work out as they compounded tangible book value on average between 9-10% in the last decade. I have no belief that the value gap wouldn’t close within 3 years but you could wait a decade for something like this to close and earn an above average annualized return.
The other piece that gives me comfort around this bank’s operations and loan book is that they were supposed to be acquired back in 2017 by Bank of Hope at 1.3x book value, a 30% premium to book. This agreement ended up being terminated due to internal control issues at Bank of Hope that devastated its stock price making the issuance of $HOPE shares to acquire $UNIF really unattractive when issuing at below book to pay for something above book.
Many investors may be interested in this bank for the acquisition potential in closing that value gap but like I said it could take a really long time especially since $HOPE’s valuations still haven’t returned to book value. Could they be acquired or merged with another K-Bank? Yes, but it’s unlikely, Hamni is not as acquisitive as Bank of Hope, and the other banks that are closer to a similar size would either incur heavy dilution or be willing to merge together and having to buyout some of the management. A problem still with all of these banks is that they don’t pile up cash since they are a bank and need to have a lot of earning assets which comes down to how they would fund such an acquisition. The K-Banks are definitely lower leverage banks and don’t pay out a large portion of their earnings so they could lever up an acquisition with debt, but the interest expenses would be quite expensive at today’s rates. It comes down to using shares as a currency and right now all of the K-Banks are quite cheap so there’s going to be hesitation on issuing shares at a discount to buy another bank instead of just making more loans.
I sometimes have friendly arguments with deep value type investors with the type of investments they like vs the ones that I like and this is a good example of one of them. People look at stocks like Unibank and CBB and say:
“Why would I buy this bank at 55% of book that hasn’t done anything, hasn’t returned enough capital, isn’t actively selling the bank. When I can buy something at 30% of book that has this M&A catalyst within 3 years”.
They might be right on this, statistically 30% of book is much better than either of these stocks I mentioned but I rarely see investors who talk about stocks where it has this deep discount with that lottery ticket attached to close the gap AND you can earn potentially a market return or better while you wait. Truthfully with these two stocks, we don’t know if we will earn a market return holding them, banking in the US is a commodity business that rarely earns above average returns and it’s very hard to earn good returns in the stock without buying below book or excellent capital allocation. These stocks haven’t increase share price by 10% per year looking back at it like some compounder stock. It’s not reflective in the share price but the growth of book value definitely is as well as the business returns. Our return is basically the capital payouts + return on equity (or book value growth) each year. There’s a lot of ideas where its really statistically cheap at 30% of book value but is barely earning its cost of capital, or it can compound book value at 1 to 2% per year with a horribly inefficient operation that has generated losses. I still respect these kinds of ideas and am willing to invest in those as well, it’s a lot of what you sometimes find in Japan or other cheap bank stocks but I much rather be able to earn a decent return in the business itself AND have that lottery ticket in the event of an acquisition/liquidation/etc.
Catalysts:
1. Stock buyback program/increased dividend payouts
2. Sale to Bank of Hope or another bank
3. Stilwell activism
4. Continuing to generate returns above the average bank
Disclosure: I own shares in UNIF, CBBI, HAFC. I am not short on any of the tickers listed here.