A Closer Look at the S&Ls: Peter Lynch's Specific Picks
Book: Beating the Street by Peter Lynch with John Rothchild | ISBN: 978-0-671-75915-5
Peter Lynch says a casual stockpicker could just grab five S&Ls that fit the Jimmy Stewart profile, invest equal amounts, and do well. One would outperform, three would do OK, one would lag, and the total result would beat owning overpriced blue chips like Coca-Cola or Merck.
But Lynch isn’t the casual type. He picked up the phone and called six S&L presidents before committing. He says the phone bill goes up, but in the long run it pays off. Here’s what he found.
Glacier Bancorp
Lynch called Glacier the day after Christmas. He came into his empty office in Boston wearing plaid pants and a sweatshirt. Nobody else was in the building except the security guard. He’s always impressed when he reaches executives who are at their desks on December 26.
Glacier used to be called First Federal Savings and Loan of Kalispell. Lynch wished they’d kept the old name. “Antiquated and parochial” is reassuring to him. “Bancorp” makes him nervous.
The stock was at $12, a 60 percent gain from the year before. A 12 to 15 percent grower selling at 10 times earnings. Not a screaming bargain, but not much risk either.
Lynch didn’t jump straight into earnings questions. He chatted about Montana, the mountains, the timber industry, the spotted owl. Then he started slipping in real questions. Are you adding branches? Anything unusual in the third quarter? He peppers the conversation with bits of data so the executive knows he’s done his homework.
The mood was good. Nonperforming loans were almost nonexistent. In all of 1991, Glacier wrote off just $16,000 in bad loans. It had raised its dividend 15 years in a row. And it just acquired two thrifts with great names: First National Banks of Whitefish and Eureka.
Lynch’s one concern was the 9.2 percent in commercial loans. But Montana wasn’t Massachusetts. These weren’t loans to condo developers building into a bubble. They were mostly multifamily housing in a growing state where Californians kept moving to escape smog and taxes.
Before hanging up, Lynch always asks: what competitor do you admire most? Glacier mentioned United Savings and Security Federal, both Montana thrifts with equity-to-assets ratios as high as 20 percent. Lynch punched up the symbols and added them to his list.
Germantown Savings
Another repeat recommendation. The stock went from $10 to $14 in a year, but it was still earning $2 per share. That’s a p/e under 7. Book value was $26. Equity-to-assets of 7.5. Less than 1 percent nonperforming loans. And not a single brokerage firm covered the story.
Lynch read the annual report before calling. Deposits were up (customers keeping their money there), but loans were down and investment securities were up by $50 million. That meant the bankers were being conservative, parking money in bonds instead of making new loans. When the economy improved and they shifted back to lending, earnings would surge.
CEO Martin Kleppe told Lynch: “We have a very boring story.” That was exactly what Lynch wanted to hear. Kleppe added: “We also have a fortress balance sheet. When we get in trouble, other guys are walking the plank.”
Loan losses were scarce and getting scarcer. Germantown was adding to its loan-loss reserves, which hurt short-term earnings but would boost them later when the unused reserves came back. The area around Germantown wasn’t booming, but the people there were lifelong savers and loyal depositors. The S&L would outlast its wilder competitors.
Sovereign Bancorp
Lynch found this one through a Barron’s article called “Hometown Lender to the Well-Heeled.” Sovereign served wealthy communities in southeastern Pennsylvania from its headquarters in Reading. A bell went off in every branch when a mortgage was approved. Lynch liked that detail.
The numbers were strong. Nonperforming loans at 1 percent of assets. Commercial and construction lending at just 4 percent. Reserves covering 100 percent of nonperformers. The stock was at a p/e of 8.
President Jay Sidhu wanted to grow the business at least 12 percent annually. His model was Golden West, the penurious California S&L run by the Sandlers. Sovereign’s overhead was 2.25 percent from recent acquisitions, much higher than Golden West’s 1 percent, but Sidhu was committed to bringing it down. He owned 4 percent of the stock, so he had real skin in the game.
Sovereign’s strategy was smart. Instead of holding mortgages on its books, it made the loans, collected the up-front fees, then sold the mortgages to packagers like Fannie Mae. This got the money back quickly for new loans while transferring the risk to others. And it hadn’t made a single commercial loan since 1989.
Lynch learned something new from Sidhu. Some banks hide problem loans by offering developers bigger loans than they need, then holding the extra cash as a secret reserve to cover missed payments. That way a bad loan keeps looking good on the books. Another reason to avoid S&Ls with big commercial portfolios.
People’s Savings Financial
Based in New Britain, Connecticut. Near Hartford. Not a booming area. Unemployment was high. The biggest employer used to be hardware manufacturers, but Stanley Works was the only one left.
But People’s had an equity-to-assets ratio of 13, and they advertised it. Deposits grew from $220 million to $242 million in a year because people saw it as a safe place to keep money while weaker banks failed around them.
The really interesting part was the share buyback program. People’s had retired 16 percent of its shares in two rounds, spending $4.4 million. With fewer shares outstanding, earnings per share would keep rising even when the business was flat. When business picked up, the stock could take off.
The company went public in 1986 at $10.25 per share. Five years later, it was bigger, more profitable, had fewer shares outstanding, and was selling for $11. Why so cheap? Because it operated in Connecticut, and Connecticut was depressed. Lynch would rather invest in an S&L that proved it could survive in a bad economy than one that had only thrived in good times.
The Born-Agains: First Essex and Lawrence Savings
These were Lynch’s long shots. Both came from the Merrimack Valley near the Massachusetts-New Hampshire border, one of the most economically depressed areas in New England.
First Essex came public in 1987 at $8 per share. Management bought back 2 million shares at $8, which turned out to be terrible timing since the stock later fell to $2. The numbers were scary: 10 percent nonperforming assets, 3.5 percent real estate owned, 13 percent commercial loans. The S&L had lost $11 million in 1989 and $28 million in 1990.
But First Essex still had a book value of $7.88 and an equity-to-assets ratio of 9. Its CEO described the situation as “bottom fishing with a six-hundred-foot line.” The key math: $46 million in commercial loans versus $46 million in equity. Even if half those remaining commercial loans went bad, First Essex would survive.
Lawrence Savings was riskier. Same region, same story: profitable S&L got caught up in commercial lending and lost millions. But the math was tighter. $55 million in commercial loans against only $27 million in equity. If half the commercial loans went bad, Lawrence was done.
Lynch presents this as a lesson: with long-shot S&Ls, compare the equity to the commercial loans outstanding. Assume the worst. If the company survives the worst case, it might be worth a bet. If it doesn’t survive the worst case, move on.
The Almost Can’t-Lose Proposition
Lynch closes with something fascinating. When a mutual savings bank goes public for the first time, every dollar raised in the offering goes right back into the S&L’s vault. Unlike a normal IPO where the founders cash out, these offerings just add to the bank’s equity.
So if a thrift had $10 million in book value and then raised $10 million by selling stock at $10 per share, its book value just doubled to $20 million. You bought a $20 stock for $10.
The track record was remarkable. Of the 16 mutual thrifts that went public in 1991, the worst performer was up 87 percent. All the rest had doubled or better. There were four triples, one 7-bagger, and one 10-bagger. In 1992, another 42 came public. Only one lost money, and it was down just 7.5 percent.
Lynch’s advice: find a mutual savings bank or S&L in your area that hasn’t gone public yet. Open a savings account. That gives you the right to participate in the IPO when it happens. Then sit back and wait.
There were still 1,372 mutual savings banks that hadn’t gone public. This was the kind of nearly risk-free opportunity that most people walked right past, every day, on their way to the office.
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