Commercial Bancshares: Mighty Little Bank Meaningfully Undervalued (CMOH)

Posted by & filed under Commercial Loans.

Searching through the micro-cap space we continue to uncover highly profitable commercial banks that continue to go unnoticed, leaving them extremely undervalued but for no real good reason. Market caps are so small that many institutional investors are unable to own these banks while retail investors recency bias towards disliking anything financial has left plenty of opportunities. Commercial Bancshares (OTCQB:CMOH) is another great example of a commercial bank that has continued to generate quality earnings from a wide NIM spread and high profitability while many other commercial banks have had trouble generating returns on assets and equity near their potential. CMOH has solid asset quality, growing book value and consistent returns on assets near 1% and returns on equity near 10%, we feel the market is unjustified in its appraisal of the bank. We estimate that the bank should be at least worth book value at the absolute minimum and worth closer to 1.5x book meaning there is a substantial upside at current prices.

Company description

Commercial Bancshares is a holding company that owns and operates The Commercial Savings Bank primarily operating in the Ohio counties of Wyandot, Marion and Hancock. The bank focuses on commercial loans and we will describe later our views on the quality of the banks loan portfolio. The bank ranked last year 4th with 11.93% of the total deposit share market of their respective areas with approximately $264 million in assets. We note that back in 2007 before the financial crisis the bank ranked 13th in total market share with significantly more competitors. CMOH was not caught naked when the tide went out and this growth in market share during the financial crisis indicates to us that the bank has a conservative lending culture that should continue to perform well in the future.

Asset Quality

We continue to stress that the most important part of analyzing a bank should revolve around the quality of its assets since leverage and ignorance can create some interesting results as witnessed during the recent financial crisis. Our goal is to protect our downside and a bank with strong asset quality and a conservative, yet profitable, lending culture should protect our downside letting the upside take care of itself.

Commercial Bancshares asset quality has been consistently high throughout the financial crisis and is one of the main reasons that the bank was able to gather market share when only 19 competitors remain out of the 52 before the crisis hit. We have to keep in mind that CMOHs loan portfolio is focused on commercial lending which is riskier and tends to have more non-performing assets than a bank that strictly lends out residential real estate loans. Both non-performing assets and non-performing loans to loans and assets respectively are currently at or below 1%, which is on the lower side for a commercial focused bank. Normally, we would expect a commercial focused bank to have both non-performing loans and assets to be near 1.25% of assets and loans. CMOH has been able to continually have their non-performing assets/loans around their current mark before and during the financial crisis, which is even more reason that the bank has quality loans. The only time non-performing assets rose to higher than 1.25% was in 2008 when it reached 2% of total assets, which is in stark contrast to other banks that have continued to have npa/asset ratios well above 2-3% who continue to have trouble getting rid of their problem assets 4 years after the financial crisis.

We also like that the bank has been consistent in their allowance for loan losses. As seen below the allowance has been hovering around 1.6%, which is a respectable amount when considering the type of commercial loans the bank has on their books.

(click to enlarge)(Source: Company 10-K)

Loans

As we have been stating, CMOH is a bank that focuses on commercial lending and has continued to grow their focus on commercial lending. The key here, we believe, is that CMOH has been able to grow their commercial loans at an attractive rate of 5% compounded annually since 2009 while total loans have grown 3.4% annually. This growth has occurred while many other community banks have had to decrease their loans significantly since 2009 to rid themselves of toxic loans.

(click to enlarge)(Source: Company 10-K)

Branch Operations

(click to enlarge)(Google Maps)

CMOH operates eight branches throughout Wyandot, Marion and Hancock counties in Ohio. Many of these counties are home to a significant number of industrial firms such as Upper Sandusky with forty and Marion is the nations leader in corn and popcorn produced foods. Although we do not expect any of the counties, which CMOH operates to grow rapidly in the future, we do expect that this area of Ohio will continue to grow slowly and not have any significant problems since the areas have diversified economies.

Also, since the bank has the 4th largest deposit market share in their overall markets, it could be possible for a larger bank to take over their branches or the entire bank. Possible acquirers could be Huntington Bancshares or Fifth Third Bancorp who are trying to dominate in the central Ohio market share.

Balance Sheet and Deposits

(click to enlarge)(Source: Company 10-K)

The bank has been successful at gathering core deposits in both demand and savings deposits which has allowed the company to maintain their very high NIM of gt;4.5% while many peers have struggled to attain NIMs near 4%. Currently more than half (53%) of the banks deposits cost less than 10 basis points which is significantly higher than 2011 when 47% of deposits were of low cost core deposits.

One thing to note, however, is that the bank continues to be liability sensitive, which means that as interest rates rise, NIM will be negatively impacted. Interest rates are bound to increase over the long term so the bank has to be able to navigate towards an asset-sensitive balance sheet that will be able to benefit from the rising interest rates. Management so far has shown that they have been able to isolate their balance sheet sensitivity from interest rate risk as they have been able to maintain a stable NIM spread as interest rates fell and started to rise.

Management Incentives

Management and the board own a significant percentage of total shares outstanding at nearly 19%. The CEO owns close to 3.5% and one thing that we have liked is that seemingly all board members and managers have been buying shares of the bank on the open market consistently, and quite aggressively during the financial crisis and even up to recently. We see the management team and especially the board, highly aligned with minority shareholders who should be able to continue to have value accretion as one of their top priorities over the long term.

We feel that the managements decision to lower salaries and benefits by $858,000 after the financial crisis to keep the banks efficiency ratio low and also the decision to add a branch and relocate another during 2009 are good examples of their shareholder stewardship. We shouldnt forget that the bank has utilized share repurchases when shares were low and continue to have a shareholder repurchase plan for 23,538 shares.

Valuation

Commercial Bancshares is currently trading less than book at 0.9x, which we feel is absurd since the bank has been able to grow book value more than 7% annually since the end of 2009. The bank has also maintained returns on assets of 1% and returns on equity of 10% over that period, which is well above average for small community banks post financial crisis. We feel that the bank should be worth at least book at the absolute minimum over the short term and could fetch nearly a 1.5x multiple over the next few years as the economy continues to grow. This would mean that shares should be trading for at least $26.5 or 8.4% higher than todays price. We would even argue that since the company has been able to gain market share during the financial crisis and remain profitable, shares could be worth $40 although we would agree that the small market cap and illiquidity of the company would necessitate a discount. Even if the company were to trade at 1.2x that would still mean shares would be worth $32 or 30% higher than todays price.

To look at the bank from a different perspective the enterprise value of the bank is 4.8x EBITDA and the bank can be purchased at 5.5x pre-tax earnings. We would expect a company with inconsistent earnings and growth to be valued at such multiples instead of a highly profitable small community bank that has been able to survive and thrive during the worst financial crisis since the Depression.

Conclusion

Commercial Bancshares is another small community bank that continues to go under the radar while the bank has continued to be profitable and gained significant market share during the financial crisis. The combination of quality assets, profitability and aligned board members and management equal a recipe for a strong company that will continue to increase shareholder value over the long term. Currently, we can purchase the company with a meaningful margin of safety and let the bank continue to compound capital well into the future.