Bank balance sheets are not black boxes: AMB Financial

A bank's source of a strength can also be a source of doubt or weakness; their balance sheet.  A bank's balance sheet is their most important financial statement.  A bank makes or loses money via their balance sheet.  If they have a poor balance sheet they won't generate earnings, a strong balance sheet translates into a strong earning stream.

A criticism many investors have of banks is that bank balance sheets are "black boxes" and that it's hard to value a black box.  This criticism is true for the large money center banks with trading operations and portfolios of derivatives, but I don't believe it applies to community banks.  The stereotype of black box balance sheets is unfortunately applied across the entire banking sector.  Not only do I think community bank balance sheets aren't black boxes, I would go further and say they are much more transparent than most non-bank balance sheets.

As outside investors we have to take the financial statements presented to us on faith.  If a company says they spend $1.2m on capex we have to trust management's judgement that the company will earn a return with the equipment purchase, and that the money was spent wisely.  If a company claims their property is worth $30m we have to take that on faith.  An outside investor will always be at a disadvantage regarding the true value of a company's assets.  We can't conduct a full audit of everything a company owns.  We can obtain what we think is a close proxy for value using heuristics, but we can never know the true value unless management conducts a full audit themselves and releases the value to the public.

My own belief is that there is more of a "black box" component to industrial balance sheets when compared to bank balance sheets.  How do we know that a parcel of land held at cost is really worth it's stated value?  Or how do we know that a company's capex went into purchasing long lived equipment that will generate returns?  How do we know a company is prudently managing their purchases?  Business is built on relationships, a company could be purchasing items at a higher cost from suppliers because they've had relationships for years.  If so then shareholders lose out.  We also don't know the condition of a company's equipment or property.  Maybe management is willing to give shareholders a tour, but even still shareholders only see what management wants to show them.  It's not uncommon for investors to be led on a dog and pony show through a facility.  Even more common is when management shows off their newest facility completely ignoring their old plant and equipment ignoring their old facilities.  Do those old facilities have any value?

There are three ways to assess the quality of a balance sheet, through a third party sale, through an audit, or through returns it generates.  When a company sells itself in most cases the acquiring company pays fair value.  Through the sale to a third party a company's balance sheet value can be unlocked.  The second way a company's balance sheet value can be revealed is through an audit.  Some companies with extensive supplemental holdings conduct asset audits from time to time and publish their results.  Often the audited value and balance sheet value differ dramatically, which is why management conducts the audit.  The last way to assess the value of a company's assets are through their returns.  If a company has a significant asset base that is barely generating earnings it's likely the assets are underutilized.  If a company is earning phenomenal returns on their assets it's likely the assets aren't recorded at their current value.

All of this brings us to bank balance sheets.  Much of a bank's balance sheet is transparent, it usually consists of securities, cash, loans, and real estate (both branches and OREO).  Of those components most are marked to market.  Even loans held to maturity are marked to market if you consider the value of the portfolio and their allowance for loan and lease losses (ALLL) as one unit.  I say that held to maturity loans are marked to market because a bank has to continually adjust their ALLL depending on the condition of their loans.  If the quality of their loans improves their ALLL shrinks, if the quality deteriorates their ALLL increases.  By monitoring a bank's ALLL investors can get a sense to the true value of a bank's loan portfolio.

Unlike industrial companies banks are regulated by a regulator who is supposed to ensure that a bank is well reserved for losses and is not engaged in any risky lending.  In other words the regulator's job is to protect the value of the bank's balance sheet.  Regulators aren't perfect, no human is.  Some investors like to pin the blame for the financial crisis on the backs of regulators, and others claim the system wouldn't work without them.  In my view the truth is in the middle.  On the whole the existence of regulators gives investors better information from which they can make decisions.  

My own belief is that a bank with a strong balance sheet has value regardless of whether the current management can generate a return with it.  This is especially true in banking where regulatory and market forces push underperforming banks to merge with stronger banks.  Regulators, and bank activists are powerful catalysts unlocking value for shareholders.

All of this leads to the bank I want to talk about, AMB Financial (AMFC).  AMB Financial is the holding company for American Savings FSB in Munster, Indiana.  Even though the bank has an Indiana address they're more appropriately viewed as a Chicago bank.  The bank is located less than a mile from the Illinois border in the Indiana suburbs south of Chicago.

AMB Financial is as plain and vanilla as community banks come.  They have a sound balance sheet comprised of deposits and loans from which they generate ample interest income.  The bank is small with only $135m in loans, $8m in mortgage backed securities and $13m in cash.  They are funded with deposits and a small amount of borrowing.

The bank is cheap too, they're selling for 61% of tangible book value.  This is especially low for a profitable bank.  They earned $.66 per share last year, and in the first quarter of 2014 they earned $.21 per share.  Banking isn't seasonal, and their quarterly income isn't from a loan loss reversal, so it's likely they could earn $.84 per share this fiscal year barring any issues.

Like most banks in the US AMB Financial's non-performing assets peaked in the 2009/2010 time frame and have been declining since.  They have about $5.2m in classified assets and a loan loss reserve of $1.7m.  The bank is well capitalized with a 15% Tier 1 ratio and tangible equity/total assets of 7.2%.

There are a number of reasons investors would avoid the bank, let me try to encapsulate all of them in one sentence.  They are too small, don't earn a high enough ROE, have too high of an efficiency ratio, don't have a great deposit market share, have preferred stock, are illiquid, aren't growing, aren't Wells Fargo.  Despite all of this the fact remains, this is a cheap and profitable bank.  If this bank were trading at 1.5x TBV I wouldn't be interested in the stock, but at 61% of TBV I think they're attractive.  I have a large portion of my portfolio set aside for banks such as this.  I buy my cheap banks in bulk, most positions are small, but in aggregate they're significant.

Disclosure: Long AMFC


  1. There are opportunity costs when a company is earning a below market rate of 10% on equity. Every dollar that has to be reinvested or kept in the company will not equal $1 in market value. Companies earning above 10% that can reinvest every $1 of retained earnings will create more than a $1 in market value.

    Over the long term the market returns on an investment will track the ROIC the company is able to generate. Sure you can buy companies earning 5% on ROE for half of book and flipping it at a higher price, but paying 2x book for companies earning 15%+ that can reinvest all of it for a long time will result in early retirement for the investor. The other strategy will result in a higher frequency of sending checks to the IRS, hah.

  2. Do you think you could develop some sort of bank investing checklist, maybe something like a piotroski score with one point for texas ratio, one for declining NPAs, etc? I am thinking that every few decades there is some sort of crisis and a bunch of banks fail, and after that there is a period of calm where the bankers have gotten scared straight and underwriting is solid and balance sheets are strong and getting stronger, and yet investors are still scared to put money in. At these times you pull out the checklist and pick up a bunch of banks. Then you wait a few years and sell them and file the thing away until the next crisis.

  3. How did you find about the financial information? The latest filing on SEC is 2008 and nothing available on their website.

    1. Scott,

      The financials are available on the company's website. More detailed information can be found on


  4. Nate, been following for a long time, your clarity is pretty original... I've noticed insider buying picking up at small banks lately, does this have any meaning to you? or any kind of explanation? It is just interesting to me that there seems to be a lot of regional/small cap banks trading pretty cheaply with insider buys after a pretty good bull run by the market.

    1. Matthew,

      This is very meaningful in my view. Executives are buying in after the storm clouds have passed, they know the positioning of their portfolio and where things are headed.

      I agree, there are a lot of cheap banks out there.


  5. You are absolutely right, they don't have a high efficiency ratio. If the industry of banking has its profits drop by 15%, this company will be losing money, while companies with great efficiency ratios will still earn 30% instead of 45% (so it will lower their profits by 1/3) but they will still survive and thrive.

    And you think this company could be potentially bought out? Good luck convincing the very diversified shareholder base who are also employees that getting bought out where the larger bank would cut out half their jobs is a good idea.

    I'm gonna pass... enjoy!!!

  6. Scott - the best way to find financial statements is to go to the firm's website, usually they have investor relations page, where they have the financials. If not, then try reaching out to them.

  7. Thanks for the idea Nate.

    Does the interest rate risk of this bank not concern you slightly? They seem quite liability sensitive with around 8 years duration (net).

    Not sure if this is the default stance of most community banks rather than being matched/short, but I recall WVFC, which you posted some time back, is short duration. Probably the direction I would go if forced to choose in the current environment.


  8. I appreciate you looking at banks, very few people do. But I disagree. $0.84 (ann. Q1), as you suggest, is peak, not normalized earnings. Even pre-subprime, AMFC wasn't earning its cost of equity with a peak RoE of 6.8% and (I went back 10 years) and peak EPS of $0.87 in 2004. given their volatile results, you can't value them on the last quarter of earnings that aren't reflective of the full investment cycle. I disagree with Nate saying net income isn't coming from loan reversal. NII has been flat over the past 4 years, a boost in Non-Interest-Income from helped the top line but only due to an unsustainable high gain on loan sales (it's not a recurring revenue stream). LLPs declined by 30% 2013/2012, so a big profit driver. And worst of all, costs are creeping up. An 80% efficiency ratio leaves very little margin of safety for unexpected losses or costs. If I'm very generous and disregard their two loss making years, the normalized earnings are at around $0.5-0.6. At 10x to 13x that is $5 to $7.8 a share... not really a bargain when the shares trade at $8.