Versailles Financial, almost too good to be true

Illiquid community bank stocks are possibly some of the most neglected securities in the market.  Many investors won't consider making a bank investment, and further, not many bank investors are willing to venture into the dark reaches of the unlisted and illiquid stock world.  It's at the junction of these criteria (unlisted, illiquid, bank) that some of the best deals of the market can be found, Versailles Financial (VERF) is a perfect example.

Community banks can be scary to some investors, a few bad loans and the whole ship is sunk, especially with a small bank.  A few bad loans at a larger bank and no one notices.  A few bad loans, years worth of bad decisions, and bad management and the country's citizens will bail you out at a large bank, unfortunately (or fortunately) there is no one backstopping community banks.  I would prefer a bank with management making intelligent lending decisions resulting in few if any losses.

Versailles Financial is the holding company of Versailles Saving and Loan, a single branch bank located in Vesailles Ohio founded in the 1800s.  The company shares its name with the royal and well known palace in France.  Versailles Financial is neither well known, or anything of note.  Versailles Ohio is a city with a population of 2,687 people.  I grew up in Northern Ohio, and we used to joke places like Versailles had more cows than people, the joke was funny because it was often true.  The bank's link to agriculture is most evident with that fact that 16% of its loan book is for farmland.

The investment case for the bank is fairly simple, the company's current market cap is $5.9m against a tangible book value of $9.8m.  In other words they're selling for 57% of TBV.  The bank is also profitable, and has been for the last nine years, sailing through the financial crisis without a loss.  They're over capitalized as well with an 35% tier one capital ratio.  The company's nine year earning summary is shown below:

The company isn't generating record earnings which can mostly be attributed to the lack of scale the bank has with only one branch.  A bank's branch network is what works to gather deposits and generate new loan volume for the bank.  With only one branch deposit and loan growth can both be constricted, which is the case for Versailles Financial.

One item worth noting on the income summary above is the lack of provision for loan losses.  A bank's safety is derived from its balance sheet.  A bank's value is also derived from its balance sheet.  If a bank has a history of dodgy loans then it's worth discounting their loan book when valuing them with the expectation that the future might look similar to the past.  Versailles Financial's lending history has been absolutely pristine with a very small amount of loan loss provisions, and an even smaller amount of charge-offs and non performing assets.  As of the most recent quarter the bank had zero non performing loans, no loans past due, and no OREO holdings.  Sit and consider that for just one minute, every single loan that Versailles has made is paying on time, the company has zero bad loans, not even one tiny mistake by a junior lending officer, none.  Granted this could change quickly, but given their lending history I'm fairly confident in their lending ability.

A cynic might read the above paragraph and think that they are cooking the books.  I would argue the opposite.  Recently bank regulators have been coming down hard on community banks in the area of charge-offs forcing them to realize them early.  Because of this the income statements of small banks have been prematurely depressed.  The large banks aren't dealing with this, regulators have allowed them to post-pone charging off loans that haven't paid in over six months; extend and pretend is alive and well at our largest banks.

An astute reader might wonder why this bank hasn't sold yet, they appear to be a prime candidate.  Single branch banks make perfect acquisition targets, there are many costs that can be removed quickly, such as the duplicate CEO and CFO, where the savings flow straight to the bottom line.  In the case of Versailles the retirement of the CEO and CFO alone would most likely double earnings.

The bank was founded as a mutual in the 1800s and IPO'ed in 2006.  Mutual conversions are restricted from selling themselves anytime before the three year anniversary of their IPO.  The timing for Versailles wasn't that good, their three year anniversary fell in the beginning of 2009, not an ideal time to sell a bank.  Since 2009 the bank M&A market has been soft, especially for many smaller banks like Versailles, it's hard to get a deal done for a $48m (assets) bank, there just isn't much interest in that market size.

While size is a potential negative I'm comfortable investing in a small bank with pristine credit quality at 57% of TBV.  When the bank IPO'ed a reasonable valuation would have been 1.2x TBV, at this point even if the bank traded up to TBV shareholders would be satisfied.  Until the market realizes what a deal Versailles is I will continue to hold the stock and let management do what they do best, make high quality loans and collect interest.

It's worth mentioning that this is an extremely illiquid stock, it trades by appointment on occasion.  It took a few months for my initial order to fill.  Patience is rewarded with a stock like this.

Disclosure: Long VERF