An Old Oddball Stocks Idea Has Its Day - Sale of Sunnyside Bancorp, Inc. ($SNNY)

Back in August 2014, Nate wrote a post, "Sunnyside bank, severely undervalued on the cusp of a turnaround,"

I have a portion of my portfolio set aside specifically for cheap bank stocks.  In the terms of some value investors my dedicated cheap bank portfolio might be considered a 'basket'.  That is I buy tiny stakes in many banks if they meet certain criteria.  I purchase larger positions in banks outside of this basket, but inside of it most positions are roughly the same size, about a quarter of a percent.  No single bank is going to make or break the portfolio, but as a group I have a large exposure to undervalued banks. Sunnyside Bancorp (SNNY) is one of these banks.

Sunnyside Federal is a savings and loan that was established in 1930.  The bank is located in Westchester County about 25 miles north of New York City.  The bank's headquarters and only branch is located on Main Street of the quaint Irvington a few blocks from the Hudson River.  They're also located near a number of country clubs, which should tell you something about the area they're located in.  Westchester is the second wealthiest county in the State of New York with median home values of $533k and median household income of $81k.

The bank started as a mutual meaning the depositors owned the bank.  The bank felt constrained by their mutual structure and in 2013 conducted an IPO.  The IPO raised $7.9m with the sale of 793,500 shares at $10 per share.  Depositors are given the first opportunity to purchase shares and with the completion of the IPO the shares now trade on the secondary market.  The IPO proceeds plus their capital prior to the IPO gives them an equity value of ~$12m or $15.12 a share.  Given that shares most recently traded at $9.45 this is an attractive stock at 63% of book value.

The bank's conversion from a mutual to a stock company was in an effort to pursue growth.  The bank is as safe as they come with a 35% Tier 1 capital ratio and 13.7% Core capital ratio.  They have a very small amount of non-performing assets, and OREO.  Some small banks trade for less than book value because they have an asset quality problem, Sunnyside does not.  Sunnyside has a growth problem.

We just saw a press release from last night: DLP Bancshares Inc., an affiliate of DLP Real Estate Capital, to Acquire Sunnyside Bancorp, Inc. Under the terms of the acquisition agreement, shareholders of Sunnyside Bancorp are supposed to receive $15.55 in cash per share. From the time when Nate wrote about it, shareholders will have earned an IRR of around 8% compounded if the sale happens for $15.55 per share. Tangible book value was $14.99 per share as of September 30, 2020. 

Sunnyside is and has been an overcapitalized (27.5% Tier 1), unprofitable former mutual bank (i.e. a conversion). Note that the idea got a little bit of flak in the comments:

• Are you concerned with the declining deposit base?
• As a customer of this bank and many other banks- I find NOTHING going for this bank that deserve mention EXC EPT your figures that a buyout from another bank can make sense. WHile you glossed over the fact that this bank had to go from MUTUIAL to Stock mainly because it was losing money the fact that stockholders now have to make that up instead of its customers is no solace. Holding this banks stock for some kind of buyout may be not a reason to buy the shares as long as the bank itself has at its core a very limited banking services and simply poor business practice.

Sunny side is an impressive case of how well a poor quality business can do if bought at the right price. For seven years, book value has remained the same ($15) - meaning the occasional profitable years were offset by subsequent losses. The bank did not pay a dividend or buy back stock, either.

Owning it would have been like watching paint dry, or even worse. The only thing it had going for it as an investment was valuation - 63% of tangible book when Nate bought. Every year you would have been tempted to sell it because nothing was happening. There was no story to tell about progress or improvement. 

Lyall Taylor has some very important posts about how value investing works, and will continue to work, because of psychological barriers and institutional (principal-agent conflict) barriers to implementing it:

The fundamental issue underlying all these factors, I believe, is the nature of the payoff patterns deep value stocks typically exhibit, and why. A typical value stock has well-understood and well-publicised problems/issues/risks, and the majority of the time, for individual issues, these well-understood issues do result in subsequently lackluster investment outcomes (usually in the form of protracted periods of stagnant performance that lag go-go market favourates). [...]

[I]t is not just a principal-agency issue - this non-linear payoff profile is also psychologically very difficult for the investment practitioner/analyst themselves, because investing in/recommending such stocks requires one to endure a continuous stream of negative reinforcement most of the time, of which our human psychies are not well adapted to withstand. Indeed, academic research shows that most people's ability to remain rational breaks down in an environment of constant negative reinforcement. Day after day, month after month, and even year after year, the market, friends, associates, the media, and clients are telling you you are wrong and are a fool, and most of the time that judgement will seem vindicated by subsequent outcomes. [...]

 Many so-called 'value' investors fall into this trap. Most value investors these days do a lot of things that are actually the antithesis of true value investing as described above: they focus on buying good businesses with good outlooks trading at 'reasonable' valuations (read full/high but not absurd multiples), and they invest in concentrated portfolios. This is the antithesis of exploiting the market's tendency to overprice the best businesses with the best outlooks and underprice the worst businesses with the worst outlooks; and it focuses - just like the market - only on the base-case, most-likely outcome, and generally ignores tail risks. And yet it is changes of opinion, driven by unexpected events, which drives the vast majority of the big moves (and returns/losses) in markets. The fundamental issue underlying this dynamic is that investors systematically overestimate their ability to predict the future, and are therefore prone to overconfidence and excessive extrapolation. [...]

The truth is that there is no statistical evidence that high quality stocks - however they are measured - systematically outperform. In fact, there is evidence to the contrary, and it makes sense why: investors overestimate their ability to predict future growth and business quality, and underestimate the capacity for change. Consequently, investors systematically overpay for growth and quality. The problem is that when aspirant 'value' investors come to implement the philosophy, they notice that all the cheap businesses have problems of one type of another, and so avoid them. They end up seeking quality instead of value, and forget that you are rewarded in markets not for identifying and owning good companies, but instead for identifying and exploiting mispricings. It turns out markets are 'too efficient' at pricing in growth and quality - it is too well recognised so they overpay for it.  

Why are they finally selling? The board and officers only owned 6.5% of the company. The bank is in Irvington, NY (up the Hudson) and the top three execs were making $570k combined. The CEO turned 66 this year, maybe that was why?