Here Comes The Sun (Bancorp)

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By Hemlock Partners :

Executive Summary

We're thinking two steps ahead in the attempt to identify tomorrow's best investment opportunity today. Sun Bancorp ( SNBC ) is a unique opportunity to invest alongside Wilbur Ross, one of the great value creators of our generation. The bank is finally focused on achieving profitability, which will unlock near-term shareholder value. For long-term investors, SNBC is an exceptional chance to participate in a massive wave of consolidation about to hit the banking sector.

Background

With over 50 branches in New Jersey, SNBC is a full-service commercial bank with approximately $3 billion in assets. After surviving the credit/financial crisis, SNBC has labored through a multi-year turnaround. In addition to raising capital, the bank divested problem loans to solidify the balance sheet. SNBC also reduced expenses by closing underperforming branches.

Despite these initiatives, the bank's progress to date has been uninspiring. In addition to credit costs, non-interest expenses remain elevated, hindering the bank's ability to turn a profit. On an annual basis, SNBC was last profitable in 2008.

However, all is not lost. At the end of November, investors finally received some positive news. The Board dismissed President/CEO/Board member Thomas Geisel and has retained an executive search firm to identify a successor. SNBC's Chairman of the Board, Sidney Brown, will stand-in on an interim basis.

Step 1: Right the Ship

On SNBC's 4Q call , Mr. Brown was quite direct in the bank's go-forward strategy and what will be expected from new leadership. Indicating a new sense of urgency, SNBC expects to return to profitability in 2014 by right-sizing expenses with current revenue. A key component of this target will be the reduction of professional fees, which totaled $4.9 million in 4Q13 and $18.2 million in 2013. Beginning in 2Q14, the bank expects consulting expenses to range between $1 million and $1.5 million on a go-forward basis.

The focus on near-term profitability is significant because it will enable SNBC to begin to recapture its substantial deferred tax asset. At December 31, 2012, the bank had a valuation allowance of $113.4 million against its deferred tax asset. The release of the valuation allowance would have a positive impact on earnings, capital and, ultimately, the equity valuation.

Notably, turnaround connoisseur Wilbur Ross, best known for his deep value investment approach, is a major shareholder and Board member. Ross's involvement gives us confidence in the validity of SNBC's revised turnaround plan.

Step 2: Growth

The banking community is in the midst of a challenging situation. Although banks operate in a low net interest margin environment, there are limited organic growth opportunities available.

Further, rising compliance costs are encouraging banks to increase assets, thereby spreading the expense over a larger base. As banks look to expand, the most logical approach is to acquire smaller peers.

Once SNBC has its own house in order, there is a considerable opportunity to consolidate the New Jersey market. In fact, the Garden State is one of the most over-banked regions in the country.

Upon announcing a 25% equity stake in SNBC, Mr. Ross hinted at such a scenario.

The next 18 banks in size after this one, together, have around $5 billion in deposits, and there's another 100-some-odd banks that, in total, have $40 billion in deposits," Mr. Ross said. "That's just way too many banks for one state to have. (Source: The New York Times )

The ambition to expand is multi-fold. In addition to the obvious benefits of scale, the market simply prefers the larger banks. Over the last four years, the stock performance of large cap financial institutions has double small cap returns. As such, smaller banks, on average, are valued at about 90% of book value versus 150% for the national players.

For long-term investors, SNBC is an exceptional chance to participate in a massive wave of consolidation about to hit the banking sector. The company's footprint is at the center of what should be one of the country's most active regions.

With the backing of Mr. Ross's private equity firm (over $7 billion in AUM), we believe SNBC is ultimately the acquisition vehicle to roll-up a number of financial institutions in New Jersey and beyond.

Disclosure: I am long SNBC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Economy

Referenced Stocks: SNBC

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