Gator Financial Partners letter to investors for the first half ended June 30, 2015.
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Dear Investors:
We are pleased to provide you with Gator Financial Partners, LLC’s (the “Fund”) first half 2015 investor letter. This letter briefly reviews the Fund’s investment performance for the first half, analyzes the investment thesis for a few small cap companies we own, and discusses the Fund’s current net exposure and positioning by sub-sector.
Gator Financial Partners – Review of 2015H1 Performance
Gator Financial Partners underperformed in the first half of 2015 with a net loss of 2.42%. The broad market was up slightly during the period, while the financials sector lagged. One of the performance drivers in the first half of 2015 was a decline in the Fund’s position in Syncora. A large factor was the company did not make progress in amending its agreement with regulators. Additionally, we experienced a decline across several bank warrant positions in the portfolio as lower interest rates were a headwind to the underlying stocks. The Fund’s performance was helped by GSE preferred shares rising during the period.
Gator Financial Partners – Small Cap Growth Banks Investment Thesis
Although the banking business faces some cyclical headwinds from low interest rates and increased regulatory burden, there is a sub-sector of bank stocks that we believe is undervalued: growing, smallcap banks trading at low or reasonable valuations. These banks are generating their own organic loan and deposit growth. They are doing this by taking market share from larger banks, hiring teams of commercial bankers and paying-for-performance.
On the cost side, these banks are keeping their infrastructures reasonable by being judicious in the number of branches they open. The use of branches by both consumers and small business has declined significantly since 2010. Consumers are using online banking and credit cards to a greater degree, resulting in dropped branch visits. Small businesses have embraced remote deposit capture, so the daily visit to the bank to make deposits has morphed into weekly visits to the bank.
To continue to give you a window into our investment thinking, we review our high-level research behind two of our small cap bank holdings:
Gator Financial Partners – Peapack Gladstone
Peapack Gladstone (PGC) is a small bank located in northern New Jersey. The catalyst for the story is the CEO, Doug Kennedy, who joined the company in late 2012. In the 10 quarters since Kennedy arrived, loan and deposit growth has exploded. PGC has grown loans at 38% annualized and deposits at 17% annualized. He’s accomplished this by hiring 100 revenue producers from larger banks. In spite of this growth, Peapack-Gladstone trades at just 1.3x tangible book value.
PGC has several characteristics which we believe will help it continue its strong growth and achieve a higher valuation. First, PGC operates in the fertile New York City suburbs of northern New Jersey. This area has strong demographics and ample economic activity for a small bank like PGC to carve a niche for itself. Second, PGC is targeting wealth management in addition to basic commercial lending and deposit taking. We believe the high return on equity nature of the wealth management business will generate additional capital to reinvest into the growing bank.
We believe other investors are missing the opportunity in the bank because the market cap is small. Additionally, only one brokerage firm publishes research on PGC, and we believe their earnings estimate for 2015 is too low by 15-20 cents (or 12-16%). We believe PGC compares favorably to other banks with high organic growth and would not be surprised to see its valuation reach 2x tangible book value if it exceeds earnings estimates this year as we expect.
Gator Financial Partners – Bridge Bancorp
Bridge Bancorp (BDGE) is a high growth community bank located on Long Island. Since the current CEO, Kevin O’Conner, was appointed, he has instituted a plan to aggressively grow the bank. Loans and deposits have grown 17% annually for the last seven years.
Bridge trades at 1.7x tangible book and 10.7x our estimate of 2016 earnings per share (EPS). Bridge has been conservative with its investment portfolio in anticipation of higher rates. This defensive positioning has held down current profitability for the option of higher earnings if rates rise. In addition, Bridge has a lower than average loan-to-deposit ratio at 75%.
While we don’t buy banks on the prospect of them being acquired, we would not be surprised if BDGE is acquired by BankUnited. BDGE’s CEO, Mr. O’Conner, was an EVP and Treasurer at North Fork Bank. North Fork was a high performing bank that was eventually sold to Capital One. Former North Fork CEO, John Kanas, currently runs BankUnited and is expanding BankUnited in the New York area. As many of BDGE’s branch managers having come from North Fork, we think Bridge is a franchise primed for Mr. Kanas to acquire to get a presence in his old stomping grounds on Long Island. Even if this scenario doesn’t happen, we like the potential for BDGE to grow at an attractive compounded rate over the next five years. If this growth materializes, we believe BGDE’s valuation will expand.
Gator Financial Partners – Small Cap REITs
While we are fearful of the overall REIT sector, we have identified select opportunities among individual small cap REITs that we believe are uniquely positioned for outsized growth or are being misevaluated by the market. We think that many of the large cap REITs have high valuations driven by momentum investors piling in the sector as it was one of the best performing sectors in 2014. We also think that REIT dedicated investors are focused on the larger more liquid REITs, so some interesting small REIT opportunities slip through the cracks. Below we present a recent purchase we made in a small cap REIT focused on sales-leaseback of infrastructure assets.
Gator Financial Partners – CorEnergy Infrastructure Trust
CorEnergy Infrastructure Trust (CORR) is a REIT that owns infrastructure assets. CORR does not operate these assets, rather, it buys them from an operator and leases them back to the operator on a triple net lease basis. This can be viewed as a form of secured lending. CORR started life as a BDC and converted to a REIT in 2012. Because it is a REIT that invests in infrastructure assets, it suffers from confused investor bases. REIT investors don’t know how to analyze it because none of their other holdings own infrastructure assets. CORR’s small size also makes it difficult to garner investor attention.
In late June, CORR announced that it was going to acquire an undersea pipeline system from Energy XXI. To fund this purchase, they planned an equity offering and convertible note offering. The equity offering knocked the stock down 9%. Prior to the deal announcement, CORR was yielding 8%. With the acquisition and equity offering, they announced that they planned to increase the dividend by 11%, so at the time of the deal, the dividend yield was 9.9%.
This asset purchase was attractive for CORR because Energy XXI was a distressed seller of the pipeline assets. For example, Energy XXI’s 2017 maturity bonds trade at 60% of par. CORR paid $240 million for the asset and will receive $40 million in minimum rent. This implies they bought the pipeline asset at a 16.5% cap rate. With this cap rate on the acquisition and the leverage used in financing, CORR’s management estimates that the company’s AFFO should rise from $0.60 to $1.00 per share, so the deal is 66% accretive. CORR is only raising the dividend 11%, so dividend coverage goes from 1.1x coverage to 1.7x. We expect that they will use the excess cash flow to pay down debt before further raising the dividend.
CORR has an external management structure, similar to a Master Limited Partnership, but at a much lower cost. If you compare CORR to a traditional MLP, it has two advantages: 1) the external manager takes a lower percentage of the income and 2) they issue a 1099 versus a K-1. This bodes well for the future because they should be in a better position to bid for additional acquisitions relative to MLPs due to their lower cost of capital.
The risks to the position are:
- Asset depletion – the fields that service these wells will eventually decline, so we expect that the lease renewal 11 years from now will be at lower rates
- Long-term commodity price risk – the assets they own are leased with minimum rents, but when the leases expire, the new lease rates will depend on current commodity prices and volumes
- Customer/asset concentration risk – unlike a typical REIT, CORR only has three main assets
- Distressed customers – their two largest customers are Energy XXI and Ultra Petroleum.
We think this should eventually trade at 12x AFFO of a $1 or $12 versus recent prices around $6.35.
Gator Financial Partners – Portfolio Analysis
Below are the Fund’s largest common equity long and short positions. All data is as of June 30, 2015.
From this list, we exclude ETFs and fixed income instruments such as preferred stock.
Gator Financial Partners – Sub-sector Weightings
Below is a table showing the Fund’s positioning within the financials sector as of June 30th:
The Fund’s gross exposure is 144% and its net exposure is 48%. From this table, we exclude fixed income instruments such as preferred stock. Preferred stock positions account for an additional 4% of the portfolio.
Gator Financial Partners – Organizational Changes
We did not make any organizational changes during the first half.
Conclusion
Over the last eighteen months, our performance has been frustrating, but we continue to think we are well positioned for higher interest rates and have differentiated positions in our portfolio. Thank you for entrusting us with a portion of your wealth. On a personal level, I continue to have significantly more than 50% of my liquid net worth invested in the Fund.
As always, we are available by phone whenever you want to discuss the Fund, our other products, or investing in general.
Sincerely,
Derek S. Pilecki
Managing Member of Gator Capital Management, LLC, which is the Managing Member of Gator Financial Partners, LLC
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