As always, below represents my opinions and should not be construed as financial advice. Always do you own due diligence. I welcome your feedback of my opinions and hope to have a civil discussion.
· Company Description
o ELI5 the company’s business model
§ Hingham is a classic bank headquartered in Massachusetts. They do nothing fancy. As of 12/31/21 they had $3.4 billion in assets with 87% of assets investment in commercial real estate, 19% in residential real estate and 5% in construction loans. As you will see, Hingham does what they are good at and nothing else.
· Company Soundness
o How does the company collect revenue? Does the company have a good or services that is purchased frequently or a regular interval?
§ As a traditional bank, Hingham holds deposits for customers and lends that cash out on various real estate deals. By virtue of these investments, they have recurring revenues to the firm as payments are repaid on their loans.
o Do they operate with significant leverage?
§ Yes, all banks do. They currently operate with a reasonable 9% equity as a percentage of assets.
o Is their balance sheet will suited for a downturn and why?
§ Yes, Hingham is extremely conservative with their financials. Throughout their history they have always reserved for loan losses far more than actual realized losses. For the most recent quarter a meager 0.02% of loans are non-performing. They earmarked 0.68% of loans for losses.
§ If you look at their history, they had better loan losses then the industry in 07,08,09, and 2010 during the rise and fall of the financial crisis. Additionally during that period they grew book value and earnings each year. During covid times in 2020 and 2021, the same is true.
§ In fact, from 1997 through 2021, they have outperformed the banking industry in charge offs each and every year! If there was ever a bank suited for rough conditions, it is Hingham.
· Can it be Replicated?
o Is there evidence that the company has defended its market position in the past?
§ Hingham was incorporated in 1834 and seen many cycles. However, the most noteworthy thing to happened to them was the takeover by the Gaughen family in 1993. Robert Gaughen instilled a disciplined underwriting culture throughout the organization. He is currently chairman and CEO of the bank and owns ~13% of Hingham. Robert’s son, Patrick, is the company’s president which gives me the confidence that the underwriting culture will continue under his stewardship. The board has a policy in place for the bank to never loan to significant shareholders due to the conflict of interest.
§ Banking is a business that can be recreated in theory, but hard to do in practice. Its really a game of can you avoid being stupid permanently. So far, Hingham has, and I believe will continue to do this.
o Is there evidence that market power is growing and that this will lead to strong financials?
§ Yes. Every year for the past decade Hingham has had higher ROEs than their peer group (Mass based banks) while simultaneously having lower charge offs (bad loans).
§ Their revenue per employee is a staggering $1.5 million. The financial sector overall is at $320k.
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o What is the competitive advantage?
§ The competitive advantage is operational excellence. There are many banks in this world, and basically none of them have the financials of Hingham. Hingham has avoided the temptation to move outside of their competence in real estate lending. Management seems keenly aware of this advantage and on their annual meeting slides has a slide dedicated a slide to what they don’t do: Commercial and Industrial Lending, Consumer Lending, financial advisory, insurance, second mortgages, tax credits, solar, etc. This pure focus on real estate lending allows them to have best in class operational management.
§ Their efficiency ratio, a measure of operating expenses / net interest income is a meager 22%. According to S&P the average bank has an efficiency ratio in the 60s. This means Hingham is able to operate with 40 BPs fewer operating expenses. That is ~66% less! That alone gives them far more financial flexibility to deal with a downturn.
§ In my view, these results are a tribute to the centralized underwriting process. The executive team reviews all loans over $2 million. The board (yes the board) reviews all loans with aggregate exposure of $6 million and no entity is allowed to have more exposure than 20% of Hingham’s equity. Their largest client has loans outstanding of $56 million and is current on all payments. This process has clearly been effective but does raise concentration and scale concerns as they continue to grow.
§ Hingham through the Massachusetts Depositors Insurance Fund (DIF) offers unlimited deposit insurance. In my opinion, this is a huge advantage and is likely to attract large cash depositors any many will be large cash borrowers. This combined with the Specialized Deposit Group which works with clients who have complicated deposit and lending needs should help continue to grow the bank as they move from Massachusetts and into Washington DC and San Francisco .
o Would $10 billion of capital be enough to re-create the company?
§ Capital is not the issue here. There are many banks with far more capital than Hingham who simply can’t replicate their model as it takes considerable discipline. Embedding that into a culture is not common.
o Are parts of the company not able to be recreated with capital? Which parts and why?
§ The bank itself is as capital intensive as it gets. The operations around that are difficult to replicate.
o Are there competitive threats on the horizon?
§ Yes, many new fintech companies, digitization of banking, etc.
o Are their major company specific risks?
§ Concentration among the executive team. As mentioned, the executive team manages the underwriting process quite close to the vest. With only 75 employees and $3.5 billion in real estate loans, the executive team will need to find a way to scale their operations for continued growth.
§ While I view the Gaughen family as a positive, their concentration of ownership and leadership should be monitored. They seem to trust in Uncle Ben’s wisdom given the strong stewardship over the past 30 years.
§ Hingham in recent years has expanded geographically from Mass to San Francisco and Washington DC area. There are some questions if their methodology will continue to generate high returns in these different areas and will they be able to increase deposits at a similar clip to expand their loan portfolio.
· Growth
o Is there a 90% chance that earnings will be up 5 years from now?
§ Yes, Since 1993, when management took over, there have been 3 years when earnings have dropped and they have never had a loss. Additionally book value has grown every year since 1993.
o Is there a 50% chance earnings will continue to grow in excess of 7% per year after the 5 year period?
§ Yes, as a small regional bank, Hingham has a very long growth trajectory in front of it. Growth rates have averaged above 10% historically.
· Watch List Decision
o Do you honestly know enough about the industry and company to make an investment decision?
§ I believe I do.
o Bottom Line: Based on your answers is the company well insulated from economic and competitive shocks while able to grow for many years to come?
§ Yes, best in class margins and conservative underwriting will serve them well in weak economic scenarios.
· Valuation
o Value the company
§ Revenue CAGR over 3,5,7 and 10 years: 22.3%, 14.2%, 13.5%, 12.2%
§ Going forward I will assume 11% as an average CAGR given that they are larger than they were but have a very small footprint.
§ Net Interest Income over the TTM through 09/30/22 was $107 million
§ For 12/31/2025 this implies a revenue midpoint of $151 million. I applied a 15% premium and discount for a bull and bear case. The 15% haircut and premium make the implied revenue growth rates for the bear and bull case between 6% to 16%. I felt it was prudent to stay balanced on the upside and downside as Hingham has a history of consistently growing through 08-09 and COVID despite major concerns of a recession on the horizon.
§ The average FCF Margin over the past 5 years has been 47.5%. I assumed a 42.5% bear and 52.5% bull case.
§ Shares have marginally diluted over the past 3, 5 years. I assumed shares will increase between 0 and 0.25% going forward compared with a 0.10% dilution over the past 5.
§ Hingham has a small ordinary dividend and annually tends to have a large special dividend. I will assume this continues. I will assume a flat annual dividend of $2.75. This is off its current levels of $3.07. I believe there will likely be a smaller dividend next year assuming we have a recession followed by a return to growth.
§ 2025 FCF is estimated to be between $25.25 and $42.54.
§ Historically, FCF Yields have ranged between 6% to 12%, I will keep this range going forward.
§ Putting it all together, I get an estimated value on 12/31/2025 of $354 to $420 per share. At the midpoint this implies a 3-year CAGR of 12.74%. The low range is 9.46% and the high range is 16%.
§ If Price/Book turns you on for banks, it currently trades at 1.6x and has averaged 2.1x for the past 5 years. Let’s assume 1.9x book going forward to account for a slightly lower growth rate. Book Value per share grew at a 15% clip over the past 10 years and is currently 175.52. If we assume a 11% growth rate for 3 years and a 1.9x P/B we get an implied 3 Year CAGR of ~20%. If that turns out to be true, that is a steal. For the record I am not a fan of valuing banks on a price/book ratio as I believe the entity should be valued on the distributable cash flow of the business, like any other business. I feel this way because, the book value is not likely to be realized and the operations will stay intact. This is true even for banks that trade below book value.
o Would it be a prudent investment to buy the company at current levels?
§ For a small cap bank with rock solid fundamentals, I would like to earn 12% per year off the investment. That implies a target price today of $283 given my expectations for 2025. Currently, Hingham sells for $272.50 and therefore is fairly valued per my estimates.
Sources:
Aggregated Data: https://finbox.com/NASDAQGM:HIFS
Hingham Investor Page: https://www.hinghamsavings.com/investor-materials
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