Chris Mayer

Not every banker succumbed to the insanity of the housing bubble. Some saw what was happening and dodged it. These are the guys you want to stick with as an investor.

Marc Stefanski is one of them. He is the CEO of Third Federal Savings & Loan (TFSL on the Nasdaq). It is a Cleveland-based thrift founded by Marc’s parents in 1938.

“We were founded during the Great Depression,” Stefanski wrote in a letter in 2009, “so my parents built our company to be Depression-proof.” And so it is. Today, TFSL is one of the best-capitalized banks in the US. (More on that below.) But TFSL had to walk a lonely road to get here.

Stefanski’s bank pays its loan officers no commissions. They are paid salaries only. Hence, there is no pressure to make loans. His bank also keeps most of the loans it makes. So there is no slicing and dicing of mortgages and passing them off to investors. And finally, TFSL did not make no-money-down loans. It stuck to plain vanilla loans even as competitors offered snazzy new takes on the old mortgage loan. TFSL began making adjustable-rate mortgages only in 2010. It avoided all the junk that went into making the financial sausages that wound up giving the banking system such indigestion.

But it was costly. TFSL had a market share of 30% in northeastern Ohio. Its refusal to play ball meant that its market share dwindled to 11% by 2001. How many CEOs could survive such a decision?

Yet today, TFSL has worked its market share back up to 24%. It has done so because it has lots of capital while many of its peers have leaky loan books. It is still sticking to its conservative approach. For instance, for more-risky borrowers, TFSL requires borrowers take classes that show how their loans will work and what the consequences are of not paying. Such strategies have earned TFSL praise from community activists.

Stefanski is blunt about it all. “The whole system was based on raping the public,” he says in a New York Times article. “Not everyone should own a home — just those who can afford it.”

There is an old saying that there are more banks than bankers. Most of the people running banks have no business doing so. Banking as a corporate art requires a careful approach and a willingness to stick to conservative principles even during the good times. Stefanski has earned the title of banker in the best sense.

His institution is, as I noted, one of the best-capitalized banks in the US. It never took TARP money or any other handout. TFSL today has capital ratios far in excess of what’s required. For example, the rules require Tier 1 capital of at least 6% of assets for a thrift to be considered “well capitalized.” TFSL’s figure is 21%. It has enough excess capital to buy back all of the public shares outstanding at today’s price of $9.50 per share.

Ironically, TFSL works under a memorandum of understanding (MOU) issued in June 2010 by the OCC, which regulates TFSL. Among other things, the OCC said TFSL’s percentage of home equity lines was too high. What this meant was that TFSL cannot pay a dividend or buy back stock until the OCC lifts the MOU.

It’s a weird tale, but the short of it is that TFSL has now met the requirements of the MOU. Now TFSL is just in a waiting game. I expect the OCC will lift the MOU by the end of the year. Then TFSL should start to pay dividends and buy back shares as it did before. That is a nice catalyst for the stock, which was $12-$13 per share before the MOU.

There is another important part of this to know: TFSL is owned by a mutual holding company (MHC). There are about 81 million shares public. But there are 227 million shares in the hands of the MHC. The usual course of these things is to undergo a “second-step conversion.” The second step sells the MHC shares to the public. If done at 80% of book value, TFSL would raise $2.3 billion in cash — all of which goes to the bank. Add this cash — net of estimated friction costs of 12% — to the existing equity in the business and TFSL’s fully converted book value comes to about $12.50 per share. The stock as I write is only $9.50. While there are no plans for a second step, it’s another embedded catalyst in the shares.

At today’s price, you get a thrift with an awful lot of capital to buy back stock and/or pay a big dividend. Once the OCC lifts the MOU, I believe TFSL will start to do both of these things — and because it trades for under fully converted book, these transactions are accretive (read: value-adding) for shareholders.

I should tell you, as an aside, that I love converted thrifts. Carefully chosen, they are cash-rich, trouble-free and simple lending institutions. And they have a long history of producing winners for patient investors. I have about 40% of my personal account in just such cash-rich thrifts.

And in my Mayer’s Special Situations newsletter, I have recommended five such thrifts. I recommended three of them in January 2011, and they are up 20% or more. The two I recommended last summer are also up double digits. Slow, but steady. I’ve never lost money on a single one.

Back to TFSL. I did not formally add it the portfolio of my investment letter, Capital & Crisis. But I do believe this stick is a solid idea and that it clearly illustrates the kind of banking institution that investors should seek to own.

If US housing has bottomed and will only improve, as I believe is the case, so too should the stocks of cash-rich banks, especially those that sidestepped the worst of the housing bubble — such as Stefanski’s TFSL.

Regards,

Chris Mayer
for The Daily Reckoning

Chris Mayer

Chris Mayer is managing editor of the Capital and Crisis and Mayer's Special Situations newsletters. Graduating magna cum laude with a degree in finance and an MBA from the University of Maryland, he began his business career as a corporate banker. Mayer left the banking industry after ten years and signed on with Agora Financial. His book, Invest Like a Dealmaker, Secrets of a Former Banking Insider, documents his ability to analyze macro issues and micro investment opportunities to produce an exceptional long-term track record of winning ideas. In April 2012, Chris released his newest book World Right Side Up: Investing Across Six Continents

Recent Articles

Attack on America’s Most Important Pipeline

Byron King

America's most precious resource isn't oil, natural gas, gold or any other commodity. But it travels through an extensive pipeline that, if severed, could signal an unprecedented breach in U.S. security. What is this pipeline, and why is it so imperative that the U.S. take steps to protect it? Byron King explains...


3 Critical Correction Warnings

Greg Guenthner

The S&P 500 just clocked a new closing high last week, while the Dow and the Nasdaq both fell just short or their previous highs. But under the surface, you'll find a few bits of evidence pointing toward lower prices. And right now, there are seeing several warning signs that could point to market weakness. Greg Guenthner explains...


Extra!
Where You Can Make $56,000 a Year Delivering Pizzas

Jim Mosquera

US unemployment rates are some of the most dubious and debatable numbers in economics. And when you look at how the government fudges them it's easy to see why. Today Jim Mosquera attempts to make sense of them, and includes an insightful commentary on another controversial topic: minimum wage. Read on...


Addison Wiggin
The Quickest, Easiest Way to Store Your Wealth Overseas

Addison Wiggin

Over the years, the feds have made it increasingly difficult for you to maintain any semblance of financial freedom. So today, Addison Wiggin details one strategy that will go a long way to keeping them at bay, and allow you to keep more of your hard-earned money in the process. Read on...


The Next Phase of Gold Profits is About to Begin

Frank Holmes

Today Frank Holmes shows how tracking the past history of the Federal Reserve's Funds Rate Cycle can be a powerful prediction tool for gold investors. Specifically, he points out why this is the beginning of a period in the cycle that's historically favorable for the price of gold, and how you can take advantage of it. Read on...