Idea Brunch with John Palmer and Rich Lashley of PL Capital

Welcome to Sunday’s Idea Brunch, your interview series with great off-the-beaten-path investors. We are very excited to interview John Palmer and Rich Lashley of PL Capital, an investment firm focused on the banking sector for over 25 years.

Thanks for doing Sunday’s Idea Brunch!  Can you please tell readers a little more about your background, your passion for bank investing, and why you decided to launch PL Capital?

We both started our careers in the early to mid-80s working for KPMG as CPAs, originally in the bank audit practice.  Rich in the New Jersey and New York offices, and John in the Detroit and Chicago offices.  During our last three years at KPMG we helped create and run a national bank M&A advisory practice for KPMG.  Our 12 years each at KPMG gave us tremendous insight into the banking industry from the inside which differentiates us from most portfolio managers who learn industries as an outsider and many times only through only an investment perspective.  We left KPMG in late 1995 to start PL Capital with a focus on what we knew best, banks and thrifts, and we have never regretted the decision.  PL Capital has always been a small, nimble investment firm.  Today, we have approximately $400 mil in AUM, which is more than enough to execute our investment strategy.  We run the firm more like a PE shop than a hedge fund.  We tend to concentrate capital in our top 10-15 names and have relatively low turnover.

Over the 25+ years we have run PL Capital, we have delivered strong long-term returns for our investors without taking excessive risks.  An investor who joined our initial fund on day one in January 1996 has compounded their capital 16x.  It shows the power of long-term compounding combined with a secular consolidating industry.

We generated those returns despite the Dot-Com melt up (and down), the Great Financial Crisis, Covid, etc., and are thankful for our long-term investors who have entrusted us with their capital.  PL Capital has also thrived because banks are particularly good companies in which to invest.  Banks compound capital over long periods and the industry has been consolidating for the past 30 years and will continue to consolidate for the foreseeable future.  There were 18,000 banks in the US when we began our careers; now there are fewer than 5,000.  Bank consolidation typically occurs at the rate of 4% to 5% per year, with very few new banks being formed.  Our investment sweet spot tends to be banks with assets between one and ten billion. When we started in late 1995, there were approximately 500 banks in this category, yet today there are over 800, so even though the number of banks in the US has declined, our potential investment universe has increased.  Bank stocks are a great place for patient investors.  And the bonus you get today is banks are making high returns on tangible equity, typically in the mid-teen %s, yet most banks trade at 8-10x earnings.  In the past, banks traded for 70-90% of the overall market PE multiple. Today, banks trade for 50% of the market multiple.  That seems too cheap to us, so we will continue to do what we have been doing for the past 25+ years, invest in US banks.  And we get paid 3%++ dividends while we wait for a capital gain realization.

PL Capital has engaged in numerous shareholder activist campaigns to effect change at various banks across the US.  Why did you decide to become a shareholder activist, and can you describe PL Capital’s brand of shareholder activism?

Candidly, we stumbled into shareholder activism.  It was not our intent when we left KPMG in late 1995.

There were two banks that led us down the path to activism; neither were doing the right thing for shareholders.  The earliest one was a small thrift in Connecticut which would provide significantly more shareholder value if they were sold to another bank.  Management was resistant of our attempts to engage on the topic.  We even introduced them to an interested potential buyer, but management refused to entertain the offer.  We told them we were unhappy and might run for board seats, although we were unsure how to go about it.  Before we had a chance to follow through, the bank sold for a significant premium.  We thought to ourselves, “well, that was an interesting outcome.”  We had not intended to actively engage with management and/or run for board seats when we first bought the stock, but realized that our presence and efforts had ‘actively’ effected change. 

The second bank was Haven Bancorp, a $3.2 billion asset bank based in New York.  We recall owning about 7% of Haven, which was a significant investment for PL Capital at the time.  The stock was widely owned by institutional investors unhappy with Haven’s management because they had rebuffed an attractive takeover offer from North Fork Bank and instead plowed into supermarket branch banking.  The supermarket strategy was effectively a poison pill because most bank acquirers did not want to buy a bank with supermarket branches.  It was clear to us that Haven would earn much more if management cut expenses and shrank or closed the supermarket banking franchise.  The core, non-supermarket bank was a very attractive takeover target for acquirers looking to consolidate the NY metro market. It’s a much longer story than we have time for, but we ended up running for two board seats.  It was a contentious, high-profile fight.  We ultimately settled for two board seats, and Haven was subsequently sold to NY Community Bancorp (NYSE: NYCB).  Our battle with Haven made national news; whether we intended to or not, we became known as shareholder activists.  We were okay with the moniker because we realized it was the best way to maximize returns for our investors, and it was a unique, differentiating strategy.  And we had fun doing it.  Most retail and institutional investors in banks would never engage in activism themselves, but they were almost always supportive of us doing the work for them!

By the time Haven was sold, we had begun engaging in numerous other activist campaigns.  At first, we were the typical, aggressive shareholder activists, using press releases, proxy campaigns, litigation, and other tactics to effect change where needed.  This was often done in the public arena and was often adversarial with management teams we believed were not doing the right things for shareholders.  Many of the banks we invested in were poor performers and were worth more as takeover targets than as independent banks, but management and the board were either in denial, wanted to preserve their jobs, or both.

During the period between 2000 and 2011, we realized that we could be as or more effective if we engaged with management teams behind the scenes and by being assertive without being hostile.  Interestingly, since 2011 we have not had a proxy contest go all the way to a vote.  In almost every case where activism was needed, we have been able to work with the management teams and boards towards mutually acceptable outcomes, including improved performance, better corporate governance, board seats and/or pursuing strategic alternatives. Today, we prefer to avoid getting bogged down in protracted proxy fights, but we will do so if needed. 

We are also not “ESG” activists in the social sense, but we do care about corporate governance.  Poor corporate governance often goes hand in hand with poor stewardship of shareholders’ capital.  In short, we are primarily focused on activism which creates shareholder value.

What are the common themes or issues you see at underperforming or undervalued banks?  In your experience, do most boards/management teams care about shareholders?

We see all types of weak and strong bank boards and management teams. Often, we find that weak boards are populated by decent, well-meaning local business and civic leaders who have been lulled into indifference and apathy because the bank makes money, has decent regulatory ratings, and nothing horrible has happened on their watch.  They don’t focus on shareholder value beyond an annual visit from an investment banker for a proforma review of the bank’s strategic options.  Those board members and management teams don’t “think like shareholders” or investors.  Often, the only company bank stock they own has been given to them over the years as compensation.  Many board members also don’t have the expertise or data to fully understand whether their bank is well run, or if shareholders would be better off as part of a larger bank.   They don’t understand best practices because they only sit on one bank board. The most frustrating board members are those who simply don’t care about shareholders even though the bank is a public company; they simply want the local hometown bank to provide jobs and loans to the local community.  Or they simply like the board fees.  It is easy to be that way when it’s someone else’s money.

To counteract that indifference or ignorance, we typically provide boards and management teams with analysis and data showing what their bank is worth in various scenarios, including remaining independent or selling in the near or longer-term. We also point out areas where the bank is outperforming or underperforming.  We try not to dictate the outcome or decision.  We let the numbers speak for themselves. 

If the bank board and management team wants to remain independent, we challenge them to meet performance metrics that justify remaining independent.  We also try to let the management teams and boards define a reasonable time frame to achieve acceptable performance metrics before they think about “Plan B.”  We try to be realistic on timeframes because we know how difficult it is to optimize a bank’s performance.  A long career in banking and investing has given us the wisdom and patience to allow the right outcome to happen organically and to give well-meaning management teams and boards the right to steer the destiny of the bank.  We have less patience with mercenary management teams or recalcitrant boards who ignore reality.

Many, but not all, management teams and boards already know the “right” answer before we show up, but social factors are in play, such as the retirement age of the CEO or Chairman, good old-fashioned family nepotism, and/or macroeconomic issues that get in the way.  That is the most frustrating part of being an investor in any company, not just banks.  Capitalism doesn’t work when decisions are made for non-economic reasons, but it happens.

To be clear, we don’t want you to think that all PL Capital does is make activist investments in underperforming banks that need to sell.  We own many high-performing banks that are doing the “right” things for shareholders.  Interestingly, many of these banks are acquirers of other banks, not sellers, and we support their efforts.  Examples of well-run, high performers in our top 5 holdings include Enterprise Financial (NASDAQ: EFSC — $2.07 billion) and First Merchants (NASDAQ: FRME — $2.42 billion).