CBB Bancorp
A Korean American bank trading on OTC at 3-4x normalized earnings and 45% of book value
Disclaimer: None of what I write is a recommendation to buy or sell a stock. I am an internet stranger writing about random businesses with no successful track record in investing. This is a selfish endeavor to grow as an investor myself and to document my research as I do not have a good memory. Please do your own research before buying a stock.
If you like reading pdfs, here is a pdf version of this writeup.
Thesis - The Shorter Version
A Korean American community bank, that has compounded net income at a 11% CAGR in the past decade, book value at 13% CAGR, along with a very good track record of loan underwriting, sells for a 5x multiple of current net income(3-4x multiple of normalized net earnings) and 45% of book value.
Warning: This company is a highly illiquid micro-cap, so any trades should be placed as limit orders.
Introduction
CBB Bancorp(OTC: $CBBI) is a bank holding company that owns a Korean American Bank called Commonwealth Business Bank(CBB). This bank was started in 2005 and based majorly in Southern California. Korean American banks are those banks that primarily serve the Korean American Community in the US. Los Angeles county has a big Korean American community and this region is the primary focus of CBB. They also have branches in Texas and Hawaii.
CBB is an SBA lender - a financial institution that works with the SBA(Small Business Administration) to offer loans to small businesses. A major portion of these loans’ principals are guaranteed by the SBA and hence attractive to lenders, assuming they assess credit-worthiness of the borrowers properly. CBB participates in the SBA 7(a) and 504 Loan Programs. The 7(a) loan program is a multi-purpose loan program that can fund working capital, or an acquisition of business or property etc, which is 75-85% guaranteed by the SBA. The 504 loan program funds real estate and asset purchases, which are 50% guaranteed by the SBA.
I would love to thank
for writing this idea up on his substack. He does a much better job at it than me and graciously allowed me to write up this idea on my substack.Asset Liability Structure
CBB has a $1.42B loan portfolio, which is made up of 85% commercial real estate(CRE) loans, 11% Commercial & Industrial(C&I) loans and 3% residential loans. 30% of these loans are SBA loans(26% CRE SBA loans and 4% C&I SBA loans).
Their commercial real estate loan portfolio seems well diversified as shown in the image above, with not a lot of exposure to office real estate which has been struggling ever since COVID. Their loans are funded by a $1.48B deposit base - 20% of these are non-interest bearing, 6% are savings accounts, 18% money market deposits and 56% time deposits. Wholesale deposits make up 10% of total deposits. Core deposits1 make up 67% of total. Federal Home Loan Bank(FHLB) advances were just $50M(3% of liabilities).
NOTE: Federal Home Loan Banks are a system of 11 US government sponsored banks that provide liquidity to financial institutions to support housing finance and community investment. They operate exclusively in the secondary market. These act as temporary funding sources for banks, especially during emergencies when they see deposits go down unexpectedly. This funding source gives them time to downsize their loan portfolio or find other funding sources.
How do banks make money?
A bank takes deposits from people/businesses, pays them an interest and in turn lends this onwards to other people or businesses which need money, for a higher interest rate. While lending money, it is a bank’s responsibility to lend as safely as possible to creditworthy borrowers. A bank also has to deal with expenses associated with running the bank itself - branch leases, utility expenses, employee salaries etc. Now, what makes banks risky is the fact that depositors can ask for their money back at any time whereas the loans are not callable instantly. As one can see from how a bank works, they primarily have one revenue source, which is interest income from loans(some banks also have a considerable portion of their assets invested in securities which also earn interest) and three buckets of expenses. Their expenses consist of the following:
Interest expense
Net non-interest expense(measure of operational efficiency)
This is calculated as non-interest expense minus non-interest revenue
Loan charge-offs(from loans that are not paid back)
To be profitable, banks want to minimize the three expense categories above. All banks try to minimize their loan charge-offs(third bucket above) by underwriting loans conservatively. Now, there are two approaches banks take to minimize the first two expenses, which lead to two types of banks. Type 1 banks try to have the lowest interest expense, as a percentage of deposits. These banks have a large, loyal core deposit base, indicated by a large percentage of deposits funded by noninterest bearing accounts. This gives them the cheapest funding source amongst all banks. Type 2 banks try to have the lowest net non-interest expense(as a percentage of deposits) possible by running an efficient operation with minimal operating expenses and a good amount of non-interest income(like asset management income etc from depositors) to offset some of these expenses. These banks typically do not have a big non-interest bearing deposit base, and have to pay market rates of interest to attract depositors. Since interest expense is usually the biggest component of costs, type 1 banks generally have a lower total cost of deposits(sum of the three expense components above) as compared to type 2 banks.
Type 1 banks, as a result of their low cost deposit base, don’t typically have to make higher yielding(think riskier) loans, even with their slightly poorer efficiency figures, in order to make sufficient return on investor capital. These banks can make sleepy residential loans which are amongst the safest types of loans and can also have a significant securities portfolio as part of their assets without compromising return on equity. These banks can also have greater financial leverage(lower leverage ratio) in their balance sheets, as a result. Type 2 banks have lower financial leverage(higher leverage ratio), make higher yielding loans(commercial real estate for example) with minimal securities exposure to make sufficient RoEs. CBB is a Type 2 bank. Type 2 banks are slightly easier to analyze as they tend not to have a considerable securities portfolio - most of their deposits are usually lent out(with loan to deposit ratios typically greater than 90%).
NOTE: Most of my understanding about banks comes from reading the writings of the legendary Geoff Gannon. Here is a great article by him.
Financials
What is the Opportunity?
Historically, their yield on loans has been 4% points above the risk free rate. Currently, at 7.03%, this is only 2.8% points above the current risk free rate of 4.2%. This is because, ever since risk free rates went up from 2022 onwards, a portion of their loans were repriced but some longer duration loans are yet to be repriced as these were fixed rate loans yet to mature. The bank’s recent call reports give an idea about the maturity/repricing timelines of their loan book.
As can be seen from the table above, from 2022-2024, their loans with maturity/repricing within 1-3 years and 3-5 years have been skewing more towards the former category than the latter. The average duration of loans have also been coming down. As these loans reprice over the coming year or two, their current temporarily compressed net interest margins should go back to average levels in the past. I believe that their current return on deposits of 1.5% does not represent normalized returns. From 2015-24, they have averaged return on deposits of 2.2% - this is probably more close to a normalized number. Either way it doesn’t matter. The bank already trades just at 5.3 times current net earnings(and 45% of book value). When normalized earnings are plugged in, the bank probably trades at a 3-4x after tax multiple.
CBB has been profitable every year since 2011. They were loss making in 2009 and 2010 during the 2008 financial crisis. Maximum loss was in 2010, when they lost $1.8M, which was just 3.7% of their book value($49M) at the time. Their loan loss allowances for 2010 was 2.6% of their loan book. Today, if they had a similar loan loss allowance of 2.6% of loans, assuming 2024 pre-tax income levels, their losses(net income) would be close to a breakeven level, at just 1.7% of book value. They can easily withstand losses today, similar to their peak 2008 financial crisis losses of the past. Moreover, since we are just paying 45% of book value, the margin of safety is even higher.
How has the bank performed in the previous decade? Since 2014 to 2024, book value has compounded at a CAGR of 13%, loan book at 10% and deposits at 11%. Net income has compounded at 11% CAGR from 2014-20232. It is almost impossible for an outside investor to know of the quality of the current loan book. The best we can do is to look at their past track record. Their allowance for loan losses have also averaged just 0.15% of loans in this period. The actual loan charge-off rate has been even lower. A 3-4x multiple for such a bank that has grown NI at a 11% CAGR is too cheap. The company also has a dividend yield of 3% at its current market cap.
What is more, CBB’s loans to equity ratio(indication of leverage) was about 5.8 in Dec 2024. This number had been an average of 7.4 in the previous decade. This means that CBB is currently more capitalized than normal, with spare balance sheet capacity to take on more deposits in the future that would fund growth in their loan book and net income, without raising additional capital. Thus, normalized earnings may be even higher adjusting for this factor and the PE multiple even lower. This can be a pleasant surprise if it happens but we need not count on it, especially in the short term. All this is great, but.........
Is there a catch?
If you look at their net non-interest expense cost(% of deposits), this has gone up from 1.3-1.6% in 2015-17 to an average of 2% since 2018. This is attributable to a decline in their non-interest income(per branch) vs non-interest expense that was flat(per branch). A big source of their noninterest income was gains on the sale of their SBA loan book. Since 75-85% of SBA loans are guaranteed by the federal government, these loans are very attractive to investors in general. These SBA lender banks can often earn higher returns on capital by selling the guaranteed portion of these SBA loans at a premium to book(given that these are close to riskless). This frees up bank capital which can go into new SBA loans, rather than holding them to maturity.
In 2021, for instance, CBB realized a big gain on these SBA loan premiums. Since 2021, however, the bank has kept more SBA loans on the loan book, rather than selling them off. This was probably because making newer loans became more difficult with the interest rate rises and instead, they decided to just hold these loans to maturity, juicing up their interest income.
SBA loans now make up 30% of their loan book of $1.4B($420M). Recent articles from Barron’s and Forbes indicate that many SBA loans are going bad at this time. CBB’s loans have also been showing trends of increasing NPAs(non-performing assets3). NPAs have risen from 0.14% in Dec 2023 to 0.66% in Dec 2024. This corresponds to 0.84% of the loan book being non-performing. 1.35% of loans are delinquent4 and 1.6% of loans are marked as classified5 assets.
The rise in NPAs is definitely a worrying trend. However, let’s try to estimate the downside risk. Out of $420M of SBA loans, let’s assume that 10% of loans default - which is a conservatively high number. Of these $42M of loans that default, 75% is backed by the federal government. So, the maximum loss to CBB is just about $11M. CBB’s current book value is $254M. CBB is very well capitalized to absorb these losses(potential losses being just 4.3% of current book value). Also keep in mind that many of these loans are probably already backed by assets which give some downside protection. Moreover, their 2024 pre-tax income was $32M. This income level can absorb three times the losses that I postulated here. This income level is also already lower than normal due to a temporarily compressed net interest margin in my view.
CBB also has unrealized losses on their loan book of $55M as of Dec 2023(their latest numbers should appear on their 2024 Annual Report). This is an accounting number as a result of the interest rate raises since 2022. These unrealized losses are a result of a portion of their loan book yet to be repriced, as explained in the earlier section. As interest rates rise, yields rise on the fixed-rate loans made during a time of lower interest rates, resulting in these unrealized loan book losses. I view this as an accounting phenomenon which will go away when these loans are repriced. Nevertheless, even if you account for these losses, adjusted book value will be $200M versus a market cap today of $120M(still trades at 60% of book value).
Comparison among peer banks
Below is a table that compares the numbers of CBBI with its Korean American banking peers in Southern California. HOPE and HAFC are much larger banks with $17B and $7.7B in assets respectively. PCB and OPBK are more comparable in terms of size, but still larger than CBBI. CBBI’s return on deposits have been amongst the highest comparatively but that is also with a more concentrated loan portfolio in CRE. Still, their CRE loans are quite diversified and a significant portion of their 85% CRE loans are SBA loans. Excluding these, whose principals are 75% guaranteed by the government, CRE loan percentage drops to 60%. Also, given their slightly higher cost of deposits compared to their peers, their loan portfolio needs to have higher yields to earn a good return and they do this by having lower residential loans on their loan portfolio, which are the safest but also yield less(residential loans are also very liquid as these can be packaged and offloaded to other investors). This explains the concentration.
To go with this, their historical underwriting performance has also been very good, with NPAs averaging 0.31% since 2014 and 0.57% since 2005(which includes the 2008 financial crisis). However, as I explained earlier(and can be seen from the table above), their current NPAs have crept up in 2024. Comparatively, CBBI has the worst NPA and delinquent loans but in terms of classified assets, they are better than others(of course this could mean that more assets may become classified in the future for CBBI). In terms of NPAs, HOPE and CBBI have higher numbers and HOPE has two times more classified assets than CBBI. If one looks at capital adequacy ratios, CBBI has the highest CET1 and leverage ratios(and by a wide margin). This gives me confidence that they can withstand any negative surprises in their loan book. In terms of average duration of loan repricing, their numbers have been better than peers. Below is the comparison in valuations.
When you combine the information above and the valuations, CBBI seems to be trading at a 50% discount to peer banks on average. One of the reasons for this can also be the fact that other banks trade on Nasdaq whereas CBBI trades on the OTC markets. Even though HOPE, being much larger, also trades at a low 0.58x book value, their return on deposit numbers were poor. Their interest expense for deposits were amongst the highest and loan yields amongst the lowest, even with a good amount of concentration in CRE and C&I loans. Also, their classified assets are much higher and their average duration of loan repricing was worse compared to others. They also trade at a 12x trailing multiple of earnings. Overall, CBBI appeals to me as the best pick overall amongst the Southern Californian Korean American peers.
Pre-mortem
This is an attempt to hypothesize on what could potentially go wrong with this thesis.
Non-performing loans continue to rise in other loan categories as well apart from SBA loans
Even if 10% of the entire loan book of $1.4B goes bad(instead of just SBA), book value will still be greater than the current market cap
It may take longer for their loan yields to go up(and hence net interest margins), if a big portion of SBA loans get stuck as NPAs
If there are new interest rate hikes(if inflation comes back stronger for example), margins could remain compressed or become more compressed
Compared to some of the other publicly traded banks in the US, CBB is relatively new(started in 2005) and so, maybe more time is needed to judge its performance during times of crises
This one goes without saying - any trust issues from the depositors could lead to a bank run
Final Thoughts
Overall, assessing the downside risks vs the upside potential, CBB Bancorp($CBBI) looks very attractive. I will be watching how their NPAs trend going forward and how their SBA loans perform. In a few years from now, maybe Mr. Market will assign a higher valuation to $CBBI.
Disclosure: Long CBBI
Core deposits are deposits excluding time deposits greater than $250,000(the FDIC limit) and wholesale deposits
This is a more indicative timeline as 2024 margins are compressed - still a 7% CAGR if 2024 numbers are included
Non performing assets are in general, loans past due 90+ days
Delinquent loans are loans past due 30+ days
Classified assets are loans where management has found some weaknesses and need more monitoring