Voss Capital, an investment management firm, published its fourth quarter 2020 investor letter – a copy of which can be downloaded here. A return of 20.81% was recorded by its Voss Value Fund LP, and 20.67% by its Voss Value Offshore Fund in the fourth quarter of 2020, both below its Russell 2000 Value Benchmark that delivered a 32.72% return and its Russel 2000 TR Index that was up by 31.37% in the same period, but above the S&P 500 TR Index that gained 12.15% in the fourth quarter. You can view the fund’s top 5 holdings to have a peek at their top bets for 2021.
Voss Capital, in their Q4 2020 investor letter, mentioned Merchants Bancorp (NASDAQ: MBIN) and emphasized their views on the company. Merchants Bancorp is a Carmel, Indiana-based bank holding company that currently has a $1.1 billion market capitalization. Since the beginning of the year, MBIN delivered a 41.22% return, impressively extending its 12-month gains to 192.94%. As of March 22, 2021, the stock closed at $39.02 per share.
Here is what Voss Capital has to say about Merchants Bancorp in their Q4 2020 investor letter:
“A newly initiated long position that fits the large housing and mortgage finance related theme of the long book is Merchants Bancorp (MBIN). MBIN is a unique bank and mortgage warehouse finance lender based in Indiana run by an owner/operator team of seasoned mortgage banking executives. The company grew EPS by 112% in Q4 and tangible book value by nearly 40%, growth rates usually associated with high-flying SaaS leaders. Normally it is prudent to be skeptical of a rapidly growing bank and the market often correctly assigns growth banks a massive comp discount for fear of future credit problems that are being masked by the growth. MBIN, however, is accomplishing this growth without taking on much credit risks whatsoever in two of their three distinct segments: Mortgage Warehouse Lending and Multi-Family lending. A large earnings growth driver last year was their mortgage warehouse lines of credit to non-bank mortgage originators (who are rapidly taking share from banks), which typically turn over every 15-20 days. When you close on a house, the first month’s mortgage interest is generally prepaid and the first full P&I payment isn’t due for over a month, therefore MBIN has very little credit risk in this segment barring massive fraud being discovered right out of the gate.
Warehouse lenders typically extend lines of credit to non-bank mortgage originators to fund the issuance of their loans, with the intent that these loans will be sold to the secondary market within a short amount of time – typically within two to three weeks. In today’s market, nearly all loans originated by their warehouse line customers meet standards set by the GSEs. As a result, the loans that serve as collateral for the warehouse line of credit are high-quality mortgages that have a deep and liquid secondary market. Because of its business model, MBIN’s warehouse segment has little risk from both a collateral standpoint as well as a counterparty credit standpoint. Their credit risk is substantially mitigated because they control the collateral and can move quickly to protect their interests.
In their Multi-Family lending segment, they originate commercial mortgages and immediately securitize and sell them to the GSEs for a quick “gain on sale.” Again, because they move the loans off their balance sheet so quickly, barring an immediate payment shock, their credit risks are de minimus and this segment does an eye popping 14% ROA (~1% is normal for a traditional bank).
While MBIN is unlikely to repeat 2020’s breakneck EPS growth and industry leading Return on tangible common equity (ROTE), they don’t need to for the stock to work well from here. The stock is only priced at 5.7x conservative consensus EPS estimates. We believe this discount is due to the fact that the company is hard to model on a quarterly basis, doesn’t do quarterly conference calls or offer guidance, has a low float due to large insider ownership by its owner/operator management team and Board, and the market is pricing in a quick collapse in ROE for fear unsustainable mortgage market activity, which so far is only accelerating and continuing to defy skeptics. To the last point, mortgage applications were still growing a blistering 20% y/y for the month of January and accelerated to +35.9% for the first week of February. If they can maintain their current elevated earnings power, we believe the stock is trading at closer to 3.5x 2021 EPS. If, however, their ROTE aggressively mean reverts to their four-year trough, the stock would still only be trading at 10x earnings, which is a ~60% discount to the S&P 500 and a >25% discount to the broader US banking universe that is inferior across every relevant metric for evaluating banks. The shares have ~80% upside just to get in line with bank comps on a Price/Next Twelve Months Tangible Books Value Per Share basis when adjusting for ROTE. We think the company could ultimately be acquired in the 2.5x tangible book value range in the next few years, offering at least 100% upside from today’s market price and the current P/TB multiple of 1.2x. This conservatively assumes zero book value growth, which would be a draconian slowdown from their historical 27% BV CAGR.”
Our calculations show that Merchants Bancorp (NASDAQ: MBIN) does not belong in our list of the 30 Most Popular Stocks Among Hedge Funds. As of the end of the fourth quarter of 2020, Merchants Bancorp was in 11 hedge fund portfolios, compared to 8 funds in the third quarter. MBIN delivered a 37.44% return in the past 3 months.