Trinity Bank N.A. (TYBT)
Top tier one-branch bank in Texas with extremely high quality management team
Summary
Trinity Bank N.A. (TYBT; OTC-listed) is a small, one-branch bank in Fort Worth, Texas. They primarily focus on business lending. TYBT’s management team is extremely high quality. They created a unique bank that combines low risk, high service, and a large structural cost advantage. TYBT likely offers a reasonable future return at its current valuation, although the stock is highly illiquid.
Brief History
The uniqueness of TYBT is directly attributable to its independent-mind founder, Jeff Harp. Harp was the former President of Summit National Bank before being let go in 2001. As a 2003 Dallas Business Journal article states:
“…Harp got his walking papers after the bank's directors decided they preferred Summit Bancshares chairman Phil Norwood's growth strategy to Harp's ‘Warren Buffett mentality’ of concentrating on service over size.”
After his departure, Harp had no trouble finding investors after deciding to start his own bank in Fort Worth called Trinity Bank. As one original investor stated:
"Summit was probably the most profitable bank in Fort Worth [when Harp was President] … When you've been an investor in a commercial bank that routinely earned 2% on assets and 20% on equity, it's really, where do I get in line?"
He ultimately raised ~$11mm from 258 investors, at $10 per share, and started Trinity Bank in May 2003. As of May 2023, the stock last traded at ~$88 per share, with TYBT returning >$12 per share in dividends over the years. This 10x return over the last 20 years is tough to beat within the banking industry - especially, given the losses many/most banks experienced during the 2008-2009 Financial Crisis. Not only did TYBT stay profitable during the Financial Crisis, they also never suffered a single loan loss during ‘08-’09.
Harp and team combined three main factors to produce that unbelievable performance: (1) low risk lending, (2) high service to customers, and (3) high operational efficiency.
(1a) Low Risk Lending - Credit Risk
TYBT is a business lender. They mainly focus on providing working capital and equipment financing loans to small and medium sized businesses. Thus, the collateral on these loans is typically inventory, equipment, accounts receivable, etc. Examples of customers include brick distributors, plumbing suppliers, steel fabricators, and lumber companies.
TYBT also provides owner-occupied commercial real estate loans to business owners but mostly stay away from investor-owned (non owner-occupied) commercial real estate unless an opportunity arises. As Harp said in a 2014 interview, in his typical plain-spoken manner:
“If you compared us to other banks our size, our 57% in commercial and industrial loans are about three times what the average bank is, and it’s just because that’s what I used to do, and I know how to do, and that’s kind of what we focus on.”
And, on being opportunistic in non-owner occupied commercial real estate:
“We tend to do very little investor real estate except during periods when other banks [are retreating] and we have the ability to select good projects to do with experienced customers who have a proven track record of good performance.”
As mentioned, the bank not only remained highly profitable throughout the Financial Crisis (>1% ROA in ‘08-’09), TYBT did not experience its first non-performing loan until 3Q2010 - seven years after the bank began operations. But, as Harp states in many of his quarterly shareholder letters:
“…they key is not to have zero problem loans. If that is the case, a bank is not taking any risk and is not serving its customers (and ultimately, will not prosper). They key is how much of your money do you get back when you make a mistake. We will make some mistakes, but we will protect the bank while working to help good people through bad times.”
On that front, TYBT has succeeded. As the table below shows, their net charge-off rate, in most quarters over the past 10 years, has been zero. Meaning they have not experienced any loan losses. Most banks at least have some losses each quarter, so this result is highly unusual. Equally unusual, is that in many quarters, the net charge-off rate has been negative, due to TYBT recovering some of an already charged-off loan.
(1b) Low Risk Lending - Interest Rate Risk
In TYBT’s 1Q2021 shareholder letter, Harp stated (and this would have been prior to inflation/high rates being the “themes of the moment” - making his commentary even more impressive):
“In a low interest rate environment like the one we find ourselves in currently, it is important to remain focused on the interest rate risk we are taking. During periods of low interest rates, customers prefer to fix their rates as long as they can to lock in the lowest cost of funds possible. While we have made several fixed rate loans recently, we have been able to add rate adjustments to those loans which allows the bank to adjust to a market rate periodically throughout the term of the loan. This greatly assists in limiting the amount of interest rate risk your bank takes, especially during times like these.”
Regarding TYBT’s securities portfolio, they incurred unrealized losses as rates rose just like most banks. However, their portfolio’s losses are lower than the many Texas peers (see chart below).
If you were to assume Trinity sold its entire securities portfolio today and incurred the hit to capital, TYBT would still have a Tier 1 Leverage ratio >10%. Still higher than most banks in the U.S., before adjusting for their own securities losses.
(2) High Service
TYBT, like many business-focused lenders, does not seek to generate deposits if a longer-term relationship is not involved. They do not offer brokered CD’s, or pay the highest CD rates necessarily, attracting short-term customers. As Harp says, they want “people that are going to have money here when times are good and times are bad, not the kind of people that will move a CD because of a quarter of a point”. However, TYBT does seek to pay competitive rates, aiming to pay the highest they can while still generating high profitability for shareholders.
TYBT believes one of the competitive advantages they offer is high service to their their lending customers. With only 25 full-time employees, TYBT is able (and seeks) to respond with extreme quickness to customers. They believe speed and quality of service are the few ways they can differentiate themselves.
Harp stated in an February 2020 interview:
“It seems to me, there is and has been a lot of irrational pricing competition. We typically don’t try to match those rates even if we have to lose some business. We try to find people that understand that price is a component of value and an important component of value. But it’s not the only component, and that’s why we try to be responsive, flexible and creative when we go after a piece of business. That approach appeals to some people. And some people just want the cheapest rate they can get. That’s usually not somebody we’re going to pursue very hard.”
Additionally, Harp tells the story in one of this shareholder letters that after rolling out a new technology product, TYBT’s operations guy visited many of the bank’s larger relationships to make sure they thoroughly understood how to use the new tech. That is a very high level of service that few banks can match.
(3) High Operational Efficiency
TYBT’s high operational efficiency creates a low cost structure. When I wrote last year about FFD Financial (FFDF), I mentioned how they have a local cost structure advantage because they have more deposits per branch than their local competitors. But I also mentioned that many more extreme examples exist of bank’s with high deposits/assets per branch.
TYBT is one of those extreme examples, operating only one branch with $400mm in deposits. Looking at employees, TYBT has $18mm of assets per full-time employee - ranking them #8 of 332, by that metric, against all Texas banks with <$2bn in assets (top ~3%). And, although not the perfect comparison, TYBT even exceeds most of the largest banks in the U.S. on assets per FTE (JPM 0.00%↑ C 0.00%↑ WFC 0.00%↑ BAC 0.00%↑USB 0.00%↑).
Besides not needing to spend money on additional branch infrastructure/employees, TYBT focuses on fewer, larger customers and therefore, provides fewer, larger loans. This means they need less lenders and loan administrative employees. The combination of less occupancy and employee expenses means TYBT’s overall overhead, as a percent of their assets, is much below their peers (as shown in the table below).
Ultimately, this cost advantage is so large it drives 100% of the differential in Return on Assets (“ROA”) that TYBT achieves versus peers (see below table). This ROA differential would be even more extreme if you included a “normalized” loan loss provision, since TYBT should experience much lower losses over a full economic cycle than peers.
Management
Between the statistical track record and highly rational mindset, it is easy to see that Jeff Harp and his management team are simply outstanding. TYBT’s quarterly shareholder letters are a tour de force in proper banking. The final quote I’ll include sums up management’s overall operational strategy (from 2Q2021 shareholder letter - again, well before rising rates occurred):
“There are only two ways (other than fraud) to mess up a bank –an interest rate mismatch (maybe 5% [of bank failures]) in a rising rate environment or loan losses (95%). We can’t predict interest rates so we just try to make sure that we avoid problems in a falling, flat, or rising rate environment. As far as loan losses are concerned, our track record is very good. We avoid concentrations. We focus on developing long-term relationships with quality people, not transactions. And we work with good people through bad times. We are not perfect, but we wouldn’t trade places with anyone. Finally, we spent nearly 14 years (57 quarters to be exact) with operating earnings increasing faster than operating expenses. We have spent the better part of three years building a base for future growth. We have added people, operating systems, and increased the size of our physical facility. Most of that investment is behind us. Going forward, we are in a position to grow operating income faster than operating expense. That is our main focus. We have begun to see good results and we are willing to be held accountable for that statistic.
Important to note that Harp is in his 70’s and is no longer CEO but remains an active Chairman. Outside of Harp, three additional people are in the management team. Matt Opitz took over as CEO at the end of 2019. Opitz is a former banker from Frost Bank, another strong Texas bank, and joined TYBT in 2018. Barney Wiley, with Trinity Bank since its 2003 founding, is now President. And Richard Burt, also at TYBT since the beginning, is Chief Operating Officer, overseeing IT, compliance, accounting, reporting, and security.
Overall, the management team seems very strong, with Opitz being of the “Jeff Harp mold”. In the past, Harp and team have quickly let go of lenders that did not meet Trinity’s standards. With Opitz not only lasting but being anointed CEO, I think that speaks volumes.
Valuation
***Note: Before discussing TYBT’s valuation, two items to note. One, given the declines in bank stock prices since March, TYBT is unlikely to be the best performing bank stock over the next five years (at least at current prices). Two, TYBT’s stock is highly illiquid. The last transaction in its stock was ~4 months ago in January. Despite those two factors, I think TYBT is worth watching. When markets go thru some future extreme stress, liquidity might “unlock” in TYBT’s stock as investors sell at much lower prices. If that environment occurs, both TYBT’s valuation and liquidity issues might be solved simultaneously.***
The two main factors for valuing any bank are future normalized return on assets and future asset growth.
With one exception, I would expect TYBT’s future normalized ROA to look fairly similar to its 1Q23 results (see “ROA Breakdown” table above). The exception being that over an economic cycle, I estimate loan losses likely average ~0.2% - if history serves as a rough guide. Adjusting for implies TYBT averaging an after-tax ~1.6% normalized ROA.
The second major valuation factor is asset growth. TYBT’s deposit growth was 8% annualized from 2007 to 2019 and 9% annualized from 2013-2019 (excluding COVID years since extreme, one-time deposit growth occurred). Since deposits fuel most of a bank’s assets, TYBT’s annualized growth equaled those 8-9% figures.
TYBT mainly benefitted (and still benefits) from operating in the highly attractive market of Fort Worth, Texas. No state taxes, high population growth, and overall good demographics fuels a very strong local economy and therefore bank deposit growth. TYBT has roughly maintained their deposit market share in Fort Worth over the past 10 years, meaning the overall market growth was also 8-9% annualized. Nationwide most banks grew assets at 4-5% per year.
Applying a 1.6% ROA to TYBT assets growing at a (wide) range of 4%-9% annualized over the next five years produces roughly $175-$215 per share (high-teens IRR). Those per share figures include the excess earnings available for distribution, meaning dividends (the other portion of earnings, “required capital”, will need to be retained to support TYBT’s asset growth). The valuation figures also assume, like other top-performing banks (due mainly to high ROEs and lower-risk models = lower cyclicality) TYBT should be valued at ~20x earnings. Of course, not many banks are highly valued today but, eventually the environment “normalizes”.
We’ll see if the future ever offers higher liquidity and an even larger expected return for this one-of-a-kind bank.
For reference, TYBT shareholder letters can be found here: https://www.trinitybk.com/about-us/investor-information/
Disclosure: Nothing stated in this article is investment advice. Do you your own due diligence. I/we may own shares of TYBT in the future. Note, again, that TYBT shares are highly illiquid and any investment should be viewed more as buying into a private company.
What a wonderful write up. I have always been interested about banking but it's been quite to wrap my mind around all the aspects of banking. I find it easiest to learn through the eyes of someone who really knows the industry. But as WEB states; "there are more banks than bankers.", made it difficult to find a good industry leader. I just printed out all the shareholder letters from Trinity Bank 2008-2023. I am really looking forward to reading them. Chances are slim I will ever invest in a bank. Nevertheless it's fascinating to study. Thanks.