Bank On It HIFS (Issue #22)

Hingham Institution For Savings

HIFS: $310.00

Market Cap: $665.07mm

How does it fit into the Pillars?

Competitive Advantage – Carefully cultivated company culture

Fortress Balance Sheet – One of the best loan books for safety and returns PERIOD

Growth – Doubled book value over the last 5 years

Long-Term Focus – Been around since 1834 and planning for at least year 2134

Capital Allocation And Operation – Purposefully chooses where and how to play in banking

Undervalued In Context – Reasonable (1.8x) Price/Book while growing book value

Investment Thesis

The bank is remarkable because it hasn’t succumbed to the peer pressure of operating in any spaces besides the safest and highest returning ones that it knows well. Hingham is built on values and these values have created sustainable, strong earnings. In other words, Hingham’s Pillars have made Profits.

Background

Hingham Institution For Savings was founded in 1834 in Hingham, MA (an affluent suburb on the South Shore of Boston). The original bank had no branches but exchanged money through a local general store. Currently, the bank is run by Robert Gaughen, Jr. and Patrick Gaughen, son and grandson (respectively) of Robert Gaughen, Sr. who first joined Hingham and worked to turn it around over 30 years ago. Since then the Gaughen family have run the bank in a surgical fashion. 

Hingham is a very specialized bank. They do three main things:

• Commercial Real Estate Lending

• Commercial and Personal Deposit Banking

• Residential Real Estate Lending

And just as importantly a whole host of things they don’t do:

Hingham has a very Berkshire-like strategy in the sense that it focuses first on not being stupid more so than trying to be smart. Hingham’s focus on safety is like when Buffett imagined Nebraska football’s “Remember your helmet” checklist as opposed to the Notre Dame’s aspirational “Play like a champion” mentality.

Now on to the really interesting part of the business, loans. Banking is all about managing risks of loans going bad. As you can see from the list above, if it moves or it rusts, Hingham probably does not lend on it. Hingham finds its greatness in its simplicity. There are ~5,000 banks in the US and yet there is no other bank organized like Hingham. Hingham mainly operates in desirable (very affluent mainly coastal) areas and almost exclusively focuses on commercial lending in a small number of services. Their loans are things like high-value multifamily apartments and offices. However, the offices must have multiple different tenants so that no one business failure could harm the financial security of the loan.

To bring all of this one step further Hingham’s loans are not a standard 80% loan to value, but 50% loan to value. This means they are taking significantly less risk than the alternative. Hingham’s chargeoff rates frequently round to zero. For example, they recorded $1,000 of net chargeoffs in 2021 and $260,000 in 2020. For reference, this is on $3bn in loans. Importantly, due to Hingham’s focus and execution, this doesn’t lower their bar or loan growth. For new growth areas like San Francisco, all buildings and locations are inspected by President Patrick Gaughen personally before the loans are secured. Further, Hingham only operates in the following areas: Nantucket, Boston Suburbs, Washington DC, and most recently, San Francisco. Hingham has worked tirelessly to build standards and stick to them. Going forward they have clearly said they are simply continuing the same playbook in new (but similar) markets.  Robert Gaughen Jr says, “It is not just the strategy, it is the execution of that strategy…we’ve formed that culture over a long period of time.” This shows the deep understanding that they are not unique and successful because of how they are organized, but because they have created a company culture that allows them to constantly stay close to their values.

Expansion

Digging into Hingham’s expansion the company had mainly concentrated in Boston Suburbs and Nantucket until 2017 when it started to expand to Washington DC. Since opening DC the bank has nearly tripled its earnings and nearly doubled its loan book (without sacrificing loan quality). This is significant growth for a bank.

In 2021 Hingham expanded to San Francisco. San Francisco is still too early to have a meaningful view of the results from it. But it is obviously a desirable location and the bank plans to run the same playbook that made it successful in Boston and DC.

Growth is accelerating at Hingham. The bank has built its book value in the years since starting in DC (2017-2021) from $87 per share in 2017 to $165 per share at the end of 2021.

On the personal banking customer side, Hingham keeps its services to a minimum with just a few kinds of accounts and no wealth management or similar services. When asked why they don’t provide wealth management services, President Patrick Gaughen said he didn’t think they understood it particularly well and added that he didn’t think many banks that did offer it understood it particularly well either. By keeping this simple and safe because their target market are unlikely to run into overdrawing their accounts, Hingham can focus on the side of the business that makes money.

Management

The bank's management is the exact kind of people you want running an operation like this. They are very intelligent capital allocators, clear-headed, and often pessimistic.

Management has a strong understanding of banking and often have exercised abstract thinking which has worked to their advantage. They talk about “Game Selection” (where they play) and “Game Play” (how they play). 

In every annual report the book value per share, efficiency ratio, ROE, and more are cataloged over the last 30 years.

Hingham keeps their dividend low at 0.76%, but they regularly raise the dividend and offer a special dividend at the end of each year (dependent on performance). This demonstrates their shareholder friendliness and capital allocation skills as they don’t promise this, but have it as an add-on. 

Management is also heavily invested with the Gaughen family holding ~40% of the company. There isn’t really a better incentive than this for future stock and company performance. This also ensures the emphasis on safety in investments. In the words of CEO Robert Gaughen, “When you’re lending your own money, you have a tendency to do it differently than if it’s someone else’s money. It’s a very effective means of risk management.”

Competition

One of Hingham’s main competitors is First Republic Bank (NYSE: FRC). They compete in some aspects of the high-net-worth personal banking and the high-end loan markets. However, First Republic offers many of the wealth management services that Hingham views as a low return or unnecessary venture. This means that customers that want the extra support can go to First Republic, but those that want a more simple banking experience can use Hingham. Both are good and these parts of the business can coexist.

Numbers

Hingham achieved a 20.83% Return On Equity (ROE) in 2021, a staggeringly high figure for a bank. To make the deal even sweeter the bank also achieved a 21.31% Efficiency Ratio in 2021. For the non-banking nerds, this is unheard of. Even well-regarded banks (on this basis) have efficiency ratios in the 50s or 60s. This is all made possible by a deep understanding of the people behind these numbers and the company culture it entails. In President Patrick Gaughen’s words: “If you take the concept of efficiency and operational leverage and go one step beyond just the efficiency ratio and financial statements, a team with strong alignment around how they treat each other and make decisions can perform with greater leverage by pushing decision-making and operational functions down in ways that make a company nimbler, more efficient and more responsive to customers,”

Valuation

Hingham has put the profits it has made to work in an equity portfolio. The portfolio is one of the largest relative to its size for a bank, but it still remains under $100mm meaning the holdings are not disclosed. The Gaughens have an investor mindset, not a banking mindset. This means they are looking for the best and safest returns. Most banks are not operated this way. This difference sets Hingham apart for the better.

For banks like insurance, the best statistic for valuation is Price/Book. Hingham has a Price/Book of 1.81x. This is good, but importantly Hingham is also growing book value. Over the past 5 years, Hingham has almost doubled its book value per share. This is not an anomaly, twenty years ago in 2001, Hingham’s book value per share was $16 and it ended in 2021 at $165. Consistent execution and growth should continue to drive adequate returns at Hingham.

Until Sunday,

Soren

Disclaimer: Soren Peterson and Pillars And Profits Newsletter are not responsible for any investment results. This is not financial advice. Always do your own research.