Bluestone Capital Management’s Bluestone Financial Institutions Fund is a directional, long-short hedge fund focused on publicly traded micro-, small- and mid-capitalization banks based in the U.S.
Bluestone Financial Institutions Fund is open to qualified clients only – individuals with a net worth of $2 million or more or invested assets of $1 million or more.
Jason D. O’Donnell, Bluestone Financial Institutions CIO, spoke with Benzinga about investment opportunities in that sector.
Benzinga: Why is now a good time to invest in banks?
Jason O’Donnell: We felt like there was a big opportunity from an investor standpoint in the micro and small cap bank space in the U.S. There are three reasons for that.
Number one, there's a lot of bank-on-bank acquisition activity. That activity is accelerating. It just eclipsed the pace that we witnessed before the financial crisis when it was very hot and heavy.
The second reason is interest rates. We have experienced a very low interest rate environment now for what seems like forever.
We're getting to a place that the yield curve was telling us that we're likely to see at least some type of increase in the debt funds rate in the back half of this year. That increase in interest rates is very good for banks.
The third reason has to do with excess capital. There's a tremendous amount of excess capital out there in the space right now.
BZ: What, specifically, is attractive about micro-, small- and mid-cap banks?
JO: We have what we like to call community and super-community banks. We're really investing in institutions that are very much unlike the megabanks. They're not level to investment banking or fixed income or bar exchange trading.
It's all really a bread and butter, simple type of business model, collecting deposits from businesses and consumer clients and then turning around and lending out those deposits in the form of loans and earning a spread.
BZ: What market-cap restrictions do you have for investing in these banks?
JO: Our sweet spot is $50 million in-market cap. We will never go below that. At the top end, we will go all the way up to around $5 billion in market cap.
Believe it or not, there are institutions that look and feel a lot alike at both ends of that spectrum. This is because they do essentially the same thing. They just do it on a larger floor.
BZ: Why do you avoid the extremes at each end?
JO: There's a lot of regulatory pressure out there. In general, regulatory pressure is a good thing in the bank space because it means small-cap banks are more likely to sell for a big fat premium.
When you get to banks that are below that $50 million market cap, the challenges can be quite significant.
We think that view is very consistent with our view of large cap bank space. Banks with $50 billion in assets are subject to much heavier regulation and have the hand of the federal government in their pocket on a daily basis.
BZ: Within that “sweet spot,” what drives your investment interest?
JO: We invest in three different types of stories – growth, turnaround and the potential seller. Every bank we own falls into one of those.
Many of the growth stocks we own recognize that people don't like the bank and branches the way they used to. Those banks have a much smaller branch footprint and more of a technology emphasis.
The turnaround situation is very different. Obviously, we're looking for cases where a bank has had a rough go of things for a number of years, and there's a new management team in place.
The third one is obviously just participating in the old bank mergers and acquisitions scenario. That is getting very intense at this point.
BZ: What makes M&A so important?
JO: M&A was heated before the financial crisis.
Obviously the financial crisis came and placed tremendous pressure on valuation multiples so buyer currencies weren't as valuable as they had been.
Now we're out of that stage, banks have stronger currencies and are out there acquiring in a heated way.
BZ: What about online-only banks?
JO: Yeah, Internet banks tend to be small-cap banks.
We have a bank called Customer's Bank.
It has a division they want to call Bank Mobile. Essentially, the entire bank offering is on a handheld tablet or phone.
Many millennials are clamoring for this type of product.
At the time of this writing, Jim Probasco had no position in any mentioned securities.
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