Arrowmark Financial: Big Yield On Niche Assets (NASDAQ:BANX)

If you’re looking for a niche high-yield income investment in the financial sector, you may want to check out Arrowmark Financial (NASDAQ:BANX)

Profile:

BANX has been one of our core holdings since the inception of HDS+, when it was known as StoneCastle Financial Corp. It’s a closed-end fund and initially covered a unique niche – investing in US community banks, long considered the safest sub-sector of the US banking system, but a niche which isn’t readily available to retail investors, other than some individual bank stocks, which have mostly had lower yields.

BANX entered a second niche field in late 2019: Alternative Capital Securities or regulatory capital relief securities. This was done via a deal with ArrowMark Partners, a large US $22.3B asset management firm, which bought out BANX. This deal enabled BANX to broaden its reach to international markets.

BANX’s primary investment objective is to provide stockholders with current income, and to a lesser extent, capital appreciation.

Holdings:

Arrowmark has radically changed BANX’s asset base, which is now nearly 88% invested in regulatory capital relief securities, with just 11.3% invested in community banks, via structured debt, term loans, and preferreds:

80% of the issuers of Regulatory Capital Relief securities are G-SIB’s, Globally Systemic Important Banks, such as Citigroup (C), Goldman Sachs (GS), Deutsche Bank (DB), and BNP Paribas (OTCQX:BNPQF).

Under Basel II and III rules, these banks are subject to more stringent oversight, which limits the amount of risk-weighted assets that they can carry. In the example below, the subject bank reduces those assets by 50% via a $500M regulatory capital relief security transaction with BANX.

This frees up $52.5M of capital, which can then be redeployed and earn money.

As of 3/28/24, BANX’s top 10 holdings comprised ~53% of its portfolio, and included Citigroup, Deutsche Bank, and Barclays (BCS):

Dividends:

The stock yielded 9.31% as of Aug. 15. It should go ex-dividend next on ~9/20/24, with a ~9/30/24 pay date.

BANX has a five-year dividend growth rate of 6.34%. Management raised the quarterly distribution from $.39 to $.45 for Q3 ’23.

As the portfolio shifted more to regulatory capital relief securities, quarterly NII/share began to climb in 2021, rising from $.40 all the way to $.72 in Q3 ’23, and $.70 in Q1 ’24.

That rise in NII was huge in 2023, jumping 42.4%, which enabled management to raise the distributions by 32.5% in 2023.

Distribution coverage also rose, from 1.11X in 2022, to 1.19X in 2023, and rose further in Q1 ’24, to 1.56X:

Taxes:

BANX issues a 1099-DIV at tax time.

Earnings:

Q1 ’24 vs. Q4 ’23: While total investment income was down 4%, NII rose 3.7%, and NII/share was up ~13%, with NAV/share ending at $21.24.

2023: Total investment income rose 33%, and NII rose 42.7%, both aided by higher interest rates. Interest expense jumped 52%, but was outpaced by higher volume and profitability.

Performance:

BANX has outperformed its industry, the financial sector, and the S&P 500 over the past year on a total return basis. It has also outperformed them over the past quarter on a price basis.

Profitability and Leverage:

ROA and ROE both improved considerably in 2023. Debt/equity leverage also improved to .29X, vs. .37X in 2022, as did assets/debt coverage which rose to 4.5X:

Debt:

In May 2022, BANX’s $62M credit facility was further amended to reflect the addition of two lenders, a new rate of SOFR +2.61% and a maximum borrowing amount of $70M. The maturity date of the facility was extended to May 27, 2025 (which may be extended until May 27, 2026 at the option of the company).

There was $23M in credit availability, and $427K in cash, as of 12/31/23.

Valuations:

At its 8/15/24 closing price of $19.34, BANX was selling at an 11.08% discount to its 7/31/24 NAV/share of $21.75. That discount is deeper than its five-year average discount of 9.06%, but not as deep as its one-year average discount of 15.78% and its three-year average discount of 11.69%.

Expenses:

BANX carries a 2% sales load on new investments. Its internal annual expenses were 8.35% of net assets in 2023, including 3.71% in interest.

Parting Thoughts:

While BANX’s investing focus has changed radically, that change has thus far produced good results, with earnings surging in 2023. We continue to rate BANX a Buy.