Codorus Valley Bancorp (CVLY) – Activist Pressure/Potential Company Sale – 18%+ Upside

Current Price: $22.00

Target Price: $26.05+

Upside: 18%+

Expiration Date: May 2022

 

Activist hedge fund Driver Management acquired 6.5% of Pennsylvania/Maryland bank Codorus Valley Bancorp and is now pushing for a sale of the bank. Driver Management is a relatively fresh fund (started filing early 2019), but already has a somewhat decent track record in targeting only Pennsylvania and Maryland banks. Activist uses the same playbook across its campaigns – agitating the sale and starting intense proxy wars with the management. Driver Management says CVLY could be worth 1.5x TBV in a sale and says that there are many potential acquirers that are interested in the bank. From the Jan 18th letter:

I believe that there are a number of publicly traded banking organizations that are very interested in acquiring CVLY at a significant premium to the current (and even the highest) trading price for CVLY’s common stock.

[…]

At the same time, (i.e., while the stock is trading around $22 per share, representing only the slightest premium to tangible book value), I believe there are a number of interested parties who might offer shareholders consideration worth in excess of $31 per share (implying a valuation of approximately 1.5x tangible book value) in a sale.

While the activist might be painting a bit too rosy picture, the banking industry consolidation mode has intensified in 2021 – a number of CVLY Pennsylvania/Maryland peers were acquired (or are due to be) last/this year. All of the transactions were announced at a price of 1.3x TBV or higher. Assuming the same multiple for CVLY would result in 18%+ upside.

Driver Management urges the board to engage with investment bankers to solicit acquisition proposals and intends to nominate 3 directors (one is ex. COO) to the board (8 seats in total) in the upcoming shareholder meeting in May. The activist is also demanding the board to give it access to certain books and records of the company to perform due diligence on certain suspicions about the bank’s governance issues (also standard playbook for Driver Management).

The board is trying to fend off the activist, however, there are some positive factors here, which indicate that the board might finally yield and start a sale process:

  • After the activist pressure, the board has already replaced Mr. Miller, the entrenched ex. chair and CEO (was the CEO since 1980s). According to the activist, he was the main guy behind long years of CVLY mismanagement.
  • The board has also started an intense share repurchasing program and has recently announced a third $5m buyback program since Sep’21  – this is in contrast to very limited share buybacks historically. During the last 2 quarters, the bank has repurchased 3.4% of shares at around $22.30/share (above current market price).
  • At the end of January, CVLY released weak Q4 results showing a significant drop in profitability YoY and worsening operating efficiency – this strengthens activist’s campaign and clearly shows that the current bank’s plan of simply focusing on growing commercial loans is not working.
  • The activist is claiming that CVLY has already received takeover interests before, but Mr. Miller (previous chair/CEO) has always rejected them.

In addition, I believe that it is Mr. Miller’s practice to avoid any activities that might spur investor interest in CVLY, such as trying to secure equity research coverage or attending investor conferences. It is also my belief that Mr. Miller has chilled potential acquisition overtures by other banking organizations.

  • Apparently, there were rumors that Mr. Miller was exploring the potential sale of CVLY in H2’21, but then decided to abandon the process and transfer the wheel to a new CEO instead. By the way, Mr. Miller owns only a tiny amount of shares (<2%). From the letter to the CEO (10th Jan):

I recently heard a rumor that Larry Miller, the former chief executive officer of Codorus Valley Bancorp, Inc. (“CVLY”) and chairman of CVLY’s board of directors (the “Board”), was in the process of exploring a potential sale of CVLY during the past fall but abandoned those plans because he believed that you “deserved a chance” to run CVLY. This was a rumor, so I have no idea whether it is true or, if so, I have accurately described the situation, but based on what I know about Mr. Miller, the Board and CVLY, it sounds plausible enough

Given that Mr. Miller is out and the board is facing significant pressure now, there’s a decent chance that the bank might get sold – same way like Driver Management’s first activist campaign ended in 2019 (DnB Financial, see more details below).

Aside from the obvious risk that the activist pressure might fail to deliver any results, an additional risk is Driver Management settling with the company for some kind of cash compensation. A similar case has already happened back in 2019-2020 when Driver Management settled with FUNC, extracting benefit for itself but not for the other shareholders. However, Driver is a fresh activist and going into a similar settlement for the second time in a row would definitely hurt its credibility.

Given the ongoing buybacks and low valuation, the downside seems protected at least till the shareholder meeting. Even if the activist campaign eventually fails, I believe that pretty much for the same reasons, the downside should still be rather limited.

On a side note, recent purchases by one independent director John Giambalvo might be fairly interesting. Since the start of the activist campaign (Sep’21) started he acquired $260k+ of shares at the current price level. However, none of the other directors are buying shares at the moment (management owns 4.5%+).

 

Codorus Valley Bancorp

CVLY has 31 branches in Pennsylvania and 5 in Maryland. Although Maryland is a small part of locations, it comprises 40% of CVLY loans. Total assets are $2.4bn.

The company’s loan portfolio focuses mostly on commercial loans and commercial/residential real estate:

  • 42% – commercial;
  • 20% – commercial RE;
  • 15% – residential RE;
  • 10% – builder & construction;
  • 7% – residential mortgage;
  • 6% – home equity.

RE and builder loans are collateralized by real estate. Credit risk is sort of higher than for the average community bank here due to large exposure to commercial loans (hotels, retailers, etc.). This has played out negatively to CVLY during the pandemic and in 2020 the company had to make a $15m loan loss provision (vs historical $3m-$4m provisions annually). However, half of that ($7.5m) was due to borrower fraud (the activist says it’s most likely Welkowitz real estate fraud). In 2021 the performance rebounded but still has to recover to pre-COVID levels – which is likely to happen after the pandemic effects in the industries the bank lends are fully over.

Historical financials:

 

Valuation

In its letters, the activist is claiming that CVLY might be worth 1.5x TBV in a sale, however as the basis for this estimate the activist is using much larger banking peers (all in the table below have market caps of around $2bn).

Mercer Capital’s bank watch M&A data (Jan’22 for the last 12 months) also shows similar target multiple valuations – 1.8x TBV for the Atlantic Coast region (Maryland) and 1.44x TBV for Northeast (Pennsylvania). The median deal value/asset size is much more comparable, however, the multiple’s are still likely skewed by the larger bank transactions:

In the table below I have selected a number of bank transactions in Pennsylvania/Maryland that are of more similar size to CLVY. Assuming the eventual performance normalization, potential synergies, and improved risk management, I don’t see why CVLY wouldn’t be able to fetch a 1.3x TBV multiple in case of a sale.

A couple of highlights:

  • Loan books of the peers are mostly comparable here focusing on commercial RE and commercial loans.
  • All peers, even the ones with worse profitability (LDKB, CBMB) were acquired at substantially higher P/TBV multiples to CVLY’s current valuation. LDKB merger was announced at 1.2x, however, it is a much less profitable bank. By the way, since LDKB merger announcement (Feb’21), regional bank ETF (KRE) is up by 17%.
  • CVLY is a rather operationally inefficient bank for its size and has the lowest efficiency ratio among the listed peers. This suggests substantial synergies in the acquisition scenario (potentially much higher than with smaller, more efficient peers).
  • The caveat here is that, unlike other peers, CVLY post-COVID performance rebound was much more limited due to loan provisions in the commercial segment and overall higher portion of non-performing loans.

 

Driver Management

Driver Management invests exclusively in the US banking sector with the aim to ” identify undervalued banks and seek to unlock value through active engagement with senior leadership and boards of directors”.

So far it has made 4 activist campaigns, two of them are still ongoing:

  • DnB Financial – Pennsylvanian bank with 14 locations and $1.2bn assets. Driver Management acquired a 6% stake in Jan’19, shares were trading at 1.4x TBV at the time. In time, the stake was increased to 6.5%. The activist wrote a number of letters regarding the bank’s underperformance, governance failures, problematic executive pay practices, and agitated the sale. Driver Management demanded the board to inspect certain books and records regarding these suspicions as well. Driver did not nominate any directors to the board but instead urged shareholders to withhold their votes for DnB’s nominees and reject the exec. compensation package. The board had mostly ignored the activist, although did not allow it to inspect the books. Unexpectedly in June’21, DNBF announced a merger agreement at 2.06x TBV.
  • FUNC – Maryland bank with 25 branches and $1.7bn assets. Driver filed the initial 13D in Sep’19 saying the board has mismanaged the bank for many years and that due to the lack of scale, the best outcome for shareholders is the bank’s sale. FUNC was trading at 1.3x TBV at the time and the activist claimed that there’s 20-30% upside in the sale scenario. Driver wanted to nominate 2 directors and undertake board refreshment over the next year + make changes to corporate governance practices. The board fought off the activist, which ended up with Driver filing a federal lawsuit in mid’20 claiming the board lied during the proxy fight and abused the regulatory process. Both parties finally settled in Apr’21 with Driver selling its stake to FUNC for $6.5m + $3.3m settlement charge vs Driver’s stake cost basis of $7.4m (32% profit). Both parties also agreed to a 10-year standstill agreement.
  • CVLY – third campaign. First 13D was filed in July’21 with 6.27% stake at an average price of $19.65/share. The stake was raised in August to 6.5% (incremental shares acquired at $22.08/share avg. price). So far, Driver has been playing pretty much the same playbook. CVLY management tried to stop the activist from nominating its directors by changing the bylaws and nomination deadline at the last minute. As I understand, the activist managed to comply but sued CVLY for that. CVLY has now hired the same lawyers, which represented FUNC against Driver before.
  • FRBK – 30 branches, mostly in Pennsylvania, others in NJ and NY. Driver Management did not file 13D so most likely it holds less than 5%. The letters to the board, however, are available on the Driver Management’s website. The campaign started as a pushback against FRBK’s intended dilutive equity raise. The activist wrote 3 letters (first on Oct’21) to the board objecting to the raise and again pushing for a sale. In Jan’21 the board has yielded and postponed the raise. Several other activists have joined the party and are now pushing the board to start discussions regarding strategic options. Recently, the board has finally said it will communicate with the shareholder group and is open to proposals. The activist campaign started with FRBK trading at 0.7x TBV and over the last couple of months valuation increased to 1.14x TBV.

7 COMMENTS

  1. brettrush1

    The settlement with FUNC is interesting. I have zero background knowledge on bank activist campaigns so I may just not understand how this works, however it seems strange that a case involving the board’s misdeeds that would have seemingly had an effect on all shareholders was settled between Driver and FUNC directly without a larger class being represented or taking part in the claim.

    Do you know the background on that? Were other shareholders offered the opportunity to take part in the claim and just chose not to?

    This seems pretty interesting, just would hate to get cut out of a positive outcome somehow.

    1. spmcmahon

      I had a large (~15%) position in FUNC throughout the entire Driver campaign. I may have a detail or two wrong, but this is how it played out.

      Though I agreed with Driver in that the Board could do more to maximize shareholder value and should explore a sale of the company, Driver acted like a caricature of the worst stereotypes associated with activist investors. Between I want to say March and June of 2020, every week or so Driver would issue a PR full of disparagements, mischaracterizations, and personal attacks leveled at FUNC’s officers and directors. It was unprofessional and then some. Read their letters to CVLY; they’re juvenile as hell.

      The company offered them 2 board seats. Driver declined and nominated 3 at the AGM. Driver’s nominees lost badly. Fast forward 9 months and Driver nominates another board candidate. Instead of fight, the company paid them to go away by buying out Driver for $18 per share with the stock around $17, plus an additional $3.3M extortion fee. This money, of course, came directly from the pockets of the other shareholders.

      I’m sure it happens, but I’d never seen anything like that outcome. It was messed up, and I felt robbed by both parties. My emotionally-biased take away is that, despite their rhetoric, Driver is concerned only with maximizing value for one shareholder and shouldn’t be counted on to do what’s in the best interest of all owners.

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  2. Ilja

    An incredibly bizzare situation here. Driver Management has released the court docs on the previous Welkowitz fraud loan with CVLY. Just to remind this was a defaulted loan from 2020 (not new), which the management didn’t provide any details on before. So, apparently, CVLY made an $8m loan (4% of CVLY equity at the time) to Welkowitz to refinance his two existing loans. The collateral was 1959 Ferrari Testa Rossa car, one of the most valuable cars on Earth. The borrower did an appraisal valuing it at $45-$50m. For some reason, CVLY didn’t bother to do their own appraisal. Then in 2019 Wekowitz committed suicide, which was an event of default. By the time the car was to be auctioned it appeared that this Ferrari was a replica and it got sold for $209k instead.

    Driver Management also mentioned CVLY CEO’s alleged ties/relationship with Welkowitz. CVLY rejected the relationship allegations, however, made no comment on the Ferrari case yet. Will be interesting to see what they’re gonna say now that the docs/affidavit/emails were released. But overall, CVLY management’s credibility has been completely shattered and I find it hard to imagine the board keeping seats in the upcoming shareholder meeting. A few excerpts from the activists letter/questions to the management:

    – Q: When is a Ferrari not a Ferrari? A: When it is securing a loan made by Craig Kauffman.
    – Did the fact that someone who claimed to own a “Ferrari” worth $45-50 million urgently needed a $10 million loan raise any red flags?
    – Did the fact that Welkowitz specifically approached CVLY with this request concern you? Did it occur to you that someone with a “Ferrari” allegedly worth $45-50 million might get more favorable terms from a lender that was more experienced in lending against such assets?
    – Were you aware when the loan was made that 40% of your cash incentive compensation for 2019 would be based on “Pre-tax, Pre-Provision Income?

    The activist is in a rampage mode now and has changed their tone to a really aggressive one. See the quote below. I understand that is just their playbook (see spmcmahon comment above), but the activist seems to hold all of the cards right now:

    the “immediate sale” of CVLY has been my “true objective” all along, which I thought had made perfectly clear to you. If that wasn’t obvious, then you are clearly the kind of person who can’t tell a Ferrari from a “Faux-rrari”. You don’t have the slightest clue on how to create shareholder value and, based on the facts—admitted to by CVLY in documents filed in Federal court—regarding the loan secured by the “Faux-rrari,” I think the board should immediately demand your resignation as well as that of Amy Doll, CVLY’s chief banking officer, and whoever was the chief credit officer when the “Faux-rrari” loan was made.

    Judging by the press release, you and the board have clearly determined to spend millions of dollars of shareholders’ money so you can keep your job and the current directors can keep their board seats. I guess that if you are the kind of person that risks $8 million of shareholders’ capital on what may or may not actually be a Ferrari, that might sound like a reasonable thing to do, but you and the board are wasting shareholders’ money. If you weren’t capable of ensuring that an $8 million loan was adequately secured and likely to be repaid (and the board wasn’t capable of ensuring adequate risk controls were in place and being adhered to), why should shareholders want you to be CEO and why shouldn’t they want some new directors?

    So the situation is definitely interesting apart from the two major risks:
    – Knowing that CVLY management is so incompetent, what other bad loans have they made and could the whole Ferrari story change the attractiveness of the bank in the eyes of the potential buyers. Just to remind, the activist previously said that there are many potential acquirers who are interested in the bank.
    – The board should be really incentivized to go for a settlement and the situation could end up like FUNC again. However, I still believe that Driver should be hesitant to go that route for the second time in a row and completely destroy its credibility as an activist who cares for all shareholder value.

    On a side note – yes, it seems that these Ferrari models can really cost $50m, at least theoretically. One was sold in 2009 for $16.4m and another one in 2014 for a rumoured $40m price tag. https://www.classicdriver.com/en/article/cars/tom-hartley-sells-1957-ferrari-testa-rossa-world-record-price

    Court documents – https://www.bamsec.com/filing/147793222001354?cik=806279

    Driver’s letters:
    https://www.bamsec.com/filing/92189522000816?cik=806279
    https://www.bamsec.com/filing/147793222001331?cik=806279
    https://www.bamsec.com/filing/147793222001389?cik=806279

    CVLY response:
    https://www.bamsec.com/filing/89710122000214?cik=806279

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  3. brettrush1

    Wow. Don’t know for sure about the stock, but I’d say the entertainment value here is excellent!

    1
  4. Ilja

    It seems that the activist campaign has been progressing quite nicely. Apparently, CVLY and the activist entered into a cooperation agreement. Driver has agreed to a standstill, while CVLY will implement several operational changes to address previous concerns of the activist. CVLY will add 3 new board members (1 chosen by Driver, 1 by CVLY, and 1 by both), do a comprehensive compensation study regarding initiatives proposed by Driver, and engage an advisor to review CVLY’s credit risk policies and practices.

    CVLY is also undergoing a strategic review and if I understand this correctly, they’ve kind of hinted at the potential sale. The stock is up 7% since the write-up price level and now trades at 1.15x TBV.

    The Board reiterates its commitment to an ongoing review, together with independent advisors, including Keefe Bruyette & Woods, of the Corporation’s strategy and all potential avenues for value creation, including potential transaction opportunities and management’s regular reporting to, and solicitation of feedback from, the Board, on management’s detailed strategic plan.

    https://www.bamsec.com/filing/89710122000409?cik=806279

    1. RW

      CVLY has a $300mm available for sale securities portfolio which is marked to market each quarter impacting TBV. About a third of that is in the reprice/mature greater than 15y bucket (long duration). In aggregate, the portfolio was marked close to par at year-end but is now more than 5 pts (5%) below par due to rising rates which are causing TBV to decline Q/Q for many other banks as well. TBV for some banks has declined > 20% since year-end despite reporting positive earnings (MTM on AFS securities does not flow through income statement but does impact equity).

      5y UST yield is already 50 bps higher since March 31, so TBV may continue lower in Q2 from additional negative MTM.

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