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My Fixation with Bridgewater Bancorporation Preferred Stock

Disclosure–I own this security and am ‘talking my book’ here. Not a recommendation as each investor determines their own risk/reward demands.

I am trying to figure out what I am missing with Bridgewater Bancorp (BWB), the smallish Minnesota bank that I have mentioned many times. Is it simply because I live in Minnesota? Certainly I have a bias in that regard–sometimes it seems like you ‘know’ a company better just because you drive by their banks from time to time. But in the banking scene in Minnesota this $4 billion banking company BWB is simply a pimple on the butt of an elephant.

Is it because while many banking companys have had their preferreds jump nicely in the last couple weeks as interest rates have dropped little old BWB has gotten no bump at all and thus yields 9.55% at Fridays close? Why is my little banker preferred being punished?

Is it because someone ‘knows something’ I don’t know? Not very likely given the banker just published their 3rd quarter investor presentation 4 days ago—it is here.

Or is it simply because as Gridbird has correctly said many times ‘names matter’. Witness the Gabelli Funds CEF preferreds–really nothing special about these funds but the preferreds garner great respect—but the name-Mario Gabelli – the friendly gent we have wached on TV since ‘Wall Street Week” with Louis Rukeyser started in 1970 garners respect. Bridgewater Bancorporation – who the hell is that?

Well to get by the bolony stuff –what are their numbers? Is there big time trouble ahead? Well let’s check the data out!

A thumbnail sketch of BWB–

I have been quite amazed at the efficiency ratio of Bridgewater. Only in the last 6 months have I started watching this as a sign of a well run bank. BWB has always been low – although with the net interest margin getting squeezed in the last 18 months their efficiency ratio jumped – but still very low compared to competitors. I suspect they will get their net interest rate margin up during the next 6 months and their ratio will fall. The efficiency ratio is how much non interest expense is required to generate revenue.

Then I look at the non performing assets and net charge offs – to say they are low would be an understatement. Less than 1/2 million charge offs since 2019–essentially zero.

So does BWB make office loans all over the U.S.? No–only 14% of the office loans are out of state with the balance mainly in the Twin Cities–and only 13% of those are in the central business districts (downtown)-the balance are suburban. The average loan size is small with excellent loan-to-value (although one should be skeptical of LTV numbers of all lenders–values are falling and what was a 62% LTV might be 80% now).

Or maybe it is articles like this one that ran in the local newspaper a few days ago that has spooked investors (not sure everyone can access–I have a subscription). Although with a 2.98% of office loans in default across the Twin Cities right now the risk seems somewhat muted. Will defaults rise? I think they may double or even triple in the next year depending on where interest rates go. But as shown above the average non owner occupied office loan at BWB is $2.3 million – these are more like loans on small properties – realtors, bankers, dentists and the like – not office towers in the downtown area, which seem to be continually in trouble. I would expect BWB to experience some increases–but not super serious increases—when you are near zilch there is only one up to go.

Yes earnings at BWB have been down—not unexpected as the costs of funds rose sharply–as it did for every lender. As you can see below the cost of funds rose 5X year over year. While interest income rose substantially it certainly didn’t keep pace with the cost of funds. This will change for BWB and all banks as the costs of funds falls and interest income rises. So assuming this is already occurring as rates have fallen I would expect improved net interest margins—at least for the next few quarters (then who knows for sure as the interest rates for the future are not really predictable). Below are the financials for the latest quarter and 9 months–softer–yes–terrible–no.

So with a careful review I added to my position on Friday and added more this morning (at 15.52) I am at now at 50% of a full position. We’ll see what happens and determine further moves.

Note that I am ‘talking my book’–this is not a recommendation, but at 9.55% current yield the risk/reward seems good – I would think a 10-20% capital gain is attainable in the next 3 months or so (plus dividends).

If You Want a Safe Income Stream

Recently a number of folks here and on other websites have mentioned some utility ‘illiquids’ for a possible purchase for those wanting a very safe income stream.

The very old (issued in the 1950’s and 1960’s) preferred shares from Connecticut Light and Power (parent Eversource-ES) are now selling at attractive levels providing current yields of 6.3% to 6.9%. These issues are all $50 issues and trading volumes are pretty lite. They may be redeemed at anytime at various redemption prices – $50 or above. They are cumulative and qualified.

I have a spreadsheet of $50 and $100 issues here – I do not keep this well updated but it is a starting point for potential investments.

Added a GTC Lowball Order

I added a low ball Good Until Cancelled order this morning for the XAI Octagon 6.50% term preferred (XFLT-A). I currently hold a full position, but at the right price I am not against adding another 100 shares (for now). This has a mandatory redemption in 3/2026 and at my $24.00 order price will meet my current hurdle of 8% yield to maturity. The odds of this order executing seem pretty remote, but one never knows.

This is an unrated issue with a coverage ratio of 234% (200% is required) – not the highest quality term trust, but one which I have owned for a long time and feel comfortable holding.

Note that XFLT directors have voted (just today or yesterday) to make this CEF perpetual, as they previously had a term trust agreement which would have had the trust liquidate in 2029. This should have no effect whatsoever on this issue.

Some Previous Nibbles

I had mentioned a week or two ago that I have made some nibbles on some good until cancelled orders for some baby bonds. I wanted to get the details out here and then I will update my ‘laundry list’ of holdings.

I made 3 small purchases of the Hennessy Advisors (HNNA) 4.875% Notes due in 2026 (HNNAZ).

8/10/2023 $22.55

8/16/2023 $22.55

8/23/2023 $22.25

Note that I had a good til cancelled order in at $22.55 for the 1st 2 ‘nibbles’–which was lowered to $22.25 for the last nibble.

Now do I want this low coupon security that bad? No–but it has a maturity on 12/31/2026 and the yield to maturity was just over 8%–and I do want the 8%. These nibbles were added to what was already a full position–and while I don’t necessarily want more I have a $22/share good til cancelled order in right now.

It should be noted that I am very comfortable with this small company (Hennessy Advisors)–they have a market cap of just over $50 million so definitely a small cap. They advise open end funds and thus are paid on assets under management which have trended down in recent years, but finally they have assets moving higher and are taking over management of other funds which should drive assets higher.

Their latest earnings release is here.

Additionally the company carries a high cash balance of $59 million and essentially has no debt EXCEPT the HNNAZ issue which is $39 million.

Here is their most recent (6/30/2023) 10-Q.

This is not a recommendation to buy this security–but maybe a yield to maturity of over 8% is attractive to someone. Please fully understand how they make their money and the motivations of managers to secure more assets under management (money of course).

I will add these to my laundry list of securities owned soon.

Revisiting an Old Topic

This is a topic which I have written about many times and was reminded of it when reading some comments on long term bonds (baby bonds) in one of the threads.

When you are fearful–worried about risk to your capital the place to turn to is either ‘term preferreds’ or short dated baby bonds.

When long term bonds are being hammered by rising interest rates in almost all cases issues that are out there with a ‘date certain’ maturity in the next 1-5 years will move only a small fraction of the price movement of those bonds which have maturity dates out in 2050, 2060 or way, way out. This is exactly why in the past I have held exclusively term preferreds and short maturity baby bonds (that is not currently the case).

My best example is 2 term preferreds from CEFs that I own (overweight on both). These 2 are the RiverNorth Capital and Income Fund 5.875% term preferred (RMPL-P) and the XAI Octagon 6.5% term preferred (XFLT-A).

You can see below that over the course of the last year these 2 issues have traded in a tight range of less than $1/share. The RiverNorth issue has a mandatory redemption in about 14 months (10/31/2024) and the XAI issue has a mandatory redemption in 31 months (3/31/2026).

One will give up some coupon for the pleasure of have a more stable capital investment. Obviously one wants to purchase these in the lower part of their trading range–and in no case should one pay over $25 or your yield to maturity will fall.

I have a page of the term preferreds and short dated maturity baby bonds which one can find here. Of course regardless of the issue one must do their due diligence on the issuer–short or long dated maturities will make no difference if the company files for bankruptcy.