I was scrolling twitter and came across a tweet by Turtle Bay (who might be one of my favourite accounts on twitter) who had a link to shareholder letters from Trinity Bank. I clicked the link and have been hooked, as I have read them all this past week. I thought I’d share some interesting things from the letters. I have been looking at a potential investment in a bank recently and these letters helped explain some of the inter-workings.

Trinity was founded in 2003 by Jeff Harp. They raised about $11m from shareholders and have been growing ever since. What’s amazing about Trinity is that they didn’t have one bad loan through the 07-08 crisis. Not until 2010 did they have their first problem loan of $1.78m. Their underwriting was so good that their accountants told them that they didn’t have to provision for loan losses for a period of time. Their first actual loss/charge off was in August 2012, almost 10 years after founding the bank. They focus more on commercial and industrial loans and don’t take on transactional deposits but want to develop relationships with their customers. Today they have a $300m loan book and $429m deposits. You can read the letters here at this link which I highly recommend.

First, from there 2008 Q1 press release:

$51m loans into the crisis and not a single nonperforming loan. That is remarkable based on the number of loans that went bad during this period.

**From Q1 2012 shareholder letter:**
Here is the CEO doing an acquisition analysis of other banks based on their current loan books. His reasoning for not purchasing another bank that he was pitched by an investment banker is is 1) He doesn’t want to go outside the banks circle of competence or core focus area of commercial and industrial vs non-owner occupied real estate lending and 2) For less costs, he can just hire 2-3 lenders to develop their own book and not have to pay millions of dollars above book value for loans he doesn’t really want. Both of these reasons seem extremely simple and logical but a lot of CEOs are willing to do M&A to empire build without thinking through the actual ramifications of acquisitions.

From the Q1 2014 letter:
The CEO talks about what a bank’s performance boils down to: 1) Volume, 2) Margin, 3) Asset Quality and 4) Efficiency.

The volume of loans is key to a bank as that is where they get their highest return, followed by security investments and then short-term investments.

Margin is vital for assessing a banks performance (the net interest margin) because it measures the rate the bank is earning on its money less the difference it is paying to hold the deposits. Obviously asset quality is important because if the loans are bad, the bank won’t exist for long. The problem with banks is that you won’t know the loans are bad for a few years. The efficiency ratio measures how well the bank is at managing its costs.

Near the end of this letter the CEO also talks about what can go wrong in banking: having problem loans or a rapid rise in interest rates (very prescient to Spring 2023 that caught some banks off guard).

From Q2 2014 Letter:

Here the CEO lays out the bank’s securities portfolio analysis and goes over what a bank usually buys in this portfolio. It can consist of US Treasuries, Federal agency securities, corporate bonds or tax-exempt securities. These are ordered from least to most risky.

From Q2 2015 letter:

In this letter the CEO goes over an M&A analysis of why he doesn’t think it’s a good idea to sell the bank. Banks can be valued on a book value basis, earnings basis, or percentage of assets basis. There is no real perfect answer but he prefers percentage of assets and explains why as well as using precedent transactions to determine the value of Trinity.

From Q2 2019 letter:

This letter explains why it is hard to make money in a flat yield curve environment. If you are paying depositors 3% and the 5 and 10-year is sitting at roughly 3%, it is hard to loan that money out on a long term-basis because you’re going to be loaning at roughly 3% as well. You won’t make any money and will probably break-even or lose a bit of money.

From Q1 2022 letter:

Explains how their bank mitigates interest rate risk. If a customer enters into a long-dated loan, Trinity puts interest-rate adjustment clauses into the loan so as not to have a negative carry on their loan book. For example, if Trinity loans out a 10-year loan at 2% and their cost of deposits are 1% and assume in 5 years that rates are now sitting at 4%. If they don’t enter into those rate adjustment loans, they will be receiving income at 2% but paying interest at 4% which is not sustainable. But by entering the rate adjustments, this 2% long term rate will adjust up in a few years so as to not sit below the rate that they are paying depositors.

The key thing here is that they are not betting on where interest rates will go but preparing for if they move in an adverse way.

From Q3 2022 Letter:

Determining a banks liquidity is adding the amount of “overnight money” held at the federal reserve bank plus the marked-to-market of the securities portfolio. You can then compare this amount to the total deposits a bank has to determine how quick the bank could meet potential deposit withdrawals in a crisis. You could also add any LOCs the bank has from other banks as well.

One of the reasons they stay away from investor or speculative lending (NOORE – Non-Owner-Occupied Real Estate loans) is because the repayment of the loans relies on rental rates and occupancy levels. When rates rise rapidly, the interest cost obviously increases rapidly but the rent/lease income from those properties won’t be able to increase as fast. This leaves the owner of the property potentially burning money each month as financing costs are now greater than the income and the loan could turn non-performing. We are currently potentially seeing this at Bancorp Inc’s loan book.

From Q3 2023 Letter:

Managing a banks interest rate risk is the one of the most important aspects of banking. Trinity manages this risk by not only stress testing their loan book but by also having 49% of the loans floating rate and 51% fixed, pretty much 50/50. And the fixed portion has rate adjustments every 3-5 years as seen from the Q1 2022 letter. This allows them to keep their income on par with where rates move in a cycle and not to be stuck at a certain rate.

In terms of the nature of their deposits, this is a source of their competitive advantage. They don’t take fast money by offering higher rates for deposits. They want to develop the relationship with each customer so they have access to all of the customers accounts.

If a bank doesn’t have that type of relationship with the customer and needs deposits, they can just offer a higher rate, borrow from the FHLB or purchase brokered deposits. Since Trinity doesn’t have to do that but relies on the relationship, 98% of their total deposits are “core” deposits, which is exceptional.

Some ways they explain on how to improve banking services and other tidbits in the letters:

Instead of charging overdraft fees right away, call the customer to let them know that their bank is in overdraft. And give them several overdrafts free each year. However, no one should abuse the service.
“No voicemail unless customer asks for it. During banking hours, someone must answer the phone.”
When a mistake is made on the account, usually have to call a toll-free number. Jeff gave his direct line out to customers for them to call him to fix the mistake and make sure it is not systemic.
Focus on growth, profitability and quality rather than just focusing on growth.
The key is not having problem loans but how much of your money you get back when you have one (a problem loan).
Of the banks that perform poorly or are closed by the regulators, 99% of them do so because of bad loans. The other 1% is usually some kind of fraud or liquidity issue (In later years he says 95% and 5% but you get the picture).

Reading these letters leaves you feeling like you have an MBA in banking. I am hoping to increase my banking knowledge this year and am looking to read all of Jamie Dimon’s, Robert Wilmer’s, Richard Davis’, and Frost Bank shareholder letters. If anyone has any other recommendations please let me know. Hopefully I’ll get a few banking books in as well.

Highlights from Reading Trinity Bank’s CEO Letters