Gator Capital Management, an investment management firm, published its second-quarter 2021 investor letter – a copy of which can be downloaded here. A return of 2.35% was recorded by the fund for the Q2 of 2021, below the S&P 500 Total Return Index that delivered an 8.55% return and the S&P 1500 Financials Index that had a 7.60% gain for the same period. You can take a look at the fund’s top 5 holdings to have an idea about their top bets for 2021.
In the Q2 2021 investor letter of Gator Capital Management, the fund mentioned Esquire Financial Holdings, Inc. (NASDAQ: ESQ) and discussed its stance on the firm. Esquire Financial Holdings, Inc. is a United States-based bank holding company with a $202.8 million market capitalization. NTP delivered a 35.02% return since the beginning of the year, extending its 12-month returns to 54.23%. The stock closed at $25.94 per share on August 23, 2021.
Here is what Gator Capital Management has to say about Esquire Financial Holdings, Inc. in its Q2 2021 investor letter:
“One of the new small bank positions that we purchased for the Fund is in Esquire Financial Holdings (“Esquire” or “ESQ”). Esquire is a bank headquartered on Long Island, focused on serving the banking market for attorneys. By the nature of their business, attorneys often have control of money in escrow accounts for the benefit of their clients. These escrow deposits are attractive to banks because they tend to be sticky and not rate sensitive. Attorneys also have borrowing needs that haven’t been wellserved by traditional banks. In addition, Esquire has an attractive merchant acquiring business. Esquire has developed a good track record of earnings growth in the few years since its 2017 IPO.
We believe there is a disconnect between Esquire’s growth and its valuation. It trades at 8.4x 2022 consensus Wall Street estimated earnings, but the bank’s earnings per share (“EPS”) is growing at 20%. We believe the major reason for this disconnect stems from Esquire’s removal from the Russell 2000 index this past June. Index funds that track the Russell 2000 had to sell their Esquire shares. We believe prospective buyers of Esquire’s stock waited to buy until the Russell deletion date had passed. We think Esquire should trade at 15x or greater, which is in line with other high-growth banks.
We believe the most attractive part of the Esquire investment thesis is Esquire’s deposit franchise. Esquire’s deposits have a very low cost. Esquire also has more deposits than it needs. It has a low loanto-deposit ratio and sweeps more than $300 million of other customer funds off its balance sheet to
other banks or money market mutual funds. Esquire gets these attractive deposits by:
- Getting the law firm operating checking accounts when they extend credit to the law firms and
- Capturing escrow deposits from law firms for funds and settlements that the law firm’s attorneys control. These deposits are not rate-sensitive, as the attorneys place ease of use above the rate paid in choosing their banking relationships.
Esquire is growing its loan portfolio at an attractive rate because it is attacking several opportunities. First, Esquire is making loans to attorneys for two different purposes. One is to provide working capital to law firms for managing their cash flow. The second reason is to provide funding for law firm expenses in contingency cases. Law firms regularly have expenses in cases that they take on contingency, which are then reimbursed when the client’s case is settled. However, attorneys cannot charge their clients a financing fee if they self-finance these up-front expenses. If the attorneys borrow money from a bank, they can get reimbursed for the interest paid to the bank when the client’s case is settled. Esquire doesn’t bear the contingency risk in these loans. Instead, the law firm’s overall cash flow is the security for these loans rather than the settlement proceeds from any particular case.
Esquire built a merchant acquiring business over the last 10-years, which generates a good amount of fee income and enhances the bank’s value. We are happy that Esquire’s management is focused on growing a fee income business. We are hopeful that the management team will expand into other feegenerating businesses such as trust & investments, insurance, and/or mortgage banking.
Esquire’s focus on the attorney market leads to wider margins than typical banks. As Esquire scales, we believe the wider margins will lead to higher returns and eventually a higher valuation. Esquire Bank has better net interest margins (“NIM”) than a typical bank. The bank’s focus on attorneys leads to higher than average loan yields and low deposit costs.
We admire the management team at Esquire. Andrew Sagliocca has been the CEO of Esquire for the past 13 years, but he is still relatively young for a bank CEO at 53 years old. Sagliocca previously worked at KPMG and North Fork Bank before joining Esquire as the CFO in 2007. We believe Sagliocca has focused the bank on an attractive niche. He understands how to create value as a banker. We look forward to how much value he can create at Esquire over the next 15 to 20 years.
The main risk with Esquire is the typical credit risk of any small bank. In addition to loans to law firms, Esquire also makes real estate loans in the New York City metro area. Through our research, we don’t have any outsized concerns about Esquire’s credit quality. We think Esquire is a cheap small bank with attractive growth in a unique niche. We believe the bank has a long runway for growth and should have a valuation significantly higher than the current valuation.”
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Based on our calculations, Esquire Financial Holdings, Inc. (NASDAQ: ESQ) was not able to clinch a spot in our list of the 30 Most Popular Stocks Among Hedge Funds. ESQ was in 3 hedge fund portfolios at the end of the first half of 2021, compared to 2 funds in the previous quarter. Esquire Financial Holdings, Inc. (NASDAQ: ESQ) delivered a 6.85% return in the past 3 months.
Hedge funds’ reputation as shrewd investors has been tarnished in the last decade as their hedged returns couldn’t keep up with the unhedged returns of the market indices. Our research has shown that hedge funds’ small-cap stock picks managed to beat the market by double digits annually between 1999 and 2016, but the margin of outperformance has been declining in recent years. Nevertheless, we were still able to identify in advance a select group of hedge fund holdings that outperformed the S&P 500 ETFs by 115 percentage points since March 2017 (see the details here). We were also able to identify in advance a select group of hedge fund holdings that underperformed the market by 10 percentage points annually between 2006 and 2017. Interestingly the margin of underperformance of these stocks has been increasing in recent years. Investors who are long the market and short these stocks would have returned more than 27% annually between 2015 and 2017. We have been tracking and sharing the list of these stocks since February 2017 in our quarterly newsletter.
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Disclosure: None. This article is originally published at Insider Monkey.
