GBank - Unique Bank with 5-10x Upside Potential

More than 30% of the total loan portfolio is government-guaranteed

Dec 17, 2024

High quality and growing core banking division: ROE ~20%, growth well above 20%, low-cost deposit base, and healthy Net Interest Margin ~5%
One of the national top SBA loan providers - more than 30% of GBank’s total loan portfolio is government-guaranteed (reduces risk)
Potential 5-10x opportunity due to their unique IP, expertise, and network in the Gaming FinTech business. This may allow them to bring hundreds of millions or billions of interest-free deposits into the bank.
Very experienced and invested (46% insider ownership) management team and the board
NASDAQ uplisting is planned by next spring; potential inclusion in the Russell 2000

Business and History

At its core GBank is a well-run growing bank business. From their 2023 annual statement:

GBank‘s primary market for deposit customers is in Las Vegas and Clark County, Nevada, although GBank accepts deposits from deposit listing services as needed to support its funding needs. GBank’s lending operations are carried out in two distinct departments:
“Local Market” Department, which originates conventional and Small Business Administration (“SBA”) 504 loans in Nevada, California, Utah and Arizona, and
“National Market” Department, which originates, sells and services loans guaranteed by the SBA and the United States Department of Agriculture (“USDA”) in thirty-nine states. In addition, the Department originates conventional loans, but these are not significant in relation to the overall National Market loan portfolio.

Their loan portfolio is concentrated mostly in commercial real estate, accounting for more than 85% of the total loans. Geographically, Nevada is their biggest loan market with a 29% share.

The most interesting part is their SBA lending department. These loans for small businesses have government backing, which makes them less risky for lenders. Essentially, the US guarantees up to 85% of the loan amount to the lender. Currently, more than 30% of GBank’s total loan portfolio is government-guaranteed, which provides a strong risk mitigant to the bank.

The most common kind of SBA loan is the standard 7(a) loan which allows businesses to borrow up to $5 million. GBank is:

A top 10 national SBA 7(a) lender by volume
And a top (#1) National Hotel/Motel lender for each of the past four years.

The Bank maintains strong national relationships and has established itself as the premier government-guaranteed lender within the industry. What is more, their network is mostly in-house:

Someone asked me, he said, "You must have an enormous broker network to be able to grow and develop that fast." And the answer to that is, no. But we have a dedicated broker network. 2/3 of our generation of that $474 million come from our network that are either shareholders, significant shareholders or employees. So that's very internal and very identified and very dedicated. (Q3 earnings call)

Experienced and Invested Management

GBank has a very experienced Board and Management. The Executive Management Team represents over 200 years of combined banking experience, while all members of the Board of Directors come from a variety of industries and possess significant skills, leadership, and experience. One example is the CEO of MGM Resorts International, William Hornbuckle.

This is very impressive leadership for a small-cap company. Check GBanks website or listen to their Annual Shareholder Meeting, if you want to learn more.

Management and the Board are also very invested - they own 46% of shares together. At the same time, there are no large shareholders, who can alone decide for the whole company.

The founder, 82-years old Ed Nigro, brings extensive expertise in real estate, casino management, and banking, having developed commercial and residential projects across multiple states and held senior leadership roles in major gaming and financial institutions since 1979. He served as COO of Del Webb Corporation’s six casino properties, a Director at Western Alliance Bank and BankWest of Nevada, and has been instrumental in shaping GBank's growth as its Executive Chairman.

This is what Ed said during the last Annual Meeting about their strengths:

I believe our strength today and our growth today, when we say we want to grow internally, we want to do things ourselves. We want to issue and manufacture and develop and credit our own credit card. We want to issue and create our own SBA division. … everything we do, technology and otherwise, we want internal to our bank. We don't want our bank tied simply by APIs with every kind of program there is on earth to function. We want to do it ourselves. But it's a part of our founding principle and our founding strategy. When we were founded -- our strength really lies in our Board and our shareholders. We had 180 shareholders when we were founded back in 2007 and the reason for that is, we didn't want there to be one influencer and the shareholders that would own over 10% and be able to influence through his vote or her vote the outcome of our company.

Improving Asset Sensitivity - Getting Ready for Lower Interest Rates

In Q3 2023, they started implementing what they called a “Great Pivot”. The gain on sales of SBA loans dropped to 3.5% back then and they decided to:

Retain more loans for themselves. These loans were boarded at 10%+ interest, so in 90 days they could earn same the amount in interest payments as if they had sold the loan.
Repurchase some of the previously sold loans from those who were looking for refinancing. Essentially, they converted a 1% servicing fee (which they earn after selling a loan) into an 8.55%-8.75% 5-year fixed rate loan. And almost all of these were guaranteed loans - without additional risk to the bank.

As a result, their assets have increased dramatically in 2024. Total gross loans increased by 61% and guaranteed loans increased by 193% in comparison to Q3 2023.

Another driver of this asset growth was their increased loan origination speed - they originated $474.6 million in SBA loans in the last fiscal year, up from $223.9 million the year before or a 112% increase.

Now that they are returning their SBA activity to a largely sell position and expect to maintain the same high level of loan originations next year, we should see a higher income from gains on sale. In addition, lower interest rates may boost the margin on these gains even more.

And if we had even close to those gain on sale numbers [as in previous 12 months] with the volume we have today, it would be quite amazing results. (Q3 earnings call)

GBank has also a very short-term portfolio of CDs (certificates of deposit). Almost half of the CD portfolio ($155 mln out of $344 mln) will mature or will be repriced before March 31, 2025. In addition, they have ~$40 mln of callable CDs. This will reduce their financing cost if interest rates continue to fall.

On top of that, they have ~$310 mln in non-maturity interest-bearing deposits, and those are already pricing down.

So, with their increased portion of fixed loans, soon-to-be-repriced deposits, and more loan sales, they are well prepared for a lowering interest rates environment.

Other points that highlight the quality of their core banking business:

Healthy NIM (net interest margin) at ~4.5-5% (compared to a national average of banks between $1 billion and $10 billion of 3.42%)
High ROE ~17-20% and ROAA ~1.7-2% (top decile for returns when compared to its peers)
Low-cost and stable core deposit base - 2.14% YTD (Non-interest-bearing deposits comprise 29% of total deposits)
Low non-performing assets (SBA 7(a) 5-year default rate is less than 1/2 of 1%. cumulative 5-year loss rate is less than 10 basis points)
Strong asset growth (historically ~25-30% CAGR)
Efficiency improvement (efficiency ratio increased from 76% to 55% over a year). They increased expenses starting back in 2022 to build a capacity for growth. Now the growth has materialized, but they managed to keep these expenses flat.
Strong capital ratio (Tier 1 capital ratio ~13%, while required is 9%)

Given all the above points, I am quite sure that the core banking business can grow at least 20% in 2025 (and beyond). If we assume they end 2024 with EPS of $1.4, then 2025 EPS of the banking business will be ~$1.7. Given the quality and growth of the bank, a forward PE of 10-12x or PB of 2-2.5x would be reasonable. This gives us ~$20 fair value for a banking division only.

Now, let’s dig into other opportunities.

Entering FinTech Business with Prepaid Cards

In 2014, management saw some opportunities in the FinTech field. Initially, they wanted to start a FinTech business inside GBank, but it was not easy to do from the regulatory perspective. So, Ed Nigro - Executive Chairman and one of the GBank’s largest shareholders - cofounded BankCard Services, LLC (“BCS”).

BCS agreed with Sightline Payments (which provides payment solutions for casino and digital gaming) to provide the bank necessary, G-Bank, to issue prepaid cards, branded for each of Sightline Distributors (Casinos), to their customers. All this was done to facilitate cashless transactions between players and wagering accounts.

Under this agreement, GBank issues prepaid debit cards through its memberships in Discover, MasterCard, VISA, and various other networks, and BCS serves as the program manager for the cards. In addition to card issuance, GBank provides settlement accounts and receives a percentage of BCS’s gross revenues as compensation for these services.

However, prepaid card business with Sightline Payments has been declining since 2022. The main reason was that credit card issuing banks started declining gaming-related transactions because Visa and Mastercard changed transaction merchant codes and started classifying these as gaming transactions instead of financial transactions.

GBank used this opportunity and created its own credit card division and became an issuer of a Visa Signature credit card. This is what Ed Nigro said during the last Annual Shareholder Meeting (May 2024):

And a Signature is a level that you must have a very good credit score in order to get this initial $11,000 credit with a Visa card. So it's not a subprime market.
Already now, I think you'll see in some other charts that we are achieving $1 million a month in payments on our credit card. And we see that our objective is to get that to $10 million a month by the end of the year. And we believe that that's going to be very achievable.
…
$1.2 million [credit balance] with $14 million in transactions. So you can see that over 90% pay it down every month, which is exactly what we want it used for. We want it used as a payment card as much as possible.

So, firstly, these cardholders are active and, secondly, they have high credit scores and pay everything back every month - meaning high quality.

Fast forward a few quarters, and GBank seems to be able to deliver on these promises. They achieved $1.1 mln transactions in Q1, $7 mln transactions in Q2, and $14 mln in Q3. They have recently signed a co-merchant, co-marketing agreement with Everi - one of the biggest cash management players in the casino industry, which handles $40+ billion in cash a year and has access to a very big audience. They are developing a digital wallet for their customers now, so there is a huge potential for GBank to tackle part of these $40+ billion. Moreover, Everi is soon merging with another big player - International Gaming Technology (IGT).

Apart from that, they have signed marketing agreements with Sightline Payments (with whom they have their prepaid card business) and 3 other companies.

With such agreements and partnerships in place, I believe they can achieve $10 mln a month by the end of the year. They expect their credit card division to become profitable already in Q4 2024.

Most income from this division will come from interchange fees. These are fees paid by merchants to the cardholder's bank for processing debit or credit card transactions. The average interchange fee for a Visa Signature card is ~1.65%.

If we assume a 30-50% growth rate per quarter (which is much smaller than their current growth rate of 100%+), they will be able to generate ~$200 mln transactions in 2025. This will translate into 200mln * 1.65% * (1 - 0.23 tax rate) / 14.5 mln shares = ~$0.2 additional EPS in 2025. Applying the same bank multiple of 10-12x we get to $2-2.5 value per share for credit card division.

Pooled Player Account and Digital Payments Regulation

The decline of Sightline Payments prepaid card business was offset by their newer PPA/PCA (Pooled Player Account / Pooled Customer Account) business line. PPA is a technology that was originally developed by BCS in 2018 for the Oregon State Lottery that wanted to enter Sports Wagering but did not have a license to hold and settle wagering accounts - thus needed a new process.

The management saw further potential in this technology and patented it.

With the PPA/PCA solution, custodial accounts for Lottery’s customers are opened in GBank in a structure similar to traditional FBO (For Benefit Of) accounts. But there are several key advantages of PPA/PCA structure over a traditional FBO:

Individual Consumer Deposit Accounts
In traditional FBO arrangements, funds are pooled and held in the name of the company, introducing legal ambiguity and risks of mismanagement or fraud. PPA/PCA accounts are owned, controlled, and monitored directly by the bank, and each consumer has his own individual deposit account.
Guaranteed FDIC Insurance Coverage and Other Protections
Since PPA/PCA accounts are individual consumer deposit accounts, they ensure the same consumer protections as traditional U.S. bank accounts, such as FDIC insurance, Regulation E, UDAAP compliance, etc. There is no more risk of
Real-Time Payment Capabilities
PPA/PCA accounts enable consumers to use real-time payments (RTP) and request-for-payments (RFP), allowing seamless, instant fund transfers in and out of accounts, including gaming and wagering activities. This is possible again only because all accounts are individual.
Resilience Against Fintech Failures
FBO structures expose consumer funds to fintech mismanagement or failure, as seen in a recent high-profile Synapse/Evolve failure, which left more than $200 mln customer funds frozen. PPA/PCA accounts protect funds from fintech failures because they are held in individual bank accounts, ensuring users retain access to their money even in case of bankruptcy.

After recent fintech failures, such as the collapse of Synapse, regulators are intensifying the oversight of digital wallets and Banking as a Service (BaaS) models. A few key developments here are:

The Federal Deposit Insurance Corporation (FDIC) has proposed new rules mandating banks to maintain detailed records for accounts managed by fintech firms. This includes daily reconciliation of accounts to ensure accurate tracking of customer funds.
The Consumer Financial Protection Bureau (CFPB) has finalized a rule to supervise large nonbank companies offering digital payment services. This rule subjects them to the same consumer protection standards as traditional banks.

With all the features of the PPA/PCA solution, which we discussed above, it seems as if it was created exactly to comply with all these coming regulations. I don’t know if management has seen it in advance, but now they clearly have an advantage.

But why should we care about this solution at all?

The Secret is in Free Deposits

GBank gets some fees for managing prepaid cards and PPA/PCA solutions for BCS, but it’s not a main priority here.

As the company stated many times, the main strategic focus for the Gaming FinTech division is to generate deposits. The beauty of this is that all consumers’ funds become non-interest-bearing deposits for GBank. Basically, free money to grow (3Q23 earnings call):

So we've created this network, and we really believe that the Gaming FinTech Division is going to manifest itself in future deposits. And this is very important to our growth. Very important to our growth in terms of being able to continually increase our guaranteed loan portfolio. And we believe that this growth will be there for us as we move forward.

At the moment, these accounts average approx. $30 mln, but there is much more potential here. At the moment, BCS and GBank have 16 active prepaid access and PPA/PCA clients. And they are conducting due diligence for 6 more clients, with anticipated onboarding in future quarters.

The management expects to grow deposits significantly in the next year (3Q24 earnings call):

So when we look at all of them, we're still running around $32 million in average monthly deposits right now. We expect those to start to grow in -- some in the fourth quarter, but we see those growing to $100 million to $150 million next year. And we think that's achievable just with the programs we have on the pipeline. … And instead of replacing CDs that's now in the low 4%, but replacing those with noninterest-bearing deposits to the degree that we grow gaming fintech, it provides a pretty powerful story.

We have mentioned above, that GBank repurchased some guaranteed SBA loans at ~8.5% rates. But let’s say that not all the deposits will be converted into SBA loans and interest rates will go down. Then GBank will manage to make 2-4% from these deposits. This will translate into another 100mln * 3% * (1 - 0.23 tax rate) / 14.5 mln shares = ~$0.2 additional EPS in 2025. Again, applying the bank multiple of 10-12x we get to $2-2.5 value per share for additional PPA deposits.

The Main Opportunity: Slot Machines

BCS has recently partnered with Konami, the #3 top provider of Casino Management Systems (CMS) in the US. They are connected to 140.000 slot machines. This is a great opportunity for GBank.

BCS (together with its partner BoltBetz, founded by Ed’s son - Todd Nigro) will provide an app for access to cashless slot machines. This solution will connect Konami’s CMS to the PPA and will have all the features we discussed above - instant transfers from the account to the app to the slot machine and back, FDIC insurance, and others.

If you are, like me, not really into gaming, then you don’t see why it’s so important. The thing is, a midsized American casino has between 2.000 and 3.000 machines and ~$50 mln in cash on the floor. This is a tremendous amount of cash, which just sits there idle. And many players in the industry seek ways to unlock this cash. BCS together with GBank provides quite a unique and regulation-proof solution to this problem.

They did the analysis and expect that 150 slot machines would generate deposits of about $4 mln on average. If they can capture just 10% of Konami’s slot machines, this will result in $400 mln in deposits for GBank. It is almost half of all the existing deposits of GBank.

If Konami likes the solution, then nothing would prevent them from signing for more slot machines. 40% of slot machines would bring GBank $1.5 bln in deposits, 70% - $2.5 bln. These amounts are mind-blowing and can increase the value of GBank by many times.

In the rest of the United States, there are another 250,000 or 300,000 slot machines. This opens even more opportunities.

This solution is planned to be launched in Q4. This is what management has to say about it:

Look, we'll get our market share, we believe with the implementation of dispersed application in which they have all of these three working, the PPA, the RTP, RFP [instant transfers] and the digital platform provider not touching the money. And the consumer protection that it offers. It has all the solutions in one, and we're going to launch it in a very few months with a really manageable program.

Licensing and Failed Acquisition of BCS

Another potential business line is to license the BCS’s PPA/PCA solution to other banks or payment providers. Given the current tightening regulatory situation, many financial institutions could be interested in getting a ready-compliant solution:

We still believe there are going to be licensing opportunities for that with the big players because the CFPB is not going to go away.
The fact that there's enormous pressures on banks and how they bank Banking-as-a-Service now from the regulators, all of them, not just the FDIC, but the OCC and the Federal Reserve, they're all looking at these. (3Q24)

Since this solution belongs to BCS, it makes sense to make a short introduction to the relationship between BCS and GBFH.

Initially, Ed Nigro wanted to open this FinTech business inside GBank, but it was quite hard from a regulatory perspective back then given the size of GBank. Since then, GBank tried to acquire BCS twice but failed both times.

Last time they tried in the beginning of 2024. However, due to regulatory complexities, including new FDIC requirements under the Bank Merger Act for banks acquiring non-bank entities, GBFH decided to withdraw its full acquisition application. These new FDIC rules require extensive oversight for acquisitions, including governance changes for the acquired company. For BCS, operating under stricter financial institution governance (e.g., compliance committees and enhanced internal controls) could hinder its entrepreneurial flexibility.

Instead, GBFH opted to secure a 32.99% stake in BCS as quickly as possible and close this topic for now. This is the maximum allowed stake, that GBank can acquire without much regulatory consequences. They said, that they can revisit it, but they are not sure, whether in the near term or long term.

Instead of prioritizing licensing agreements, GBFH is leveraging its close relationship with BCS to generate activity and deposits for GBank and remains the exclusive banking partner for BCS:

And these [deals] already go through the existing contract in BCS and GBank. And GBank is the only bank BCS is working with and only bank we shall be working with because the beauty of this is that GBank is the only bank that knows how to manage PPA and PCA. And we are being recognized as being very good at what we do, very good in our compliance. Remember, we're not a Banking as a Service, PCA has no access to the banking at GBank, nor do we ever run it that way. … … we're way less focused on licensing agreements right now versus generating the activity for GBank. GBank is capable of handling millions of accounts. We've already proven that. We've already handled over 1 million accounts when we were in our Sightline [ heyday ], with over with about 700,000 prepaid cards issued with Sightline.

Other Opportunities

There are several other opportunities on the radar:

Mastercard Express program

It's an Express program for companies that wish to issue prepaid cards in a record short time (30-60 days). Normally, it takes 7-9 months. GBank and BCS were recognized for their thorough vendor vetting process and they became the initial bank for this program.

This program will help GBank to accelerate its prepaid card business in three areas: gaming, government (state lotteries), and healthcare. At the moment, they have two applicants through this program.

State lotteries

GBank with BCS are working on an agreement to provide Visa prepaid and debit cards for a state lottery, as the state wants to replace checks and cash for payments over $600. This would allow the state to move to a digital payment system for lottery winnings.

It can become a substantial source of revenue with state lotteries paying tens of billions in winnings each year ($64.3 bln in 2021, Motley Fool).

Healthcare

Healthcare could be an interesting long-term opportunity, given the size of the industry and GBank’s strategic partnership with Mastercard.

We haven't been in health care, however, we are receiving certain inquiries in the health care industry for issuing prepaid cards. (3Q24)

Other early-stage opportunities

There are more in our pipeline, but they're in their early stages. And what we are finding is that because out there right now there is more clients or tech companies that are losing their relationships with their bank because of various issues that either they have or their bank is identifying a new business approach and they're not part of it. (3Q24)

Given so many areas that GBank explores and tries to penetrate, it could qualify as an Adjacent spawner in Monish Pabrai’s spawner framework to identify 10-100x baggers.

The Margin of Safety and Potential Upside

If we look only into 2025, then we have 1 sure and 2 highly probable streams of income:

Core banking division, which we valued at ~$20
Moderate income streams from growing credit card division and a few successful PPA deployments, which we together valued at $4-5 ($2-2.5 for each)

The price of the share now is $33. It means that we would pay $8-10 for an option on all the potential future projects, which include:

More rapid (70-100%) credit card growth and growth beyond 2025
Successful partnership with Konami (getting a bigger share of their slot machines universe) and with other Casino Management Systems
PPA/PCA Licensing
Mastercard Express program
More state lotteries
Healthcare market penetration
Other opportunities, which are early stage at the moment

If some of these projects prove to be successful, the value of GBank can increase five- or ten-fold over the next ~3-5 years, depending on the implementation speed. Just look at the “slot machines” opportunity, which could bring hundreds of millions or even billions of free deposits.

But if all of them fail, then we have a ~30% downside potential.

I like the potential upside, but I also like to have a solid margin of safety. So, I’ve entered only a small initial position in GBFH at these prices (~30% of the normal position). If the stock would trade at $25 now, I would buy the full position immediately. I will see, how the situation develops and will add if the price goes down a bit, or if there are some positive developments.

In the end, you should do your own due diligence and decide for yourself, if the potential upside costs 10$ or not.

Conclusion and Why Does the Opportunity Exist?

In the end, we have a high-quality and growing bank (ROE ~20%, growth well above 20%) with experienced and invested management, and a unique SBA structure (30% of loans are government-guaranteed), which alone can be fairly valued at ~$20-25.

Other fintech/BCS-related growth opportunities, which can potentially bring 5-10x (or fail), are currently priced at $8-10.

I see a few reasons, why this opportunity exists:

The business opportunity (Gaming FinTech) is not usual for a bank.
The bank is still small and not so visible. It’s also OTC and quite illiquid. However, in recent months they have been getting more traction, which can also be seen in the recent stock price moves.

Catalysts and some indicators to watch in the next quarters:

High (70-100%) growth rates in credit card division
Further details about the Konami slot machine deal (how many slot machines are signed and going to be signed)
Disclosures about other PPA deals, state lotteries, licensing, healthcare, etc.
NASDAQ uplisting - planned by next spring; maybe inclusion in the Russell 2000
They could be a potential acquisition target, given their valuable IP

Thanks for reading Value Investing by Double Alpha Factory! This post is public so feel free to share it.

Value Investing by Double Alpha Factory