Southern First Bancshares (SFST)

Southern First Bancshares, Inc. (SFST), headquartered in Greenville, SC, is the holding company for Southern First Bank, the third-largest bank headquartered in South Carolina. Relative to the other companies highlighted on this blog, Southern First is a relative baby; it was founded in 1999 and now operates a 11-branch network in several attractive markets in the southeast (Greenville/Columbia/Charleston SC; Raleigh, NC; Atlanta, GA).

As of six months ago, there was one major reason I didn’t think Southern First would have any chance of showing up on my screens: valuation. In June 2018, shares of SFST were trading a ~220% TBV and ~22x TTM EPS. No matter how attractive a bank franchise may be, the math just never works if you are trying to justify a 200%+ TBV valuation is a good setup/entry for a long-term investment.

So, its only after a material selloff that SFST popped back up on the radar. Shares of SFST have declined ~33% from the June 2018 highs, cutting its P/E valuation in half to ~11x (lowest levels of the current expansionary cycle) and its TBV valuation down to ~145% (lowest since early 2016). One of the main reasons I’m hesitant to invest in young banks is the lack of an underwriting and performance track record through various credit cycles. If there is one sliver of a silver lining of the 2007-2010 era, it provides a very nice window into how a community bank performed through both a credit and liquidity shock. So I do get some comfort in seeing that while SFST is a young institution and focused on growth (an initiative that can get a lot of banks into trouble), SFST weathered through the financial crisis with a full-year net income. SFST’s trough year for profitability occurred in 2010 when it printed a 0.18% and 1.90% ROA and ROE, respectively.

I naturally gravitate towards the older, traditional bank franchises that have been around for 100+ years, but I also have to recognize when the market is giving patient investors a nice opportunity to hop aboard a “growth” story (at least my definition of a growth bank) in the community bank space. So, in the spirit of mixing in a little growth with my typical value-based approach, I think it is time to start buying some SFST.

Post-crisis, SFST has been executing its growth strategy and expanding its presence in some quality southeastern markets. Management has entered Charleston, Raleigh, Greensboro, and Atlanta markets since 2012, and growth has been impressive. Since 2015, loans and deposits have grown 60%+ and equity has grown 75%+ (retained earnings and two equity raises). While the market has not been kind to SFST recently, it doesn’t appear to be impacting the business performance. SFST has printed quarterly EPS of ~$0.70 for Q1-Q3 2018, so ROA is ~1.25% and ROE is ~14% YTD thru Q3 2018. At these levels, SFST will double its capital base in 5 years time. There is a lot to like in the underlying business: earnings are top-notch, growth appears sustainable, valuation is manageable, and somebody is going to try and take over this franchise at some point.

Some concerns that could pressure earnings/profitability/growth to keep an eye on:

  • Economic Cycle – Hard to forecast how close we are to a turn in the credit cycle, but all banks and shareholders, no matter the quality of management, bear the risk of a downturn in local and national economies.
  • Index Inclusion – SFST is a Russell 2000 member. Russell ETF flows and rebalances can drive near-term price dislocations in smaller, less-liquid bank names.
  • There is such a think as too much growth – high-flying growth pulls a lot of unforeseen risks into a bank’s orbit. Focus on growth can take attention away from credit risk and underwriting standards (we’ve seen issues pop during this cycle already, e.g. Opus Bank).

Bank Description & Geography

Nice pu pu platter of southeastern geographies

sfst geo

Financial Overview

sfst

Notable Ownership

  • Directors / Named Executives, as group – 10.9%
  • T Rowe– 7.6%
  • Manulife – 7.0%
  • Banc Funds – 6.3%
  • Wellington – 6.3%
  • Vanguard – 5.8%
  • Blackrock – 4.7%
  • Mendon – 3.9%
  • Elizabeth Park Capital – 2.8%
  • Castine Capital – 2.5%

Prospective Buyers

  • Synovus ($43.4B Assets / SNV)
  • First Horizon ($40.6B / FCNCA)
  • First Citizens Bancshares ($36.4B / FCNCA)
  • IBERIABANK ($30.1B / IBKC)
  • Pinnacle Financial ($23.8B / PNFP)
  • South State ($14.6B / SSB)
  • United Community ($12.3B / UCBI)
  • Carolina Financial ($3.7B / CARO)
Advertisements

Auburn National Bancorporation (AUBN)

Auburn National Bancorporation (AUBN), the bank-holding company for AuburnBank, operates 9 branch locations in southeast Alabama with total assets of approximately $800 million. Founded in 1907, the Bank has operated continuously since it was established as the first financial institution in Auburn, Alabama. AuburnBank is community oriented and focuses primarily on offering commercial and consumer loan and deposit services to individuals, and small and middle market businesses.

AUBN had an interesting year in 2018: balance sheet growth was nonexistent, profitability improved, and the stock traded from $35 to $55 and back to $30. In June 2018, AUBN was added to the Russell 2000 Index — which can be a challenge for a stock that doesn’t have more than 4,000 shares trade on a typical day. The share price of AUBN had a version of a melt-up in June as it moved from ~$42 to ~$55 over the course of the month as the Russell rebalancing flows impacted the stock. Since then, the stock has sold off by nearly 35% (it was worse in December…) as the entire banking sector has traded lower and, I’d argue, selling in the Russell-linked funds put additional pressure on AUBN.

As a result, I think we are getting a nice opportunity to begin accumulating AUBN shares. It is an valuable community franchise and I think there are some nice near- and long-term drivers. AUBN’s P/TBV valuation (148%) is a touch on the high-end for my taste, but the P/E valuation (~14x) is manageable. I’m a buyer on any additional weakness.

AuburnBank has proven its mettle over the years. The bank was established in 1907 and managed well through the previous financial crisis; its worst year of profitability was 2009 when it printed a full-year ~4.25% ROE and full-year charge-offs peaked at 1.01% in 2012. AUBN has printed normalized earnings since FY 2011 and they’ve posted at least 0.90% ROA and 9.00% ROE every year since 2012. As positioned today, 1%+ ROA and 10%+ ROE profile is a reasonable forecast for returns during expansionary periods.

There is one ownership/management dynamic I’d like to address: it’s two largest shareholders are E.L. Spencer (former Chairman and CEO) and Emil Wright (former Vice Chairman). Mr. Spencer owns ~20% of the bank and is 87 years old. Dr. Wright owns ~11% and is 82 years old. I’ll address the elephant in the room: there could be a couple tax events on the horizon that impact AUBN shareholders should it remain a standalone entity over the next 5 years.

Primary drivers setting up AUBN shareholders for continued investment performance over the near- and longer-term:

  1. Compounding Earnings: Under the current regulatory environment, ROE should print a 10%+ rate and provide attractive growth and investment returns to shareholders.
  2. Dividend Income: AUBN pays a ~2.75% dividend yield (40% payout ratio).
  3. Potential M&A Upside: from an acquirer’s perspective, AUBN checks the boxes that most acquirers are searching for in this market.
    • Deposit Funding: impressive, all around
      • 28% of AUBN’s deposits are noninterest-bearing
      • The cost of the interest-bearing deposits is 0.65% – somewhat high due to mix of time deposits, but interest-rate has only increased 3bps since 12/2017.
      • The total cost of funds on AUBN’s $720 Million deposit book is 0.58%
      • Loan/Deposit ratio is just ~64%, meaning an acquirer can tap into the excess (and cheap) deposit funding for loan/asset growth.
    • Capital Positions: AUBN is over-capitalized (16% Tier 1 Ratio) and under-levered (11% leverage) – acquirer can right-size those positions.
    • Asset Quality: credit book is in great shape; low 0.15% NPA/Assets metric along with a reserve balance 3.9x the NPAs. Bank management proved its underwriting strength thru the financial crisis when NPLs peaked at 3.1% and charge-offs peaked at 1.0%. Loan allocation to Construction & Land Development a touch high for me at 9.7%, but management ran that mix at 18% pre-crisis and the underwriting strength held up fine.

Some concerns that could pressure earnings/profitability/growth to keep an eye on:

  • Economic Cycle – Hard to forecast how close we are to a turn in the credit cycle, but all banks and shareholders, no matter the quality of management, bear the risk of a downturn in local and national economies.
  • Russell 2000 Member – Back in June 2018, AUBN was added to the Russell 2000 Index and, as a result of the low float, caused a melt-up scenario as shares moved from low/mid $40s to nearly $55 from early-June to mid-July. Given the concentrated ownership at AUBN and low daily liquidity, ETF rebalancing could cause outsized price swings in AUBN.
  • Father Time – Don’t like having to point this out again, but there are two octogenarian shareholders holding nearly 35% of the shares. There are material estate/tax implications should one or both pass while AUBN is a standalone entity. This could also act as a catalyst for Mr. Spencer and/or Dr. Wright to advocate for a sale.

Bank Description & Geography

AuburnBank’s roots trace back to 1907, and the bank currently has a 9 branch network in and around the Auburn, AL area. Nicely adjacent to Birmingham, Atlanta, and Northern Florida market footprints.

aubn_geo

Financial Overview

 

aubn

Notable Ownership

  • E.L. Spencer – 20.4%
  • Dr. Emil Wright – 10.8%
  • BlackRock –  2.9%
  • Banc Funds –  1.5% (sold shares in Q3 2018)

Prospective Buyers

  • CenterState Bank ($12.2B Assets / IBCP)
  • BancorpSouth Bank ($17.2B / BXS)
  • Trustmark Corporation ($13.4B / TRMK)
  • Renasant Corporation ($12.7B / RNST)
  • Capital City Bank Group ($2.8B / CCBG)
  • River Financial Corporation ($1.1B / RVRF)

ChoiceOne Financial Services, Inc. (COFS)

ChoiceOne Financial Services (COFS), headquartered in Sparta, MI, is the holding company for ChoiceOne Bank. ChoiceOne operates a 14-branch network in western Michigan (in/around Grand Rapids area).

ChoiceOne trades with a fairly limited float so the market weakness in bank stocks has not hit COFS as hard as most of its peers as shares are down ~12% since its 2018 highs. While COFS’s P/TBV valuation (143%) is a touch on the high-end for my taste, the P/E valuation (~13x) is very manageable and I think shares have entered a range that provides a good entry point to start accumulating a position in an attractive banking franchise.

ChoiceOne has proven its mettle over the years. The bank was established in 1898 and managed through the previous financial crisis without printing a full year net loss and COFS has been printing some healthy returns since FY 2013. As positioned today, 1%+ ROA and 10%+ ROE profile is a reasonable forecast for returns during expansionary periods. Primary drivers setting up COFS shareholders for continued investment performance over the near- and longer-term:

  1. Compounding Earnings: Under the current regulatory environment, ROE should print a 10%+ rate and provide attractive growth and investment returns to shareholders.
  2. Dividend Income: COFS pays a ~2.90% dividend yield (38% payout ratio).
  3. Potential M&A Upside: from an acquirer’s perspective, COFS checks the boxes that most acquirers are searching for in this market.
    • Market Geography: nestled nicely around Grand Rapids, MI, which is one of the fastest growing economies in the US over the past 5 years.
    • Deposit Funding: impressive, all around
      • 27% of CIVB’s deposits are noninterest-bearing
      • The cost of the interest-bearing deposits is 0.45%
      • The total cost of funds on COFS’ $545 Million deposit book is 0.33%
    • Capital Positions: ChoiceOne is well-capitalized with a 13% Tier 1 Ratio.
    • Asset Quality: credit book is in good shape; low 0.6% NPA/Assets metrics along with a reserve balance 1.2x the NPAs. Bank management proved its underwriting strength thru the financial crisis when NPLs peaked at 4.2% and charge-offs peaked at 1.3%. Nice 22% weighting to C&I portfolio, a nice diversifying asset mix for an acquiring bank more heavily weighted to residential and commercial real estate lending.

Some concerns that could pressure earnings/profitability/growth to keep an eye on:

  • Economic Cycle – Hard to forecast how close we are to a turn in the credit cycle, but all banks and shareholders, no matter the quality of management, bear the risk of a downturn in local and national economies.
  • Unforeseen credit losses – Another challenge to forecast, but the smaller you go down in the asset size of the banking industry, the more dangerous one or two bad loans can be for an institution.

Bank Description & Geography

ChoiceOne’s roots trace back to 1898, and the bank currently has a 14 branch network in and around the Grand Rapids area

cofs_geo

Financial Overview

 

cofs

Notable Ownership

  • Directors / Named Executives, as group – 9.1%

Prospective Buyers

  • Independent Bank Corporation ($3.3B Assets / IBCP)
  • Mercantile Bank Corporation ($3.3B / PRK)
  • Horizon Bancorp ($5.1B / HBCN)
  • Macatawa Bank Corporation ($1.9B / MCBC)
  • Chemical Financial ($20.9B / CHFC)
  • Old National Bancorp ($17.6B / ONB)