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)
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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)

Civista Bancshares (CIVB)

Civista Bancshares (CIVB), headquartered in Sandusky, Ohio, is the holding company for Civista Bank. Civista’s operating history traces all the way back to 1884 and it currently operates 35 Branches and 3 Loan Production facilities (primarily in Ohio, but footprint extends into Indiana and Kentucky).

Recent market weakness along with a negative reaction to Q3 2018 results has dropped CIVB shares nearly 35% since the end of September. After its earnings report on November 2nd, CIVB shares underperformed the BKX Index by ~10% as shares were under pressure due to some significant one-time expense items that weighed on earnings during the quarter. CIVB closed its purchase of Indiana-based United Community Bancorp in early September, and CIVB management decided to convert United Community’s systems and operations concurrent with the merger close (most banks wait a period of 6-12 months for conversion to smooth the expenses over multiple quarters). All told, CIVB reported $8.8 million of acquisition- and integration-related expenses during Q3 2018, or $0.63 per share. On its Q3 earnings call, management indicated Q4 noninterest-expense should return to a normalized ~$15mm run rate. I believe the earnings-related selloff provides a current buyer a nice ~10% discount on top of the ~25% revaluation the market slapped on just about every other bank stock in Q4.

Looking past the integration expenses and broad market selloff, there are many attractive components in Civista’s operational performance, balance sheet, and core deposit franchise. Since 2014, Civista has printed 1%+ ROAs and 9%+ ROEs for its shareholders and, after adjusting for acquisition expenses, the bank is printing a YTD ROA and ROE of 1.45% and 12.18%, respectively. A huge part of the attractive profitability metrics is the value of its deposit franchise; nearly 30% of the bank’s deposits are noninterest-bearing and only ~16% is higher-cost Time Deposits. Overall, Civista’s total cost of deposits is just 0.22%.

(Quick aside on stock structure – Civista currently has a convertible preferred (CIVBP) paying a 6.5% dividend. Unless the common price plummets in 2019, the company will likely call the preferred in December 2019, providing a small cost save).

The aggressive selloff provides a nice entry level to invest alongside a bank set up for strong performance over a full cycle and upside potential for a takeout. Primary drivers setting up CIVB 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: CIVB pays a ~2.25% dividend yield (a very manageable 21% payout ratio).
  3. Potential M&A Upside: from an acquirer’s perspective, CIVB delivers a lot of value.
    • Market Geography: nestled in all 5 of Ohio’s, plenty of buyers to consider as a fit.
    • Deposit Funding: impressive, all around
      • 30% of CIVB’s deposits are noninterest-bearing
      • The cost of the interest-bearing deposits is 0.35%
      • The total cost of funds on CIVB’s $1.6 Billion deposit book is 0.22%
    • Capital Positions: Civista is well-capitalized when analyzing the as-reported capital ratios, or even after adjusting for its Trust Preferred borrowings (CIVB Tier 1 and Total Capital levels get the benefit of ~$29mm in qualifying Trust Preferred borrowings). If CIVB decided to call its TruPs, its capital levels would be closer to 13%, still very well-capitalized.
    • Asset Quality: credit book looks to be in decent shape, CRE loan mix is a little high but its manageable. Management speaks to its confidence in its credit work and maintain a conservative level of reserves; current LLR/NPL ratio is ~125%.

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

  • CRE Mix – CIVBs loan mix is ~40% CRE and CRE as a % of Capital is ~270%, just shy of the 300% regulatory threshold/watch. I won’t waste the ink here given the amount of coverage CRE lending has received in the business press, but that concentration is worth monitoring.
  • 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.

Bank Description & Geography

Civista Bank’s roots trace back to 1884, and the bank currently has a 35 branch network in spread across the five largest MSAs in Ohio as well as some spillover into Indiana and Kentucky.

CIVB_geo

Source: Civista Investor Presentation (SEC.gov link)

Financial Overview

CIVB

Notable Ownership

  • Directors / Named Executives, as group – 4.1%
  • RMB Capital – 5.4%
  • BlackRock – 4.6%
  • Vanguard – 3.7%
  • Castine Capital – 2.7%
  • Maltese Capital – ~2% (assuming preferred stake is converted into common)
  • EJF Capital – ~1% (assuming preferred stake is converted into common)

Prospective Buyers

  • First Financial ($13.8B Assets / FFBC)
  • WesBanco ($12.6B / WSBC)
  • First Merchants ($11.1B / FRME)
  • Park National ($8.4B / PRK)
  • First Commonwealth ($7.7B / FCF)
  • Peoples Bancorp ($4.0B / PEBO)
  • German American ($3.4B / GABC)
  • S&T Bancorp ($7.1B / STBA)
  • FNB Corp ($32B / FNB)

LCNB Corp (LCNB)

LCNB Corp (LCNB), headquartered in Lebanon, Ohio, is the one-bank holding company for LCNB National Bank. LCNB’s roots trace all the way back to 1877 (founded as The Lebanon Citizens National Bank) and it currently operates a 33 branches in markets in or adjacent to Cincinnati, Dayton, and Columbus.

While recent market weakness has not spared many bank socks, LCNB’s share performance has been in a sustained downtrend since shares peaked after the 2016 election. While its hard to attribute the downtrend to a singular cause (the bank’s operating results support an argument that its not an earnings-related issue), there are a couple of items that could be at play. First, LCNB announced a fairly-large acquisition at the end of 2017 (Columbus First Bancorp) with a TBV earnback estimate of 4.3 years. Columbus is a new market for LCNB and that brings heightened execution risk and, typically, a bump in expense items beyond typical one-time deal charges. The one-time items have hit profitability YTD, but this is a proven management team and they should be able to normalize operational costs and begin to see deal benefits in the intermediate-term. Second, the rally in shares in late 2016 and early 2017 got ahead of itself: LCNB shares traded above 200% TBV for nearly the first half of 2017. Its hard for a bank to grow into and justify such a lofty valuation, which is another reason I think shares trended down mid-2017 to early-2018.

Beyond the share price and market valuation, there is a lot to like in LCNB’s underlying business and performance. LCNB managed through the previous financial crisis without printing a full year net loss. In fact, the crisis and credit overhang hit bank profitability the hardest in FY 2011, and LCNB still reported $1.20 EPS, 1.0% ROA, 10.9% ROE, and 2.53% NPAs (its highest level of nonperforming assets). At the risk of sounding like a dolt, I believe current market valuation of LCNB provides a good entry point for a long-term investment even as it is printing a lower EPS, ROA, and ROE than it did in 2011.

There is certainly some operational overhang to work through on the Columbus merger, but I think the aggressive selloff is not warranted and provides a nice entry level to invest alongside a bank set up for strong performance over a full cycle and upside potential for a takeout. Primary drivers setting up LCNB shareholders for continued investment performance over the near- and longer-term:

  1. Compounding Earnings: Under the current regulatory environment, ROE should normalize post-merger and return to a 10%+ rate and provide attractive growth and investment returns to shareholders. LCNB has printed a ROAA in 38 of its last 41 years of operation – I’ll take that.
  2. Dividend Income: LCNB pays a healthy 4.4% dividend yield. The 57% payout ratio is high, but current EPS is currently depressed by one-time merger expenses so that figure should decline as EPS normalizes. Even with the large payout ratio, the bank has already has a healthy equity/capital base and doesn’t see the need to retain earnings.
  3. Potential M&A Upside: from an acquirer’s perspective, LCNB has some nice attributes. I’m a sucker for valuable deposit funding and LCNB delivers on that front.
    • Market Geography: nestled in three larger markets in Ohio, plenty of buyers to consider as a fit.
    • Deposit Funding: impressive, all around
      • 24% of LCNB’s deposits are noninterest-bearing
      • The cost of the interest-bearing deposits is 0.51%
      • The total cost of funds on LCNB’s $1.1 Billion deposit book is 0.41%
      • LCNB has a ~85% loan/deposit ratio; acquiring banks are looking at $200 Million of “excess” (and cheap) funding.
    • Capital Positions: LCNB has a healthy capital position and an acquirer can easily shut down the current dividend payment to let that healthy income generation flow directly to its capital base.
    • Asset Quality: credit book looks to be in decent shape, CRE loan mix is a little high but its manageable. Biggest issue is the softer loan loss reserve balance relative to NPA/NPLs; ratios such as LLR/NPA are likely understated as they don’t include credit marks/discounts applied to acquired loans, but there is a risk an acquirer would have to consider an above-average credit market to normalize.

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

  • CRE Mix – the arbitrarily-set industry threshold for CRE allocation is 300% of Capital, which LCNB (barely) currently exceeds. I won’t waste the ink here given the amount of coverage CRE lending has received in the business press, but that concentration is worth monitoring.
  • Economic Cycle
    • Hard to forecast where we are here, but all banks and shareholders, no matter the quality of management, bear the risk of a downturn in the local and national economy.

Bank Description & Geography

LCNB Bank was established in 1877 and currently has a 33 branch network in Ohio.

lcnb_geo

Financial Overview

LCNB

Notable Ownership

  • Directors / Named Executives, as group – 3.1%
  • LCNB National Bank – 4.7%
  • BlackRock – 3.6%
  • Vanguard – 2.9%
  • Castine Capital – 2.5%
  • Kennedy Capital – 1.7%

Prospective Buyers

  • First Financial ($13.8B Assets / FFBC)
  • WesBanco ($12.6B / WSBC)
  • First Merchants ($11.1B / FRME)
  • First Commonwealth ($7.7B / FCF)
  • Peoples Bancorp ($4.0B / PEBO)

First Northern Community Bancorp (FNRN)

First Northern Community Bancorp (FNRN), headquartered in Dixon, California (Solano County, near Sacramento) is the single-bank holding company for First Northern Bank. First Northern Bank was established in 1910 and currently has a 10 branch network in and around Sacramento.

The market weakness in bank stocks has not hit FNRN as hard as most of its peers as shares are down ~10% since the 2018 highs. The current valuation on shares of FNRN (14x P/E and 135% P/TBV) provides a good entry point to start accumulating a position in an attractive banking franchise.

Like most CA-based banks, FNRN had to work through some credit and income challenges during the financial crisis (albeit small, FNRN reported full year net losses in 2008-2009). Going into the crisis, the bank was positioned with a heavy allocation to Construction and Land Development loans (~22% of total loans) and Residential Loans (~18%). It seems hard to believe given the size of its land/construction book, but FNRN had returned to what I would describe a normalized operating/profitability profile by 2012. The credit turnaround and recent strength in performance metrics coincides with the appointment of Louise Walker as President and CEO (assumed role in 2011). Since the crisis, management has better allocated its loan composition (current mix detail in financial overview section).

The current management team has done a nice job of growing the bank’s balance sheet (all organic growth – no M&A activity) and the current funding structure provides a wonderful foundation to drive shareholder returns. In its Q3 2018 earnings report, FNRN reported YTD ROA and ROE of 1.02% and 11.9%, respectively, along with an expanding net interest margin (currently 3.77%). I’ll touch on the deposit book in a bit, but expect continued NIM expansion from FNRN going forward.

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

  1. Compounding Earnings: Under the current regulatory environment, ROE should continue to compound at a 10%+ rate and provide attractive growth and investment returns to shareholders. First Northern has done a wonderful job establishing and strengthening its franchise and the bank is well positioned to continue to deliver healthy returns to its shareholders.
  2. Dividend Income: FNRN does not pay a dividend. Management prefers to retain earnings to fund organic growth and bolster its capital position.
  3. Potential M&A Upside: from an acquirer’s perspective, FNRN checks all the boxes and, I don’t say this lightly, FNRN has one of the best deposit franchises in the United States.
    • Market Geography: nestled in and around Sacramento, potential buyers abound!
    • Deposit Funding: impressive, all around
      • 36% of FNRN’s deposits are noninterest-bearing
      • The cost of the interest-bearing deposits is 0.17%
      • The total cost of funds on FNRN’s $1.1 Billion deposit book is 0.11%
      • FNRN only has $775 Million loans on its balance sheet, meaning acquiring banks are looking at $350 Million of “excess” (and cheap) funding available to them.
    • Capital Positions: FNRN has a healthy capital position and its income run-rate continues to flow directly to its capital base.
    • Asset Quality: Louise Walker and her team have done a nice job cleaning up the credit book and repositioning its loan assets to a more diversified allocation. Current NPLs total 0.88% the bank has loan loss reserve account totaling ~1.8x its current NPL position.

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

  • CRE Mix – while below the arbitrarily-set industry threshold of 300% of Capital, nearly 50% of FNRN’s loan book is classified as CRE. I won’t waste the ink here given the amount of coverage CRE lending has received in the business press, but that concentration is worth monitoring.
  • Economic Cycle
    • Hard to forecast where we are here, but all banks and shareholders, no matter the quality of management, bear the risk of a downturn in the local and national economy.

Bank Description & Geography

First Northern Bank was established in 1910 and currently has a 10 branch network in and around Sacramento.

FNRN_geo.PNG

Financial Overview

FNRN

Notable Ownership

  • Directors / Named Executives, as group – 9.7%
  • Banc Funds – 3.4%

Prospective Buyers

  • Umpqua ($26B Assets / UMPQ)
  • TriCo Bancshares ($6.3B / TCBK)
  • First Foundation ($5.5B / FFWM)
  • Westamerica Bancorporation ($5.5B / WABC)
  • River City Bank ($2.2B / RCBC)

Eagle Financial Services, Inc. (EFSI)

Eagle Financial Services, Inc (EFSI), headquartered in Berryville, VA , is a bank holding company for the Bank of Clarke County. Bank of Clarke County currently operates 12 branch offices in Northern Virginia (west of Washington DC) and its largest market is Winchester, a city of ~28,000 residents in the Shenandoah Valley.

The weakness in bank stocks and the broader market has EFSI shares down ~20% since its 2018 highs. The current valuation on shares of EFSI (12x P/E and 125% P/TBV) provides a good entry point to start accumulating a position in an attractive banking franchise.

EFSI has proven its mettle over the years. Bank of Clarke County has been in business since 1881(!). EFSI managed through the previous financial crisis without printing a full year net loss. The crisis and credit overhang hit bank profitability the hardest in FY 2010, when EFSI reported $1.12 EPS, 6.7% ROE, and 3.34% NPAs (its highest level of nonperforming assets). Since 2012, EFSI has been firing on all cylinders with full-year ROAs above 1% and ROEs ranging from 8-11%. As positioned today, 1%+ ROA and 10%+ ROE profile is a reasonable forecast for returns during expansionary periods.

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

  1. Compounding Earnings: Under the current regulatory environment, ROE should continue to compound at a 10%+ rate and provide attractive growth and investment returns to shareholders. Bank of Clarke County is well established in its banking markets (very attractive deposit/funding franchise) and is positioned to deliver continued returns on equity.
  2. Dividend Income: EFSI pays a current dividend yield of ~3.14% and the current payout ratio is a manageable 39%.
  3. Potential M&A Upside: from an acquirer’s perspective, EFSI checks off just about every box on a Bank M&A wish list:
    • Market Geography: Bank of Clarke County is a well-established deposit franchise in the Shenandoah Valley area of Northern Virginia. There are several in-market and adjacent-market competitors that would take a long look at EFSI.
    • Deposit Funding: Just like Peoples Bancorp of NC (PEBK), EFSI’s deposit position is as good as it gets in 2018. Nearly 37% of its deposits are noninterest-bearing, which is great, and the cost of its interest-bearing deposits is an attractive 47bps. This is a valuable deposit franchise. With a 0.30% total cost of funds: 0.30% and a ~85% loan/deposit ratio, a potential acquirer can forecast another $100 million in loan growth (agnostic to market geography) with a funding cost of 30bps.
    • Capital & Equity Positions: simply put, EFSI has excess Capital and Equity on its balance sheet, which is a lever an acquirer can pull to drive incremental earnings in its M&A model.
    • Asset Quality: the credit review and discount applied in an M&A purchase agreement can be tricky when “rural” banks are involved. EFSI has ~90bps of nonperforming loans as of 9/30/2018, which is a little high for my taste, but I can get behind a franchise with a proven credit underwriting track record: NPLs and Charge-offs never exceeded 5% and 1.5%, respectively, during the financial crisis. I’m not overly concerned about credit issues for potential buyers.

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

  • Economic Cycle
    • Hard to forecast where we are here, but all banks and shareholders, no matter the quality of management, bear the risk of a downturn in the local and national economy.
  • Rural Geography
    • Always a wild card

Bank Description & Geography

Bank of Clarke County currently operates 12 banking offices, mainly in the Shenandoah Valley area of Northern Virginia, and 1 loan production facility near its headquarters in Berryville, VA.

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Financial Overview

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Notable Ownership

  • James Wilkins, Jr. (age 72, Board member) – 8.0%
  • Directors / Named Executives, as group – 22.6%
  • Banc Funds – 2.0%

Prospective Buyers (active market a lot of potential buyers)

  • First Citizens ($36B Assets / FCNCA)
  • United Bankshares ($19B / UBSI)
  • Union Bankshares Corp ($16B / UBSH)
  • Sandy Spring Bancorp ($8.1B / SASR)
  • Eagle Bancorp ($7.9B / EGBN)
  • City Holding ($4.4B / CHCO)
  • Summit Financial Group ($2.1B / SMMF)
  • FVCBankcorp ($1.3B / FVCB)