There is a great deal of attention paid to small companies who are about to enter the Russell 2000 Index. Why? Russell 2000 Index funds need to do a lot of buying in these companies upon entry so that they can track the performance of the index. The companies are added to the index in June of each year. A preliminary list of changes to the index is published on June 14 and the list is finalized on June 28. Index funds do their buying at this time so they can track the index as closely as possible - they want to get an exact replication of index performance. Knowing this, many hedge funds and other institutional investors attempt to frontrun the index funds by buying in advance the stocks of companies who will enter the index (and selling those who will be dropped). There are currently a number of lists being circulated amongst these investors of companies who will most likely be added to the index in June. Since this information tends to be spread around it can be tough to "out-frontrun" the big players to exploit this opportunity.
But the situation is different with First Business Financial (NASDAQ:FBIZ). Why? Few investors know that FBIZ might get added to the index. Additions to the Russell 2000 index are based on market capitalization (along with a few other criteria). The cutoff for additions in 2013 on the low end this year is projected at $112 million. U.S. companies who fall below $112 million market cap on June 28 will be dropped from the index and those rising above will be added. The current lists of companies projected to be added to the index were made in April when First Business Financial traded at about $26. The lists show FBIZ as a company that will not be added to the index because its market cap was only about $100 million at the time. Keefe, Bruyette and Woods (KBW) is the leader in this type of analysis for banks and recently provided the following synopsis of financial services company changes to the Russell (this is just a summary of the thorough research they do). Notice First Business Financial in bold font down at the bottom of the chart in the section of companies currently projected NOT to be added to the Russell 2000 in June.
Source: KBW Research, Bloomberg Research, FactSet Research
If Market Cap Rises ABOVE R2000 Cut-off:
Est. Russell Rank as of 4/15/13
4/15/13 Market Cap ($M)
Stock Price 4/15/13
10D Avg. Daily Volume
% Change in Price Needed to Rank ABOVE R2000 Cut-off
Est. # Shares to Buy (NYSE:M)
Est. # Days to Buy
Est. IN RUSSELL 2000
Middleburg Financial Corp.
First Marblehead Corp.
Berkshire Bancorp Inc.
Simplicity Bancorp Inc.
Stratus Properties Inc.
Access National Corp.
BSB Bancorp Inc
Asta Funding Inc.
Orrstown Financial Services Inc.
First PacTrust Bancorp Inc.
SI Financial Group Inc.
Southern National Bancorp of Virginia Inc.
North Valley Bancorp
Peoples Federal Bancshares Inc.
Pulaski Financial Corp.
Cape Bancorp Inc.
Farmers National Banc Corp.
Gladstone Land Corp.
Est. OUT OF RUSSELL 2000
Five Oaks Investment Corp.
Heritage Financial Group Inc.
MutualFirst Financial Inc.
Gyrodyne Co. of America Inc.
BRT Realty Trust
FirstCity Financial Corp. *
Ocean Shore Holding Co.
Monarch Financial Holdings Inc.
CFS Bancorp Inc.
Pacific Mercantile Bancorp
FirstBank Corp. (Michigan)
First Business Financial Services Inc.
Norwood Financial Corp.
PVF Capital Corp. *
HF Financial Corp.
* Indicates Acquisition Target
But things have changed over the last 2 weeks. On April 25, FBIZ reported blockbuster earnings - $3.2 million in Q1, a 47% increase. While the chart lists First Business Financial with a price of $25.57, it now trades around $28. If it hits $28.63 by June 28, it will increase above $112 million and, based on the current projection, will be added to the Russell 2000 Index.
The next update to this chart is going to show First Business being very close to a Russell 2000 addition and, in my opinion, the hedge funds are going to pounce! I know the company management will be telling its story at the Davidson Financial conference in Seattle this Wednesday. So the cat may be "let out of the bag" soon.
Furthermore, I believe the stock should skyrocket once this happens because it's so thinly traded. Two other key listings in the KBW chart above are in the far right columns - the "Estimated Number of Shares to Buy" and "Estimated Number of Days to Buy." For First Business Financial, index funds would have to accumulate about 346,000 shares if it is added to the Russell 2000. Based on the average number of shares traded daily, it would take 165 days for the index funds to accumulate this many shares! This should produce a demand squeeze for the shares. Remember, the hedge funds are looking at these same statistics and will notice this as well.
Now, I haven't even touched on all of the great fundamental reasons to own this stock. They have a great management team, niche market, excellent growth plan and rock solid balance sheet.
Asset quality has been dramatically improving. In their most recent quarter, the loan loss provision came in at a mere $80,000 - well below any reasonable expectation. Collateral liquidation costs and the loss on foreclosed properties actually posted small gains. Nonaccrual loans decreased $2.4 million, or 17%, sequentially to $11.7 million while foreclosed assets declined by $0.7 million, or 43%, to $0.9 million. As a percentage of total loans and OREO, nonperforming assets fell to 1.37% from 1.72% at the end of the fourth quarter.
How has FBIZ achieved such dramatic growth with the proven ability to write new loans of such high quality? FBIZ has done a fantastic job of lifting out other bankers from its competitors. As banks in the area have been closed by the FDIC and sold in receivership to larger institutions, FBIZ has been known to poach out productive bankers. These lift outs have enabled FBIZ to hire some very productive local loan officers at limited expense. FBIZ has picked up entire books of business with high spreads and local low rate core deposits. By selectively hiring unhappy bankers whose only alternative was to work for a large bank, FBIZ has built business relationships that have, and may continue to, double core earnings.
The ABA Banking Journal ranked FBIZ 15th among all publicly traded banks (of about 250 in the U.S.) with $1-10 billion in total assets. FBIZ recently increased its quarterly dividend rate to $0.14 from $0.07.
This stock is a bargain at 1.07 x BV and a current P/E of 8 (the P/E will reduce further when earnings estimates increase, which I expect will happen soon). More importantly, First Business Financial is a primarily target for an acquisition by a larger bank. I believe First Business Financial may be bought at a substantial premium to tangible book value. Likely acquirers may be Old National Bancorp (NASDAQ:ONB), Associated Bank (NASDAQ:ASBC), which is looking to add assets and deposits in Madison where university and government jobs are based, Wintrust (NASDAQ:WTFC) and PrivateBank (NASDAQ:PVTB).
I see very little downside at current prices, even if for some reason FBIZ isn't added to the Russell 2000. But in my opinion, once the big players realize this is an expected Russell addition, the ratchet up in stock price will be explosive.