First Community Bancshares (FCBC) is a Virginian bank with $2.6 billion in assets and that is selling at close to half its business value. The stock has the potential to return 20% compounded over the next five years. Its business is basic banking, but its past record displays many qualities attributed to a successful bank. Despite major changes affecting the banking industry as well as the recent departure of its CEO, FCBC is still capable of producing strong operating and financial results.
FCBC has a banking franchise that is strengthened by its ability to offer a menu of financial products to businesses and consumers. This attribute helps it to grow its deposit base and profitability. From 2002 to 2012, deposits grew at about 8% compounded. From 2010 to 2012, deposits grew at about the same rate. According to the FDIC's Deposit Market Share report, out of the 10 counties that represent FCBC's footprint, it ranks no less than third in total deposits in eight of them. It holds first- and second-place rankings in five out of these 10 counties.
The bank's deposit base enables it to obtain funds at a low cost. Over the last nine years, FCBC's funding costs have been below the average of its peers. Annual funding cost data obtained from the FDIC's UBPR (uniform bank performance report) compares FCBC to a peer group of banks with similar attributes. The figures show that FCBC had lower funding costs than this group in eight out of the nine years. The recent data for 2011 and 2012 show funding costs are still below the peer group average. FCBC's low funding costs seem likely to continue. It has demonstrated an ability to lower funding costs over the past nine years while still growing its deposit base.
Cost of Funds Comparison to Peer Group
Year to Date
The bank offers several financial products in addition to deposit taking and lending. These products include insurance services and wealth management, which mainly consist of financial planning, security sales, and selling insurance products to both consumers and small businesses. These activities generate a large percentage of non-interest income, which contributes a meaningful percentage of FCBC's total income. The annual financials show non-interest income is about 30% of total income in 2012. This has grown from an average of about 20% in the earlier years displayed in chart below.
|Noninterest Income as a |
Percentage of Total Income
The 2009 figure is noteworthy only because of its significant variance from the other annual figures shown. During the financial crises, FCBC saw a significant decline in the value of a portfolio of trust preferred securities held as investments by the bank. These securities provided dividend income and that is why their subsequent losses are categorized as non-interest losses. FCBC wrote down the value of these securities and sold the bulk of them. The current size of the TPS portfolio is about $46 million down from about $166 million prior to 2009. Since the losses in 2009, the TPS portfolio has not caused significant losses to date.
Most of FCBC's income is generated from interest earning assets whether it is from loans or securities. Below shows a sample of FCBC's yields compared to those of Wells Fargo (WFC). All figures were again obtained from the FDIC's website. Wells is used here because it is one of the largest banks in terms of deposits in the state of Virginia and nationally, it is also one of the most profitable. As you can see, FCBC held its own against a more resourceful competitor. Recent trends show FCBC can still obtain high yielding loans from its customer base.
|Yield on All Earning Assets|
More importantly, however, these loans appear to be good quality assets that will continue to earn interest and not cause future losses. The table below illustrates the strength of FCBC's loan portfolio relative to all U.S. banks and its peer group. Again, these statistics were obtained from the FDIC's UBPR. FCBC's net loan losses as a percentage of average total loans have been steadily improving since 2006, and have been lower than all U.S. banks and the banks of its peer group from 2006 to 2012.
|Net Loan Losses/Average Total Loans|
|All U.S. Banks||0.88||0.66||0.53||0.38||0.53||1.15||2.4||2.93||1.78||1.17|
Other Important Notes
FCBC was a TARP recipient. The funds were received on Nov. 21, 2009, and paid back less than a year later. Wells Fargo has a large ownership stake. As of June 2013, the bank owns 5% of FCBC. SEC records indicate Wells Fargo acquired the shares during the last quarter of 2012.
I believe the bank could grow to be worth about $759 million, or $38 per share, at the end of the forthcoming five-year period. This would require improvements in profitability that reach previously demonstrated levels. Historically, the company has earned returns on assets just under 1.5%. However, if profitability remains at its current level, which is closer to an ROA of 1%, FCBC is still worth about $23 a share at the low end.
My valuation relies on asset and earnings growth of about 10%. It is also based on the bank being able to repeat its past performance of a ROA ratio of at least 1.4% and its demonstrated ability to safely managing its leverage at around one as measured by the debt/equity ratio.
Once it becomes apparent that FCBC is improving its profitability and leverage, the market will react with a more favorable appraisal of its earnings at around 14-15 times and an earnings figure of about $2 per share. The primary risk would be that FCBC's earnings grow at less than this rate. However, even if growth was about half of my projected rate, I still believe FCBC's shares would appreciate at about a 10% compounded from a price point of about $17 a share.
Current Price and Potential Entry Point
Currently, FCBC trades for about $17.00. I think this is a good entry price. The price is low enough in that it would protect investors if prospects don't turn out as favorably as I expect. It would put the downside return around 10% as previously mentioned and the upside around 20%. As a disclosure, the average price of my own holdings is $15.48.
FCBC's price has fluctuated significantly during the past year and may continue its previous market action with good reason. Catalysts for a decline, temporarily making it a good short, would be a combination of the recent top management changes and continued financial results judged as unsatisfactory by the market.
The management change may be the most likely catalyst. FCBC recently announced a major management change with the replacement of CEO John Mendez. Mendez served as CEO since 2001 and will be replaced by William Stafford II. Mendez also served as president and a member of the board of directors. He will no longer serve in either capacity. It appears the bank is looking to make meaningful changes in its strategy with the exclusion of Mendez from even holding a board position. Mendez's past record as CEO saw acquisitions and divestitures as a major piece of the bank's strategy. With Mendez out, the bank has yet to share with investors what changes in strategy the board and senior managers are going to pursue. It's not uncommon for a new CEO trying to execute new strategic objectives to produce uneven financial results at first. This may cause some temporary declines in the stock price, potentially creating an even better entry point for investors than my suggested $17 a share.