First Citizens Banc: Sleepy Banking, Meaningful Profits

| About: First Citizens (FCZA)
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Across the United States, local banks often offer the potential for meaningful profits. They are small, generally receive virtually no coverage on Wall Street, and their ties to the local economy afford them greater insights into the markets in which they operate. The lack of sell-side coverage of such banks means that there are often inefficiencies in the distribution of information. While such banks publish full financial statements like any other publicly traded company, many investors are simply not aware of their existence. And First Citizens Banc (NASDAQ:FCZA) (not to be confused with the larger First Citizens Bank (NASDAQ:FCNCA) of North Carolina) is no exception, garnering almost no analyst coverage on Wall Street. The bank, based in Sandusky, Ohio, operates 28 branches across the state, and if the business were to be described in one word, it would most likely be boring, given its slate of "vanilla" banking products. However, when investors examine its valuation, the bank becomes far more interesting. As the bank continues to rebuild from the financial crisis and grow earnings in 2014, we see upside of as much as 51% as First Citizens' meaningful valuation gap begins to close.

Over the past ten years, shares of First Citizens have lost over 75% of their value as the financial crisis and recession took a toll on the bank's profitability. However, since then, First Citizens has worked diligently to rebuild its balance sheet and business, and the bank has begun the process of repaying its bailout funds, raising $25 million in newly issued preferred stock to do so. But, what is perhaps most notable is that aside from a large goodwill write-down in 2008, First Citizens remained profitable throughout the financial crisis, with positive underlying net income in 2008 and 2009. And yet, despite seeing progress in rebuilding its business, and favorable metrics relative to its Ohio-focused peers, First Citizens continues to trade well below book value, something we see as unwarranted. We see upside of over 50% for shares of First Citizens as the company continues to improve its business and the wide valuation gap between it and its peers begins to close.

2013 Results: Wrapping Up a Year of Progress

First Citizens reported its results for Q4 2013 and the year as a whole on January 10, 2014. For Q4 2013, net interest income rose 3.33% to $10.29 million, boosting the bank's net interest margin by 5 basis points to 3.85%; margins for 2013 as a whole stood at 3.79%, down 18 basis points over 2012. However, we note that at 3.79%, First Citizens' net interest margin is over 20 basis points higher than the 3.56% posted by its peer group. First Citizens has continued to grow both loans and deposits; total loans rose by 4.9% year-over-year in Q4 2013 to $844.713 million, total deposits rose by 1.74% to $942.475 million during the course of 2013. We present an overview of First Citizens' financial results in the table below.

First Citizens Banc Q4 2013 & Full-Year Results (in Thousands of $)

Q4 2013

Q4 2012

Y/Y Change

2013

2012

Y/Y Change

Net Interest Income

$10,290

$9,959

+3.32%

$39,974

$40,578

-1.49%

Net Interest Margin

3.85%

3.8%

+5 bps

3.79%

3.97%

-18 bps

Non-Interest Income

$2,939

$2,740

+7.26%

$12,062

$11,200

+7.7%

Non-Interest Expense

$12,087

$9,202

+31.35%

$43,384

$38,074

+13.95%

Loan Loss Provisions

$0

$835

-100%

$1,100

$6,400

-82.81%

Pre-Tax Income

$1,142

$2,662

-57.01%

$7,552

$7,304

+3.4%

EPS

$0.10

$0.22

-54.55%

$0.65

$0.57

+14.04%

We note that pre-tax income during Q4 2013 fell sharply, declining by over 57% to $1.142 million. And EPS fell from $0.22 in Q4 2012 to $0.10 in Q4 2013. However, $2.3 million in non-recurring pension expenses tied to a slate of early retirements across First Citizens' business lines caused this decline, and when adjusting for this expense, pre-tax income rose by over 29% during Q4 2013. Even with this pension expense, pre-tax income and EPS both rose year-over-year in 2013, as loan loss provisions and a favorable tax environment helped drive earnings. Steady growth in non-interest income has also contributed to the bank's underlying earnings growth. The bulk of First Citizens' non-interest income growth is being driven by its wealth management business, which has increased assets under management by over 15% to $468.1 million during the course of 2014. We expect further increases in wealth management fee income during 2014, which will help fuel further earnings growth, alongside continued improvements in credit metrics. Over the course of 2013, First Citizens has also worked to improve the quality of its loan portfolio, and non-performing assets now account for 2.21% of total assets, falling 109 basis points over the last four quarters. Throughout 2013, First Citizens saw declines in non-performing assets across each of its three categories: nonaccrual loans (down 31.47%), debt restructurings (down 27.81%) and other real estate owned (down 63.27%). The bank's coverage ratio (defined as allowance for loan losses to non-performing loans) has also continued to climb, and now stands at 64.33%, up over 11 percentage points versus Q4 2012.

Peer Comparison

By several measures, First Citizens' results for 2013 showed solid improvements over 2012. The company grew EPS by double digits, reduced non-performing assets in all key categories, and grew non-interest income. However, First Citizens' results for 2013 have not yet showed up in its valuation, either on a standalone basis or in relation to its peers (as defined by SNL Financial). Shares of First Citizens continue to trade well below book value, and we present the bank's valuation, as well as that of its peers in the table below; figures are accurate as of the close of trading on January 13, 2014 (note: within this peer group, only two banks have available forward earnings estimates, due to a structural lack of coverage for small, local banks).

First Citizens Peer Comparison

Bank

First Citizens

Camco Financial

LNB Bancorp

NB&T

Ohio Legacy

Ohio Valley Bank

SB Financial

United Bancorp

United Bancshares

Peer Average

Ticker

FCZA

CAFI

LNBB

NBTF

OLCB

OVBC

SBFG

UBCP

UBOH

Share Price

$6.74

$6.69

$10.15

$19.64

$7.52

$22.61

$8.25

$8.62

$14.90

Shares Outstanding

7,707,917

14,167,698

9,303,702

3,425,865

1,948,966

4,062,204

4,869,629

5,362,807

3,447,051

Stockholder's Equity

$125,810,000

$67,280,000

$107,961,000

$68,127,000

$19,687,636

$79,046,000

$55,537,000

$37,114,000

$63,273,753

Book Value per Share

$10.32

$4.75

$11.60

$19.89

$10.10

$19.46

$11.40

$6.92

$18.36

Price-to-Book

0.65

1.41

0.87

0.99

0.74

1.16

0.72

1.25

0.81

0.99

2013 EPS

$0.65

N/A

$0.64

N/A

N/A

N/A

N/A

N/A

N/A

2014 EPS

$0.75

N/A

$0.78

N/A

N/A

N/A

N/A

N/A

N/A

2013 P/E

10.37

N/A

15.86

N/A

N/A

N/A

N/A

N/A

N/A

2014 P/E

8.99

N/A

13.01

N/A

N/A

N/A

N/A

N/A

N/A

Quarterly Dividend

$0.04

$0.00

$0.01

$0.30

$0.00

$0.21

$0.035

$0.08

$0.05

Dividend Yield

2.37%

0.00%

0.39%

6.11%

0.00%

3.72%

1.70%

3.71%

1.34%

2.12%

As the chart above shows, First Citizens trades at a price-to-book ratio of 0.65x, the lowest in its peer group and well below the peer average of 0.99x. Applying such a valuation to First Citizens yields a pro forma price target of $10.21, representing upside of 51.48% relative to First Citizens' closing price of $6.74 on January 13, 2014. However, the sizeable valuation gap that First Citizens trades at raises the question of why this is the case? Is it because of crisis-era transgressions? On the surface, this may seem like a logical answer. But when First Citizens' historical financial statements are examined, it becomes clear that the bank's crisis-era performance, while far from satisfactory, does not suggest that the bank was on the brink of insolvency.

From 2003-2007, First Citizens grew net income from $5.567 million to $6.885 million, with EPS rising from $1.10 to $1.25 and shareholder's equity jumping from $69.1 million to $126.2 million. These figures are in-line with First Citizens' profile as a slow growing, but stable local bank, with its investment appeal stemming from its relative lack of excitement. However, the results for 2008 tell a different story. That year, the bank lost almost $39 million. On the surface, it seems that this loss was tied to a surge in bad loans. However, as we noted above, this is not the case. First Citizens' large loss in 2008 was tied to a $43.291 million goodwill write-down tied to various acquisitions that the bank had made over the preceding 28 years. When this write-down is excluded, First Citizens posted net income of $4.313 million in 2008, and while this represents a sizeable decline from its 2007 performance, First Citizens was able to maintain underlying profitability in the face of an almost 705% increase in loan loss provisions. The same trends played out in 2009. While net income once again fell, this time to $714,000 (with loan loss provisions rising over 62%), First Citizens maintained its profitability, something that many banks failed to accomplish in 2009. However, the fall in net income that First Citizens saw forced it first cut, and then suspend its dividend; from a pre-crisis high of 29 cents per share, the bank cut its dividend to 1-3 cents in 2009, and then suspending it until 2011. These items, together with the acceptance of TARP funds, created what we believe was an erroneous perception of First Citizens' solvency, even if the bank maintained underlying profitability in both 2008 and 2009. And since the market's bottom in March 2009, shares of First Citizens have lagged each of the eight peers that comprise its peer group, despite the fact that the bank's net income has almost fully recovered to pre-crisis levels (that being said, the recovery in EPS is still under way). The discount at which shares of First Citizens trade at would be logical if the bank was still atoning for crisis-era transgressions. But as its historical financials show, First Citizens' underlying results for 2008 and 2009 were relatively uneventful, at least when taken in the context of those two years.

While valuation is certainly a core of our bullish thesis for shares of First Citizens, it is not the only lever available to generate profits for investors. The first is dividends. First Citizens currently pays a quarterly dividend of 4 cents, equivalent to an annual yield of 2.37%. Although this yield is slightly above the peer average of 2.14%, there is potential for it to be increased. First Citizens last raised its dividend in January 2013, boosting it by a penny, and based on its 2013 EPS, the bank's payout ratio stood at 24.61%, and unless the dividend is raised, it will fall to 21.33% in 2014. Given the continued improvement the bank has seen in credit quality, we expect a dividend increase in the 2nd half of the year (the dividend of Q1 2014 has already been set at 4 cents) of at least one penny, and perhaps more if First Citizens can see progress on one of its key operational goals for 2014: lowering expenses. For 2013 as a while, First Citizens posted an efficiency ratio of 81.74, over 400 basis points above the average efficiency ratio of its peers (even when adjusting for $2.3 million in one-time pension expenses, First Citizens' full-year non-interest expenses rose by 7.91%). However, this should be seen as an opportunity, not a roadblock. Elevated expenses means that First Citizens has room to cut costs, and thereby create yet another lever with which to grow EPS (as well as its dividend). CEO James Miller has gone on record in saying that the bank has begun to review strategies to cut costs throughout its operations in order to lower its efficiency ratio. Cost cuts, along with further improvements in credit quality, have the possibility of driving upside to already favorable 2014 EPS estimates, which imply growth of over 15%. And with First Citizens currently trading at just 9x estimates 2014 EPS, shares are undervalued not only on a price-to-book basis, but on a PEG basis as well. Applying a PEG ratio of 1 and using 2013 EPS yield a price target of $9.99 for First Citizens, which implies upside of over 48% for the bank's shares. In our view, the discount at which First Citizens trades at will begin to close in 2014, assuming the bank can deliver on four key goals: continue to post improvements in credit quality, begin to reign in expenses, boost its dividend, and complete the repayment of TARP funds.

Conclusions

In our view, shares of First Citizens Banc are meaningfully undervalued at present levels. However, because of an almost complete lack of coverage, many investors have yet to arrive at such a realization. The bank has made progress across multiple operational metrics in 2013, and has the potential to boost its dividend in 2014, with upside pressure created by the potential for cost cuts. On both an absolute and relative basis, shares of First Citizens are undervalued, and as the bank continues to post improvements in 2014, we believe that the true value embedded within shares of First Citizens will be unlocked.

Disclosure: I am long FCZA, FCNCA, . I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.