After falling 20% from its 52-week high, First Community Bancshares (NASDAQ:FCBC) is starting to look very attractive as its dividend yield has risen to 3.3%. This, in my opinion, is very important because I believe the bank is very misunderstood and that the stock will probably take a little more time to improve than most investors looking for capital appreciation typically want to spend.
With that said, below is my review of First Community Bancshares as it stands today.
- Current market price - $14.70 per share
- Current market cap - $270 million
- Dividend yield - 3.3%
What the market sees
Since the beginning of 2012, First Community has completed two M&A deals that have helped the bank accumulate the $2.6 billion in assets and $1.97 billion in deposits that were reported as of March 31, 2014. On the surface, however, measuring the growth the acquisitions accomplished brings up a lot of questions when coupled with the fact that assets, deposits and owners equity have all declined over the past 52-weeks. And, even more alarming, net income of $5.497 million in the first quarter of 2014 was down 20% from the same time period in 2013.
Book value per share is only up $0.03 over the past year (now at $16.79) but shares actually trade at a 30% premium to tangible book value ($11.26) due to a large amount of goodwill. That goodwill represents the premium paid on assets that don't seem to have added much to the bank's results. And, to add insult to injury, management has been buying back its own shares at the premium to tangible book price which appears to be in-line with the other lackluster purchases they have made.
On top of this, the bank just announced the purchase of seven branches in Southwestern Virginia and North Carolina from Bank of America. This purchase will add $440 million in deposits, zero loans and the branches that will add to the 28 locations First Community currently operates.
The bank's last reported loan to deposit ratio is up there but not too high (86%) and the new additions are welcome considering that bank will now have access to new customers that it can hopefully use to loan out the new deposits and grow future earnings. These new branches, though, will require new employees and other expenses that could continue to eat up earnings as the past additions seem to have been doing.
All in all, it would be easy to write the bank off as a quick sell or potential hold because shares seem to have been lumped into the current 'slow moving regional bank' pricing model that has a very large group trading with a 12-15Xs P/E and at 1-1.4Xs tangible book value. This conclusion, however, fails to give credit to the real earnings that the bank is bringing in.
What's really going on?
While every other subtotal appears to be declining, the bank's loan portfolio actually grew by just under $100 million (up 6% to $1.588 billion) over the past year. The bank has kept allowances for future losses right at $24 million but this has required a quarterly provisional expense from between $1.5 and $3.2 million in each of the past four quarters. This number is pre-tax and rather large in comparison to income before taxes that have come in between $7.7 and $8.28 million during the same time. Fortunately, non-covered nonperforming assets are down ~33% and the allowances now have them fully covered (at 102% from 78.46% in 1Q2013). Going forward, I expect the provisional charge to fall very close to 1.5% of the amount added to the loan portfolio, which is consistent to where total allowances have been in proportion to total loans for more than a year. Under this assumption, every $100 million worth of new loans added to the portfolio would require a provisional charge of only $1.5 million. And, if last year's growth rate can be relied on, this would represent more than an 80% cut to the annual provision charge that would add (or not subtract) more than $5 million to pre-tax income.
In addition to this, the bank's current earnings are being taxed by more than $5 million a year (pre-tax) due to the amortization of the bank's net FDIC indemnification asset.
Unlike bank financials, the focus on most other stock reviews revolves around the cash flow statement where EBITDA as a valuation tool is king. In this calculation, depreciation is quickly added back because of its non-cash properties. Buffett has poked fun at this sort of thinking (as an aside) but I only point it out because unlike depreciation, the amortization of the indemnification asset is done to offset an appreciation in the bank's covered assets that doesn't touch the income statement. In fact, this receivable is actually the result of re-capture of a partial loss that was recorded when the covered assets were written down. And now, as the market value on these assets rises, the bank amortizes the receivable by the amount that it doesn't expect to lose and then collect from the FDIC. This, again, means that the welcome and positive asset appreciation is being reported as a annual $5 million pre-tax charge.
Going forward, this charge could continue but it would require the assets to also continue to improve so there is no telling how long or by how much it will affect future earnings. What we do know is that $5.597 million of last year's $8.485 million income before taxes decline was due to this accounting and that the current asset stands at $32.5 million (note that the declining asset value above the $5.597 charged last year was due to cash being collected from the receivable).
1Q2013 - $43.9 million
2Q2013 - $40.3 million
3Q2013 - $37.1 million
4Q2013 - $34.6 million
1Q2014 - $32.5 million
That's not all
Unlike a lot of other regional banks, a very large portion of First Community's net-interest revenues are made from non-interest lines that are much more steady than the falling one time mortgage fees we are seeing right now. In fact, the majority of these fees can be tied to services on deposit accounts (which is growing). Going forward, these revenue lines will provide more stability and have more than a $1 million quarterly bump in-store when the amortization of the FDIC asset slows down (last 5 quarter non-interest revenues have averaged $7.465 million after an average amortization charge of $1.346 million taken from them).
In my research, I'm always looking to see if there are any other high-cost items that could potentially be cut to grow earnings but, at this point, a lot of this opportunity has already been taken advantage of. First Community, however, is holding onto some very expensive FHLB advances that are taxing earnings by over $1.6 million each quarter (pre-tax). This charge may not get a lot of attention but it should because it represents 41% of all interest charges when its liability balance ($166 million) only supports 6% of all assets. Going forward, any declines in this liability will immediately translate into higher pre-tax earnings and interest margins. This is of course no guarantee, but I'm interested to see what the bank does with the incoming deposits that it will acquire. With a 4.1% yield, just replacing the advances would equal what the bank would hope to earn on any risky asset that it would add based on the bank's last reported net interest margin of an equal 4.1%.
In addition to all of these positives, the bank is buying up shares at a very rapid pace:
1Q2013 - 21.258 million diluted shares outstanding
2Q2013 - 21.205 million
3Q2013 - 21.123 million
4Q2013 - 20.233 million
1Q2014 - 19.506 million
This, again, is being done at a premium to tangible book value but based on pre-tax earnings the purchases look like a bargain.
Over the past four quarters, the bank has made $31.969 million before taxes. Before applying any multiple to this, we need to factor in the ~$1 million that is being paid after taxes to preferred shareholders. To do this, subtracting $1.3 million of the pre-tax income (based on 5-quarter average tax rate of 31%) gets us to $30.669 million and would give the bank a market value of $306.69 billion based on 10Xs trailing pre-tax earnings.
As of where shares trade today, this would imply a 12% discount WITHOUT:
1) adjusting for the more than $5 million being amortized - would yield a 24% discount.
2) adjusting for possible pre-tax improvements from a lower provision expense - would yield a 30% discount (on top of the amortization discount and assuming a conservative $3 million improvement from the lower provisions.
3) Factoring any cost savings from the payoff of any liability or any other earnings improvements.
When I first wrote about First Community Bancshares, the dividend yield was 20% lower and shares were 20% higher. Now that the opposite is true and we have seen earnings improvements hindered by the appreciation in value of the bank's covered assets (amortization charge), I think it's fair to say investors have a pretty unique opportunity.
Even without the bank's accounting issues, real interest charges could substantially improve and the new customer and deposit base will provide more opportunity to grow earning assets and put the bank's services in-front of more people.
The true earnings may take awhile to shine through but I'm comfortable with management's work up to this point, I like the buybacks and will be more than happy to collect 3.3% a year while I wait for a higher share price.
Disclosure: The author is long FCBC. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.