First US Bancshares: Investing In A Lagger Among Laggards

Summary

• First US Bancshares has low valuations versus peers, the market, and its own historic averages.
• The stock has lagged the banking sector, which in turn has lagged the S&P and the Russell.
• Insiders have been buying.
• Risks include COVID-19 impacts, a spike in loan loss provisions, and a long economic slump.
• Bet sizing, patience, and stomaching volatility may be important given the economic backdrop.

Introduction

First US Bancshares (NASDAQ:FUSB) is a small regional bank headquartered in Birmingham, Alabama. It has 21 branches, operates in three states, and conducts the majority of its business in Alabama. Together with its two wholly owned subsidiaries, Acceptance Loan Company and FUSB Reinsurance, it is a typical regional bank. It offers personal and business banking services to depositors and provides personal, commercial, and mortgage loans to borrowers.

In the aftermath of the Financial Crisis, it fell from over $32.00 in 2005 to under $4.00 in 2011. Over the past decade it crawled back and hit highs over $14.00, but never retained its former glory. Now that COVID has hit, the bank – like the sector in general – is under pressure.

Here at Contra the Heard Investment Newsletter, we bought many financials in the aftermath of the Financial Crisis. FUSB was purchased by Benj Gallander at $8.32 in December 2015, before it changed its symbol from USBI to FUSB. After sitting on the sidelines for years, I recently bought a half-sized position for myself around $7.60.

Why Invest Now?

My rationale for a purchase now was threefold. First, the valuations are low. This table from Morningstar shows FUSB’s present ratios versus its 5-year average and the index. Price-to-book, for example, currently rests at 0.52. This is materially better than the index at 2.92 or its own 5-year trailing average of 0.79.

Source: FUSB’s Morningstar valuation table, June 2020.

The bank also looks cheap versus peers. Here, Seeking Alpha’s valuation table shows FUSB is undervalued versus other financials on most measures:

Source: FUSB’s Seeking Alpha valuation table, June 2020.

To summarize, the valuations appear low on a historic basis as well as on a relative basis versus peers and the overall market.

Second, FUSB has not participated in the market’s rebound, and regional banks haven’t participated in the rally either. Below is a chart comparing the year-to-date performance versus the SPDR S&P Regional Banking ETF (KRE), the iShares US Regional Banks ETF (IAT), the iShares Russell 2000 ETF (IWM), and the SPDR S&P 500 ETF (SPY).

Source: FUSB’s advanced chart function on Yahoo Finance.

First US Bancshares has trailed the banking sector, and the sector has trailed the market. This makes FUSB a lagger among laggards. Eventually, the gap between FUSB and its peers should narrow, and the gap between the sector and the S&P should close. In other words, the stock should return towards the mean and things should even out. If or when it does, the shares should outperform other investment opportunities.

Third, insiders have bought $100,000 since the downturn started in February. They were buyers prior to the crisis too, and over the last 12 months there has not been any insider selling.

Source: INK Research.

In my estimation, watching what insiders do is more important than listening to what they say, watching outside investors, or reading the prognostications of analysts. Insiders have their fingers on the pulse of the corporation, and a good idea as to what is really going on. This recent insider activity affirms a bullish appraisal of the enterprise, and owners should be encouraged by the support among the officers and directors. INK Research is a fantastic resource and can provide more details for those interested in recent insider activity or ownership.

Other Considerations

In addition to the above-mentioned factors, First US Bancshare’s share count has expanded only from 6.0 to 6.8 million over the last decade. Dilution can work if earnings per share growth exceeds share issuance, but in general it is better to stick with companies that limit dilution; on a related note, it’s best to avoid organizations that buy back stock at cycle highs as well.

More importantly, FUSB has generated annualized profits in eight of the last 10 years and its return on assets (while slightly lower than most regional bank peers) has steadily improved. The firm also provides a 1.6% dividend yield on a payout ratio of 16%. This low payout suggests the dividend could be increased.

Metrics such as net interest margins are respectable at 4.97% and have averaged 5.21% over the last five years. The balance sheet looks strong, as demonstrated by a loan to deposit ratio around 80%, healthy risk-based capital metrics, and nonperforming assets at under 1%.

Finally, I have followed the entity since 2011, and it has been owned in one of Contra the Heard’s portfolios since 2015. Getting to know a company takes time and sometimes understanding how an investment operates is half the battle.

Risks

Nothing is risk free though – I am betting on regression to the mean, but it might not happen. Moreover, not all regression is created equal. While regressing to the mean in a bull market means rallying faster than the benchmark, regressing to the mean in a bear market often means falling less than the index as opposed to rallying. Obviously, the former is better than the latter.

The S&P, NASDAQ, etc. have rallied too and could be overbought. More new highs are possible, but periods of selling pressure may re-emerge. The disconnect between Wall Street and Main Street appears particularly wide today. Some disconnect is normal – Wall Street is forward looking after all, while Main Street represents the present. Still, the gap between the two appears hard to justify, and the market may have another down leg before COVID is over.

Speaking of COVID, unemployment and economic contraction are often the biggest factors in determining loan repayment rates. The latest 10-Q indicated that 1,433 borrowers representing $114.99 million in loans or 20.9% of loans outstanding had taken advantage of short-term payment relief under the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”). Of this $114.99 million, roughly 71% includes deferral on principal and interest payments.

Source: FUSB’s First Quarter 2020 10-Q.

$114.9 million or 20.9% of loans outstanding is a staggering sum. Even if 1/5 or 1/10 of these deferrals resulted in default, it would blow up loan loss provisions. This prompts the reasonable question – how many of these loans are considered high risk? Management has taken a stab at an answer. According to the 10-Q, 2.7% of loans are in high-risk categories, including hotels/motels and restaurants, while another 11.8% are in moderate risk categories like fast-food, retail, etc.

Source: FUSB’s First Quarter 2020 10-Q.

It is too soon to say what the loan losses will be. Nevertheless, loan loss provisions related to a second COVID-19 wave, future lockdowns, or other economic consequences is the biggest risk. If the recession cuts deeper or turns into a protracted affair, banks like FUSB will have to report large loan loss reserves and net losses.

Another potential risk is its geographic concentration in a few states. Unlike Bank of America (BAC), Citigroup (C), JPMorgan (JPM), and other big banks, FUSB’s wellbeing is dependent on the economic fortunes of a small region (i.e Alabama, parts of Virginia, and parts of Tennessee). This means it could face more acute pain if future COVID outbreaks (or other economic shocks) are regional in nature and happen to land in their back yard. According to Google's Mobility Reports, the economic downturn has been milder in Alabama versus the rest of the United States, but it remains early days and the full economic and health impacts of this virus may not be realized for a long time.

Volumes and liquidity are low too. This makes it challenging to trade and results in greater share price volatility, especially at times when certain investors are forced sellers. March 2020 exemplified this point when the ticker fell under the $6.00 mark.

Given these risks, I purchased a smaller position than I would have otherwise. The hope is that I can flesh out the holding at lower prices in the future if loan losses add up, or at similar prices once the loan loss picture becomes clearer.

Past Experiences and Lessons Investing in Regional Banks

After 2008, America was littered with dozens of beaten up banks. Some went bust, but many survived, were acquired, or did well on their own. As contrarians, we were buyers of financials in the aftermath of the crisis.

American banks owned by either myself, Benj Gallander, Ben Stadelmann, or at Contra the Heard over the past decade included Bank of America, Bank of Commerce Holdings (BOCH), First Busey (BUSE), Cascade Bancorp which was acquired by First Interstate BancSystem (FIBK) in May 2017, Fidelity Southern which merged with Ameris Bancorp (ABCB) in 2019, First United (FUNC), Macatawa Bank (MCBC), NASB Financial (OTC:NASB), Riverview Bancorp (RVSB), Suffolk Bancorp which was acquired by People’s United Financial (PBCT) in April 2017, Sun Bancorp which was acquired by OceanFirst Financial (OCFC) in 2018, Synchrony Financial (SYF), and VIST Financial which merged with Tompkins Financial (TMP) in 2012.

These investments have generated a few key lessons for those interested in this space. The biggest lesson is to try and avoid blow-ups. There is no fool proof way to do this but assessing capital ratios and leverage is a good starting point. In addition to company disclosures, Deposit Accounts is a great resource. I have not had any holdings blow up yet, but my watch lists did have banks that went bust, and in each case poor capital levels and high leverage were contributing factors.

Investors need to accept volatility as well. Shortly after I purchased NASB and RVSB, for example, they fell by roughly half in short order, and languished before going on multi-year rallies. Even BOCH and BUSE, which never fell materially after they were purchased, went nowhere for a long time. This brings me to the next important lesson: be patient! It may take a long time for dividends to roll in or grow, and even longer for capital gains to materialize. Being patient also increases the chances for M&A which can juice results further. As the list of banks above illustrates, many were acquired.

If COVID turns into a financial crisis or debt crisis, you can be patient getting into positions too. Sometimes it even pays to wait until stocks have nearly doubled off their lows and the risks have reduced before getting serious. Investments in First United and Suffolk Bancorp, for example, occurred well off their lows but still generated good returns.

Finally, sell them when they move past your fair value range. Every decade or two banks have a way of blowing up, and there are often opportunities to buy them back later.

For full disclosure, either Contra the Heard or myself still owns positions in Bank of America, First United, Synchrony Financial, and (obviously) First US Bancshares. If you’re interested in more insights regarding some of these firms or past holdings check my March 2019 Seeking Alpha article here.

Conclusion

First US Bancshares is a small regional bank headquartered in Birmingham, Alabama, operating 21 branches in three states. It is a fairly typical regional bank, is conservatively run, and distributes a modest dividend to shareholders.

I recently took a position at approximately $7.60. Though I’ve watched the name for years and my colleague Benj Gallander has owned it since 2015, I only pulled the trigger recently because valuations are now low, insiders are buying, and its year-to-date performance has lagged, suggesting it may regress to the mean.

I was not, however, bold enough to take a full position. This is because COVID-19 has increased loan loss risks and changed the economic landscape. Deferred loans under the CARES Act currently represent $114.99 million or 20.9% of loans outstanding. Even if a small portion of these deferrals eventually default it will result in large net losses and loan loss provisions.

The hope is to purchase more at some point in the future and flesh out the position once the loan loss picture becomes clear – one way or another.

Disclaimer

The opinions expressed – imperfect and often subject to change – are not intended nor should be taken as advice or guidance. Contra the Heard Investment Newsletter is not an investment advisor or financial advisor. Contra the Heard Investment Newsletter provides research, it does not advise. The information enclosed in this article is deemed to be accurate and reliable, but is not guaranteed by the author.

Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.

Analyst’s Disclosure: I am/we are long FUSB, BAC, FUNC, SYF. 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.