Southern National Bancorp Of Virginia: After A Sizeable Run, Current Valuation Appears Full

Summary

• Credit trends look to be getting worse, while peer banks are improving.
• The loan growth outlook looks muted, and investors should expect some shrinkage.
• The margin is likely to grind lower, but the core margin looks to be holding up well.

Investment Thesis

Based in McLean, Virginia, Southern National Bancorp of Virginia (SONA) is a $3.1 billion asset holding company and parent to Sonabank. Something investors should note, in an external rebranding effort Southern National Bancorp of Virginia is changing its name to Primis Financial Corporation, and the wholly owned subsidiary, Sonabank, will be renamed Primis Bank. Finally, in addition to the name changes, the stock ticker will change from SONA to FRST. This rebranding effort will take effect March 31, 2021.

Although the bank is relatively small compared to Mid-Atlantic peers, it does have a sizable commercial real estate (CRE) lending platform. When including PPP loans (which account for 13% of the entire loan portfolio at year end), CRE loans make up 78% of the portfolio. The three largest lending subcategories are Commercial Real Estate – Non Owner Owned (25% of loan portfolio), Residential 1-4 Family (23%), and Commercial Real Estate – Owner Owned (18%).

The bank is led by Dennis Zember, who previously grew Ameris Bancorp (NASDAQ:ABCB) to what it is today. While his past endeavour was pretty noteworthy, it ended rather abruptly, with little conclusion. While I personally don't see a problem with Dennis running SONA, I do feel it is prudent to at least point out.

From an investment perspective, I find SONA to be appropriately valued. When viewing the stock from a Price to Tangible Book Value perspective, SONA trades at 1.2x relative to the peer average of 1.35x. While that relative discount might be attractive to some, the recent uptick in criticized loans gives me some investment heartburn. While I currently have a hard time recommending the stock for investors looking to put cash to work, I do think it is a pretty solid long-term hold if one were already invested. In my mind, Southern National Bancorp of Virginia - soon to be known as Primis Financial Corporation - is your run of the mill, Neutral-rated bank.

Data by YCharts

Revenue Outlook

Driven by the substantial amount of PPP loans (and forgiveness) relative to its size, fourth quarter spread revenue was up notably from third quarter levels. Fourth quarter net interest income of $25.6 million easily surpassed third quarter level of $23.0 million. While SONA saw a substantial amount of loan growth in FY20, the overall core loan growth trends are rather soft, at best. When comparing end of year 2019 to end of year 2020, core-loans (ex-PPP loans) were down $65 million.

As many of my subscribers know and understand, when PPP loans are forgiven, the remaining balance of accrued fees are pulled forward which increases the net interest margin (NIM). While this accounting principle is GAAP compliant, it does not accurately paint the true picture. In the fourth quarter reported NIM was 3.58%, up more than 30 basis points from third quarter levels.

While most banks of Southern National’s size typically do not have a substantial amount of fee income, SONA bucks the trend and usually generates a healthy amount relative to its total revenue. That said, most of it should be backed out as it is usually “one-time” or “non-core” type of income. That said, it does not matter if it is core or not, when the increased revenue falls to the bottom-line and increases book value.

Finally, I do want to point out, while larger national banks have seen a massive uptick in mortgage related loan growth (or fees), SONA’s mortgage related tailwinds are found in the “equity gain from mortgage affiliate” line item.

Source: SEC Filing and Author's Estimates

When looking forward, I assume that SONA will continue its loan portfolio shrinkage. PPP loans are likely to continue to be forgiven, which should help keep the NIM elevated. When looking at the chart above, one can see the NIM fall pretty dramatically, however, that roller-coaster track is largely driven by PPP related fees only. Long-term investors should be modeling something near 3.25% as a core margin. When looking forward, SONA’s expensive certificate deposits should continue to grind lower. While its average earning assets are destined to trickle lower, I think the margin should find its trough sometime in 3Q21.

Credit Analysis

In my mind, Southern National’s credit picture is a bit of a mixed bag. On one hand, it had a fairly average track record of Net Charge-Offs (NCOs), as seen in the last economic downturn. While it did perform a little worse than peers, its average peak-to-tough trend change followed the banking industry average. Pre-pandemic trends were actually better than the national banking average.

Source: SEC Filing

However, the more recent trends paint a much more difficult picture. While most peer banks have seen a peak, or at least the rate of criticized loan growth has slowed, SONA’s most recent trend change has been notably upward.

Source: SEC Filing

After backing out all PPP loans, more than 5.75% of the loan portfolio ($122 million) remains in deferral. Driven by its larger than average commercial real estate, SONA does have a sizable hotel portfolio (on a relative dollar basis), of which $72 million is under modification.

Concluding Thoughts

Driven by its geographic location, SONA operates in the sweet spot of being small enough to acquire, but also large enough to have it move the needle for most any would-be acquirer.

When breaking it all down, SONA looks to have some credit problems to work through. While it's not a deal-break for the longevity of the bank, it is hard to see the bank's stock continue to move higher without some substantial clean-up in the next couple quarters.

Its current valuation of 1.2x on P/TBV is a little below peers'. In my mind, this relative discount makes sense due to the recent credit deterioration. I think current investors might be disappointed in the time it takes to get back into growth mode (I would project 9+ months), but this name is not one to short. I think there are better options elsewhere.

Source: SEC Filing and Author's Estimates

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.