Simmons First's Recent Rebound To Lofty Valuation Levels Leaves Little Room For Error

Summary

• Credit trends continue to deteriorate, leaving the loan loss reserve to look somewhat underfunded.
• The stock is now more expensive than its pre-pandemic levels, but is projected to have a lower EPS.
• The Criticized Loans to Total Loans ratio is the highest it has been in the last 10 years.

Investment Thesis

I think it's a healthy practice for investors to not only review their positive investment decisions, but to also review the names they shied away from in order to fine-turn their investing skills. While it's easy to look back at all the "winners" and rest in your laurels, it takes a good deal of investment maturity to acknowledge past mistakes.

Most recently, the one investment "miss" that comes to mind is Simmons First National Corporation (NASDAQ:SFNC). For me, the Pine Bluff, Arkansas based $22.4 billion dollar asset bank is one that got away. Since I did not expect the company to perform well over the past few months, I missed out on its sizable upside gains. As one can see from my October article, my main investment thesis was,

Growth will likely come more into focus as we progress closer to the end of the year. While the overall growth outlook could improve, along with profitability, I think investors are going to be a little weary of SFNC because of its incredibly acquisitive acquisition history.

While the final decision to not recommend the stock is the only actionable catalyst investors could possibly takeaway from the article, I do find it a bit curious to see SFNC outpace the bank space while at the same time rapidly increase criticized loans.

From a valuation perspective, I continue to recommend would-be potential shareholders to watch SFNC from the sidelines. While I would fully acknowledge that I was wrong in the past, I would currently like to point out the fact that SFNC is more expensive today than at the end of 2019, months before COVID was even a part of the conversation. From my modeling, I also expect the provision to remain a little elevated and limited spread revenue tailwinds to support the excessive valuation levels. While earnings are likely to be positive, I think the year-over-year trend is only a little better than flat.

On a relative basis, SFNC has almost always traded for a premium to peers due to its core deposit base, a machine-like integration of acquisitions for growth and modest fee income stability. With that said, its current valuation of ~1.8x Price to Tangible Book Value appears excessive relative to peers at 1.35x. In my mind, SFNC's stock is likely to enter a holding pattern and I would not recommend entering a position at the current price.

Data by YCharts

Credit Update

In the past article I touched on the better than average credit underwriting standards. In my mind, the updated trend is showing a bit of deterioration. SFNC has almost always been better than peers, but as of late its net charge-offs ((NCOs)) have seen a modest ramp higher. While not overall worrisome to the grand scheme of things, it should give investors pause due to its current outsized valuation premium to peers. In my mind, most banks that trade for a premium, don't have a slipping credit profile and limited earnings growth expectations.

Source: SEC Filings

In my mind SFNC is great at underwriting, but the most recent increase in criticized loans is where my overall hesitation for an investment begins. As one can see from the chart below, criticized loans have marched higher while there has been minimal loan loss reserve building.

Source: SEC Filings

While not all criticized loans will go belly-up, some will and that is what concerns me the most. As one can see at the beginning of 2020, management did a fantastic job of rightsizing the reserve relative to criticized loans (black line). The rapid downtick in 1Q20 clearly helped insulate the bank from potential credit problems.

Working forward three quarters to the end of 2020, the criticized loans to total reserve levels has elevated higher and now stands at 2.7x. While on a fundamental basis, this level is what I would consider standard/average - it does not justify a valuation premium. Going a step further, there any many other banks that have a better ratio that are trading under SFNC's current valuation.

With that being said, relative to is more recent past, SFNC is breaking new ground (in a negative way) when one compares criticized loans to total loans (blue line). The Criticized Loans / Total Loans ratio is now over 5.0x, the highest it has been in over a decade. There is an obvious cognitive dissidence between the two lines - reserve levels good when compared to criticized loans, but criticized loans are more present than ever. While one somewhat cancels out the other, the only thing that is clear is credit risk is increasing.

Concluding Thoughts

In my mind, Simmons First is a very acquisitive bank with a stable fee income business. Through well-priced, and well-timed acquisitions, coupled with spreading total expenses across a larger asset base, is the simple formula to how SFNC increases earnings per share.

While I do not believe the bank is likely to see negative earnings via outsized provision expenses, I do have a hard time seeing NCOs not continue to increase and be above peer like levels. Very acquisitive banks, like Simmons, typically have higher early term charge-offs when rebounding off economic lows. While I would consider SFNC to be quite proficient at its growth through acquisition strategy, I think the market is giving the bank too much leeway in terms of its deteriorating credit profile.

Source: SEC Filings 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.