Sierra Bancorp: Long Runway For Growth With An Attractive Entry Point
Summary
- Continuing to grow the lending portfolio will likely drive incremental profitability improvement.
- The expense base looks poised to support a larger balance sheet, which will likely drive addition operational leverage.
- Credit looks solid and has proven to be of little concern the past six years.
Investment Thesis
While my writing has often focused on the more widely known regional banks scattered across the United States, I have gotten feedback that it leaves holes in the asset size spectrum. Being that the biggest growth driver to most banks is talented hires spread over a sustainable expense base, it often leaves smaller banks at a significant disadvantage relative to larger peers. More often than not, smaller banks simply can’t generate the profitably metrics needed to justify larger peer bank valuation levels. More plainly, the asset size and lending portfolios are simply too small to cover the operational costs and provide healthy profit margins. With that as a backdrop, Sierra Bancorp (NASDAQ:BSRR) breaks the mold and looks poised to continue to generate solid financial returns while concurrently investing in long-term growth.
Based in Porterville, California, BSRR operates as $3.2 billion asset holding company for Bank of the Sierra. While the bank has just 36 branches located throughout the middle of California, it has found a solid geographic footprint with additional growth potential. With its community-centric banking scattered across California’s Central Valley and Ventura County, the bank looks poised to continue to generate solid financial returns via its $2.1 billion loan portfolio.
When looking at the chart below, one can see that BSRR currently trades at 1.0x price to tangible book value per share, while most regional peers are closer to 1.5x. While larger peer banks often have the ability to generate solid returns more sustainably, I continue to believe BSRR will not only continue to growth its loan portfolio organically, but also through will-priced and timed acquisitions. Because the market is likely to continue to discount BSRR simply due to its size (relative to peers), as the bank grows it should narrow the valuation gap (i.e. outperform peers).
Also, its credit profile continues to look good and the net interest margin (NIM) might entice a larger peer bank to acquire BSRR. Whether its path is continued growth, or partner up with another bank, BSRR’s current valuation is too cheap to ignore.
Recent Results And A Look Forward
While loans declined slightly more than I had originally been expecting in the second quarter (due to both paydowns and mortgage warehouse seasonality), a loan loss provision recapture drove overall profitability to be better than consensus expectations. It also helped support a 1.42% ROA, significantly higher than peer banks.
With that being said, the provision recapture is not something investors are likely to pay up for, in fact it does not really drive any investment thesis other than support a higher tangible book value. Going forward, I am modeling the ROA to decline modestly to something near the mid-1.20%’s range. This 20 basis points of atrophy is due to conservatism around the forward margin. While 1.20% is likely more conservative than necessary, it does add in some wiggle room for continued "beats" of overall earnings.
Because the bank is poised to continue to see organic loan growth, I believe the FY21 portfolio lows are in (in terms of total balances). While paydowns could continue to diminish the bank’s loan growth outlook, the bottom line is that the EPS outlook should be better going forward. Furthermore, I think my new estimates and profitability metrics could still prove conservative depending on the expense path and future loan growth momentum.
I also think its noteworthy to point out, any deployment of liquidity on the balance sheet would likely result in higher average earning asset yields and improve the core franchise’s profitability profile. While the switch from cash to loans does not need to increase the balance sheet size, it does offer additional operating leverage and a higher future return profile.
Thoughts On Credit
As seen below, this bank has done a tremendous job managing growth, but more importantly the credit profile. When looking at the handful of smaller banks that continually grow faster than average, one can see that most add risky loans but don’t carry the yields necessary to mitigate the risk. BSRR has proven itself a solid underwriter and is likely to continue to have minimal credit events.
Source: SEC Filings
Put more plainly, I think provisioning will be very modest over the next few quarters and look for the continuation of limited net charge offs to persist. While this lack of provisioning does not help the bottom line, it does not hurt it either. Overall, the bank should continue to grow and reward shareholder appropriately.
When looking at BSRR relative to most of the industry, one will notice that the banking industry has seen tremendous earnings growth supported by negative provisions. While this glimpse into the credit profile is supportive of higher valuations, it's not likely to support higher P/E values. Since BSRR’s 2Q modest recapture is likely to be a one-off rather than the start of a new trend, I believe its CECL day-1 reserve will be limited (like a late FY22 event).
Concluding Thoughts
While this bank is much smaller than the ones I have written about in the past, it remains a solid name that I view as undervalued relative to peers. When looking at regional lending, I see an anticipation of stronger loan growth playing out in 2H21 and FY22. I also think a focus on core efficiency and eventual capital deployment could result in additional upside to my expectations.
I must caution investors though, BSRR does trade with limited liquidity relative to peer banks and that can sometimes create outsized amounts of volatility. It's also not a great candidate to trade because of the limited volume. That being said, if you have the ability to buy and hold for a few years, I have a hard time seeing this bank underperforming the banking index - especially at this enticing valuation.
This article was written by
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