BKSC - Bank Of South Carolina: The Book Value Got Hammered By The Securities Portfolio

2023-03-14 10:30:00 ET

Summary

• Bank of South Carolina has just more than $600M in assets, of which in excess of 40% is held in securities available for sale.
• This caused a headache in 2022 as that portfolio lost about $23M in value, thereby rapidly eroding the book value.
• The situation improved in the fourth quarter as the bank recouped some of the previously recorded unrealized losses.
• I'm on the sidelines. I like BKSC's loan portfolio but the balance sheet is starting to get a little bit concerning as just 6% of the assets consists of equity.

Introduction

It has been almost two years since I discussed the Bank of South Carolina ( BKSC ) here on Seeking Alpha. Back in June 2021 I thought the company was too expensive, and so far, I have been right. The total return is a negative 15% (including all dividends) which is a worse performance than for instance the S&P 500 which lost less than 9% in the same period. And according to the Seeking Alpha charting tool, BKSC also clearly underperformed the banking ETF Financial Select Sector SPDR ETF ( XLF ). This could be a good moment to have another look under the hood as the financial sector is rattled by the impact of the failure of Silicon Valley Bank while higher interest rates should result in higher interest margins going forward.

2022 was a decent year for the bank - but the book value collapsed

The Bank of South Carolina operates in the Charleston area of South Carolina and is a relatively small bank: The total amount of assets on the balance sheet is just $653M and the bank’s market capitalization is just under $90M.

During 2022, the bank reported a total interest and fee income of $19.2M which is an increase of approximately 10% vs. 2021 while the total amount of interest expenses increased by just under $130,000. While the interest expenses almost doubled, the total increase in absolute numbers is very manageable, and the net interest income increased by almost 10% to $18.9M.

The Bank of South Carolina also reported about $2.1M in non-interest income and $12.4M in non-interest expenses, resulting in a pre-tax and pre loan loss provision income of approximately $8.55M. Surprisingly, BKSC was actually able to unwind some historical provisions for loan losses and the income statement clearly shows about $75,000 in previously recorded provisions were released which provided a nice little boost to the earnings which climbed to $8.63M pre-tax and about $6.66M after-tax. And with approximately 5.55M shares outstanding, the EPS came in at $1.20. That sounds great but is still slightly lower than the $1.22 in EPS generated in 2021, mainly due to the fact the mortgage banking income dropped off a cliff after having generated roughly $2.3M per year in the previous two years. This fell to just $0.7M and I don’t expect things to be much better this year given the state of the economy.

So while Bank of South Carolina clearly saw its net interest income increase, it did report a slightly lower net income.

But what the income statement doesn’t show is the loss from the securities available for sale. As the whole world knows by now, those securities have to be marked to market which results in sometimes very serious value destruction. In Bank of South Carolina’s case, the unrealized loss on those securities was approximately $23.1M during the year. And that also explains why the book value fell from $54M to $38.8M as of the end of 2022.

And as you can see in the image above, throughout the year, BKSC withdrew cash from interest-bearing deposits at the Federal Reserve to buy even more securities. That does not necessarily have to be a bad thing if you believe interest rates are topping out at these levels. But it for sure is an interesting element to keep an eye on. And it’s worth emphasizing the bank actually reported an unrealized gain on its portfolio of securities available for sale in the fourth quarter. It reported an unrealized loss of $25.5M as of the end of September which was reduced to just $23.1M at the end of the year so throughout the fourth quarter, the company recouped about $2.4M of those losses and its book value increased from the $36M at the end of September .

This doesn’t mean Bank of South Carolina is out of the woods just yet. As of the end of December the bank still had in excess of $270M in securities classified as "available for sale" which represented over 40% of the total asset base. That’s a lot and additional interest rate increases will cause additional pain. Only $42.7M of those securities are maturing in 2023 and while getting the cash in on maturity, the issue is that less than 1/6 ^th of the securities will be repaid this year which isn’t a whole lot.

Should the $43M be redeployed at an average interest rate of 4.5%, Bank of South Carolina will see a pretty serious boost in its interest income but at this point it’s more an issue of avoiding further losses rather than getting excited about low-income securities rolling off. Fortunately the loan book is pretty strong with just over $0.6M (of the $330M) in non-accrual loans and less than $2.8M in impaired loans.

Investment thesis

Despite what happened to Silicon Valley Bank, I like regional banks as they usually have a better understanding of the needs of their local customers. In the case of the Bank of South Carolina, I remain very much on the sidelines. The bank is trading at about 13 times its 2022 earnings and I don’t expect the 2023 results to be much better. I like the conservative loan portfolio but limiting the damage from the portfolio of securities available for sale should be priority number one. There was an encouraging uptick in the fourth quarter of last year but BKSC still has a long way to go.

And even assuming the situation doesn’t get worse, as of the end of 2022 the book value (and tangible book value) per share was just $6.99 which makes BKSC relatively unappealing from both an earnings and a book value perspective. I’m on the sidelines. I like the bank and its loan book, but I personally would like to see a stronger balance sheet.

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