BKSC - Bank of South Carolina: The Situation Is Improving But I'm Still On The Sidelines

2023-05-17 09:42:00 ET

Summary

• Bank of South Carolina posted a satisfying result in the first quarter as net interest income increased.
• That being said, the stock is still not cheap at around 11x annualized earnings and almost 1.80 times its book value.
• The bank is well managed but I'm too conservative to pay an almost triple-digit premium over book value.

Introduction

It has only been two months since I last had a look at the Bank of South Carolina ( BKSC ), but as the US financial sector (and more particularly the regional financial banking scene) is changing fast, I wanted to keep close tabs on this particular bank . BKSC reported its financial results about a month ago but it took the company four more weeks to also publish the quarterly report which provides much more detail than the very summarized news release. Plenty of information for me to dive into, and I focused on the balance sheet (and asset quality) and the bank's reported earnings.

The balance sheet still contains a substantial amount of securities available for sale, but the value remains stable

The main issue the smaller regional banks were facing since the fallout caused by the implosion of the Silicon Valley Bank was the fair value of the portfolio of securities available for sale , which had to be marked to market. As interest rates increased, the value of those securities decreased and this put pressure on the equity portion of the balance sheet resulting in depositors getting nervous (also because other investments that are not subject to the mark-to-market requirement would have a book value that likely exceeds the fair value on the financial markets) and pulling cash out of the bank.

This means there are a lot of moving parts and regional banks need to keep an eye on liquidity levels, but even more importantly, they need to show balance sheet strength in general.

Looking at BKSC's balance sheet as of the end of March, the bank continued to invest rather heavily in securities available for sale. Together with the $22M in cash and deposits at the Federal Reserve, these liquid assets cover about 50% of the deposits held at the bank ($588M as of the end of March).

It's interesting to see the bank actually reported a value increase of the portfolio of securities available for sale. The comprehensive income statement shows a $3.93M value increase (an unrealized gain) during the first quarter.

I will discuss the bank's financial performance in the next part of this article) and this boosted the equity value to just over $43M. That's important to regain the trust of the financial markets as the total equity value increased while the total size of the balance sheet decreased. As of the end of December 2022, the equity ratio (equity vs. balance sheet total) was just 5.94% and this increased to 6.72% at the end of Q1, partially because of the retained earnings during Q1 but the unrealized gains on the portfolio of securities available for sale had a much bigger impact.

So, about half of the deposits are held in what should be pretty liquid assets (cash, deposits and securities available for sale). That's good to know, but we should obviously also keep an eye on the $330M loan book. Just over a quarter of the loan book consists of mortgages on residential real estate, but in excess of half of the loan book is invested in (non-construction) commercial real estate. Unfortunately the bank does not provide a more detailed breakdown of the underlying assets but the breakdown of the loan quality is encouraging: Of the $333.8M in loans, $332.5M is classified as "current" with only $1.26M classified as loans past due (including the $628,000 in loans that are classified as non-accruing). It isn't really a surprise to see the vast majority of the loans past due can be found in the commercial real estate segment.

While we obviously have to keep an eye on how the loans are performing (and it's a pity BKSC doesn't disclose the average LTV ratios) there doesn't appear to be a reason to be too nervous about the Bank of South Carolina.

The earnings report in Q1 was satisfying

During the first quarter, the Bank of South Carolina saw its interest income increased by almost a third, to $5.6M. That's not really a surprise considering the higher interest rates on the financial markets also are boosting the interest income. Unfortunately most banks see a corresponding increase in their interest expenses, but in BKSC's case, the interest income increased at a faster pace than the interest expenses. The net interest income increased by more than 10% to $4.7M.

The bank also recorded an additional $45,000 in loan loss provisions and the net non-interest expenses were approximately $2.8M. The combination of these elements resulted in a pre-tax income of $1.85M and a net income of just under $1.6M. This represents an EPS of $0.29 per share ($0.28 on a fully diluted basis ), an increase of almost 10% compared to the first quarter of last year.

The company does pay a cash dividend of 17 cents per quarter , which means that based on the Q1 results, it retained about 12 cents or approximately $650,000 in earnings on its balance sheet. While this bolsters the equity position and improves the balance sheet safety, the progress is relatively slow and it once again shows how important the positive revaluation of the portfolio of securities available for sale was in the first quarter.

Investment thesis

While the earnings are robust and the access to liquidity is good, this still doesn't mean the Bank of Carolina is cheap from an investment perspective. As of the end of March, the bank's book value per share was just $7.84/share (despite the positive impact of the revaluation of the securities available for sale). This means that despite the most recent drop, the stock is still trading at a premium of 77% to the book value.

As a small bank, BKSC also isn't as transparent as its larger counter parts (including larger regional banks). Timberland Bancorp for instance, provided details on what percentage of its deposits are insured and uninsured, and I wish BKSC would provide a little bit more color on the LTV ratios in its commercial real estate portfolio.

I'm on the sidelines.

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