FNLC - The First Bancorp: A Great Regional Bank Opportunity

2023-08-04 14:42:55 ET

Summary

• The First Bancorp is the parent company of First National Bank, which serves Maine through its 18 branches.
• The bank's steady growth and healthy financial position make it a promising investment opportunity.
• I believe FNLC presents a highly attractive way to benefit from the broader recovery in regional bank stocks.

Intro and Background

The First Bancorp Inc. ( FNLC ) is the parent company of First National Bank (more specifically known as First National Bank of Damariscotta, or the First National Lincoln Corporation). The bank operates solely in Maine. It currently has 18 branches and has expanded over the years, adding branches and also making various acquisitions including FNB Bancshares in 2005, and a branch in Belfast, Maine in 2020.

Its steady growth and healthy financial position make it a great way to profit from the broader recovery in regional bank stocks, which were broadly beaten down as a result of the failures of a handful of regional banks in early 2023. In addition to its strong growth, FNLC currently trades at a significant discount to my fair value estimate, making it a prime opportunity for those with a focus on "growth at a reasonable price" and value investors alike.

Asset Quality

A primary reason for the market's unclear outlook for FNLC is its concentration in commercial real estate loans. However, the firm maintains that its current loan portfolio is perfectly healthy, and its annual report supports that assertion; at 2022 year-end, non-performing loans stood at only 0.09% compared to 0.35% a year earlier. In Q4 2021, the bank also sold $14.5 million of commercial loans to reduce concentration, which shows a commitment by management to maintain appropriate diversification in assets.

According to the annual report , "The company's total risk-based capital ratio was 13.58%... above the well-capitalized threshold of 10.0% set by the [FDIC, Fed and Comptroller of the Currency]." In other words, the bank meets the highest standards for capitalization as set by all major regulators.

Loan and Deposit Growth

The firm has seen strong loan and deposit growth, even through recent market uncertainty. Total loans grew from $1.65 billion in 2021 to 1.91 billion in 2022, a 15.7% year-over-year increase.

Deposits grew similarly as well. FNLC ended 2022 with $2.379 billion in total deposits, an increase of 12% over the 2021 figure, $2.123 billion.

Book Value

The First Bancorp's book value as listed on the current balance sheet as $228.92 million, equal to its $2.728 billion in assets, less liabilities of $2.499 billion. I prefer to take dividends and buybacks into account, so I use an adjusted "clean surplus" book value as calculated below:

Consistent Record of Profitability and Growth

The First Bancorp's record is outstanding. Not only has the firm been profitable every year since 2013, but in each of those years, the firm has grown its profits over the previous year. The firm's average earnings growth rate over this period 13%. While normally it may be reckless to estimate such high rates of future growth, FNLC has demonstrated unique consistency in its profitability and earnings growth which separates it from other regional banks.

Valuation & Modeling

While FNLC has seen consistent earnings growth for the past decade, I want to be more conservative. Therefore, I assume 8% short-run earnings growth and 2% thereafter. Based its high dividend and dividend growth, I assume a 9.45% cost of equity (calculated by estimating next year's dividend and adding it to the short-term risk-free rate). The following table shows my intrinsic value calculation based on the residual income model:

*Note: These figures represent projected residual income after discounting to present value.

As you can see, my fair value estimate is $508.787 million or $45.91 per share, which represents a 73.5% potential upside from the current share price of $26.46.

Bond Investing Perspective

Ben Graham, in his "Security Analysis," explained that stable, growing companies (such as FNLC) could be thought of as investment-grade bonds; if the current earnings yield (Net Income / Current Price) is 10%, for instance, then investors can consider themselves buyers of a 10% bond with the potential for growth in its coupons.

The First Bancorp certainly meets the criteria of consistent profit and stable growth to warrant such a consideration. In FNLC's case, though, the "bond yield" is about 13.1%. Its ability to consistently grow its earnings (coupons, in this analogy) has been demonstrated over the past decade.

Risk Factors

Interest Rates

The main risk for banks in general is the current interest rate environment. Many banks, and potentially The First Bancorp, made a majority of their loans during the past decade of low rates, which means that margins could shrink or disappear altogether if rates stay at elevated levels for longer than anticipated. FNLC's consistent loan volume growth does decrease this risk, as it means a larger percentage of its loans are made at current rates than those of its competitors.

Regional Banking Fears

As The First Bancorp is a relatively small regional bank, investors may worry that FNLC could face potential bank runs if its financial position became uncertain. While this is a risk for all banks, and particularly regional banks, it's also the case that Silicon Valley Bank ( SVB ), First Republic Bank ( OTCPK:FRCB ), and other risky banks are (or were) outliers in their levels of FDIC coverage. Customers likely pulled capital from these banks because there was a high likelihood that the banks would not be able to pay their depositors. The rates of uninsured deposits in these banks were far higher than the general market . In other words, the bank failures seen earlier this year represent the exception, not the rule.

In FNLC's case, the bank's deposit quality could hardly be safer. Uninsured deposits total $173.5 million, or less than 8% of total deposits. Silicon Valley Bank, by contrast, had uninsured deposits greater than 85% of total deposits, according to multiple reports .

Commercial Real Estate Weakness

The bank's loan portfolio is highly concentrated in commercial real estate loans relative to many peers. As of the 2022 annual report, these loans made up 36.5% of the total loan portfolio, with commercial construction and other commercial loans making up an additional 4.9% and 16.7%, respectively.

The First Bancorp, however, maintains that its portfolio is safe, citing regulatory guidance: commercial real estate loans account for 224% of the bank's asset value, while the FDIC guidance is about 33.9% higher, at 300% of asset value. Additionally, the Boulos Company , one of the largest commercial real estate firms in Maine, reports a strengthening market with increasing demand and decreasing vacancies.

Conclusion

For anyone who is interested in profiting from the rebound in regional banks, which have yet to fully recover from their decline in early 2023, The First Bancorp ( FNLC ) is a fantastic option. The firm's asset quality is very high, it consistently grows its deposits and loans, and it is "well capitalized" according to standards set by regulators. Its strong growth positions it to be resilient in a high-rate environment, and its undervaluation provides a large margin of safety.

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