2023-10-11 10:30:00 ET
Summary
- FMBL is focusing on the greater Long Beach, Calif., area.
- The bank only provides summarized financial results on a quarterly basis and only goes into detail in its annual reports.
- I would be very interested in seeing an update on the loan book and the fair value of the securities portfolio.
Introduction
There are plenty of banks called "Farmers & Merchants" in the US and the one headquartered in Long Beach ( FMBL ) was started in 1907 . The bank likes to brag about its strong history and rightly so as the bank has been profitable in every single year since it was started (and yes, this includes the financial performance during the Global Financial Crisis). It also has paid dividends for 106 consecutive years. The bank is active in the greater Long Beach area with 26 branches, and plans to open a 27th branch by the end of next year.
The bank once again confirms with a robust performance
It's always nice when a bank opens its quarterly earnings statement with "our first priority continues to be safeguarding our clients ' deposits through challenging economic times." While that should be a core principle of any bank out there, FMBL’s strong history lends more gravitas to those words and you are inclined to believe them.
The bank continued to perform well, but as you can imagine, its net interest income was definitely impacted by the increasing interest rates which reduced the net interest income. As you can see below, total interest and dividend income increased by $21M compared to the second quarter of 2022, but interest expenses more than twelve-folded to just over $37M, resulting in a net interest income of $65.1M. That’s indeed substantially lower than the $78.1M generated in the second quarter of last year and also slightly lower on a QoQ basis as the net interest income was almost $71M in the first quarter of this year.
But the bank remains profitable, even during these difficult times. Its net non-interest expenses increased to $46.5M (up from $42M in the second quarter of last year) and as there were no provisions required to cover potential loan losses, the pre-tax income was $18.6M. Just over half the pre-tax income of Q2 last year.
The total tax bill was exceptionally low at just $0.5M and this resulted in a total net income of $18.15M for an EPS of $147.28. The total EPS in the first half of the year was approximately $322.75 based on the current share count of 123,228 shares. The company did not provide an explanation on the low tax bill so it would be safer to assume a normal tax rate will be due in the future, in which case the first half earnings would be around $288 per share of which $120/share was generated in the second quarter.
Looking at the balance sheet, FMBL was again able to expand its balance sheet in the first half of the year as it raised $300M by increasing its borrowings. And as you can see in the image below, the total amount of deposits decreased, and that’s perhaps something to keep an eye on. There's no reason to be alarmed but it's definitely interesting to see a bank with a robust history of profitability seeing its total amount of deposits coming under pressure. Perhaps it's just a temporary blip but it for sure is one of the main elements I will keep an eye out for in the next few quarterly reports.
The balance sheet remains pretty liquid as almost half of the assets are held in cash and securities. The majority of the securities are securities held to maturity, and then it's a legitimate question or comment to figure out what the difference is between the book value and the fair value of those securities. Unfortunately, Farmers & Merchants only provides very detailed numbers and breakdowns in its full-year results so unfortunately that's an unknown factor at this point. We can easily look back at the annual report for FY 2022 and there we see there was a $525M unrealized loss on that portfolio.
As the vast majority of the portfolio is only due after 10 years, it's safe to assume there was an additional value erosion in the first six months of the year. The image below shows the change in the US Treasury yields on three separate time frames. So yes, I do expect additional value erosion and unrealized losses on the securities held to maturity and that likely is a contributing factor to the weak share price.
The bank is still very proud of its strong capital position and at the end of June the CET1 ratio stood at 15.68%. And as FMBL hasn’t recorded a loan loss provision in several quarters now, it's quite confident in its loan book quality where it has a total provision of almost $100M on a loan book size of just over $6.8B.
Unfortunately the bank also does not provide details on the quality of its loan book on a quarterly basis, but as of the end of last year, only $3.2M of loans were placed on non-accrual status while an additional $6.3M in loans were classified as past due.
Virtually all those soured loans were backed by residential real estate. While that used to be excellent collateral, the California real estate market can be volatile and it would be interesting to learn the average LTV ratio of the loans that are past due.
Investment thesis
As of the end of June, FMBL’s book value was $10,750 per share. That’s great. But if you would assume an unrealized loss of $750M on the portfolio of securities held to maturity, the book value would decrease to just over $4,600 per share. That’s still good but I definitely appreciate FMBL paying a relatively low dividend of $28 per quarter as this allows the bank to retain about $100 per share on a quarterly basis to mitigate the impact of the higher interest rates on the portfolio of securities.
I currently have no position in FMBL. I like the bank and its approach to prioritize its financial health. That being said, if you would apply the current market value of the securities held to maturity on the current equity position, the balance sheet would look substantially weaker. It's in FMBL’s best interest to see the long-term interest rates stabilize as this would stop the unrealized losses while the retained earnings will help to shore up the balance sheet again. The worst should be behind us on the interest rate front, and now it's important to keep the loan book in a good shape to avoid losses and additional provisions there.
For further details see:
Farmers & Merchants Bank of Long Beach: Strong Results But The Securities Portfolio Is A Risk