2023-06-30 10:30:00 ET
Summary
- TowneBank has completed the acquisition of Farmers Bankshares.
- The net income in Q1 was still pretty strong thanks to an increased net interest income.
- The total amount of loan loss provisions spiked, but very few loans (less than 0.2% of the loan book) are either past due or non-accruing.
- It will be interesting to see how the net interest income will develop.
Introduction
When I last discussed TowneBank ( TOWN ) in August 2022, the bank had just announced it was acquiring Farmers Bankshares (FBVA) to further expand its asset base. We're now almost one year after my previous update, and as the acquisition has been consummated I figured this is a good moment to have another look under the hood of the enlarged TowneBank to see if the recent banking crisis in the US is threatening TowneBank.
Strong earnings in the first quarter of the year
The acquisition of Farmers Bankshares was completed on Jan. 13 , so the balance sheet of the bank now contains the combination of both entities for the first time. Thanks to the enlarged balance sheet and increasing interest rates, TowneBank’s net interest income increased pretty sharply in the first quarter of the year (and the contribution from Farmers only started from Jan. 13).
The total interest income increased by in excess of 50% to just over $163M but as the bank obviously also had to start paying higher interest rates on the savings accounts and deposits. The total interest expenses more than quadrupled to in excess of $40M, resulting in a net interest income of approximately $123M, which is a 24% increase compared to the first quarter of last year.
That is good news mainly because net non-interest expenses continued to increase. Compared to the first quarter of 2022, the bank saw a reduction in its non-interest income to just under $61M while the total non-interest expenses increased to $124M, resulting in a net non-interest expense of $63M. Keep in mind these expenses include almost $6M in acquisition-related expenses .
The bank reported a pre-tax income of $48M after also recording a $11.7M loan loss provision and on an after tax basis, the net income attributable to the shareholders of TowneBank came in at $38.3M. Considering there are currently 74.8M shares outstanding, the net income was approximately 51 cents per share (the official EPS was $0.52 as the bank used a lower average share count while I used the total share count as of the end of the first quarter).
Subsequent to the end of the first quarter, TowneBank hiked its dividend from $0.23 to $0.25 per share, which means the payout ratio is currently approximately 50%. The dividend yield based on the current share price of just under $24 is approximately 4.2%.
A closer look at the balance sheet and the exposure to commercial real estate
The banking sector had a liquidity issue in the first half of the current financial year and the access to liquidity was an important item when the Q1 results of most banks were released. Looking at TowneBank’s balance sheet (see below), the bank has about $1.24B in cash and interest bearing deposits on its balance sheet, with an additional $2.62B in securities available for sale and securities held to maturity. The fair value of the latter is just $24M less than the book value so the risk to encounter sudden surprises is relatively low. And the securities available for sale are obviously marked to market, so "what you see is what you get."
This means that on top of the $1.24B in cash and deposits, the bank also has access to about $2.6B in securities for a total access to liquidity of around $3.8B. That’s approximately 28% of all the deposits. That’s an increase from the 26% as of the end of FY 2022. Additionally, the bank has access to about $6.6B in liquidity.
Another element TowneBank has to deal with is the breakdown of its loan portfolio. As you can see below, just over $5B of the total $11.2B loan portfolio consists of commercial real estate.
Fortunately the bank provided an excellent breakdown in its Q1 presentation and I think the riskiest portion of the commercial real estate loans are the office buildings (just over $1B) and shopping centers (just under $700M).
The bank understands investors are not too keen on office real estate these days, and in its Q1 presentation, TowneBank inserted an additional slide explaining that over half of the office real estate is in Hampton Roads where vacancy levels have been decreasing while there still was a noticeable low single-digit rent growth.
It's nice to see the bank is providing more details on its exposure to office buildings but unfortunately it did not disclose the average LTV value in the office segment. I think that would be an important piece of information to determine the actual risk. Fortunately about $300M of the non-multi family commercial real estate loans is maturing in the current financial year, and hopefully the default rates will remain low. Fortunately the total amount of loans past due remains very low, as you can see below. Less than $10M of the total $11.2B loan book is currently classified as "past due," and a substantial portion of that $8.6M is not even related to commercial real estate. About 30% of the total amount of loans past due is related to the residential loans and HELOCs.
As of the end of the first quarter the total allowance for credit losses was almost 13 times higher than the current amount of non-performing loans, which stood at $9.3M as of the end of Q1. This means the current cushion of $120M in loan loss provisions should be pretty comfortable and the strong earnings profile of the bank ($60M in pre-tax income before loan loss provisions in Q1) means the bank can easily further increase the loan loss provisions if there’s a need to do so. Even if it needs to triple its loan loss provisions, the bank would still report a net income of approximately $0.27 per quarter.
Investment thesis
It looks like TowneBank has a good grip on its financial situation. The access to liquidity remains very strong and the earnings are comfortably covering the dividend while it also allows the bank to retain close to $20M per quarter in earnings (and this already includes a loan loss provision of in excess of $11M). It will be interesting to see how the net interest income will develop over the next few quarters as I expect the interest expenses will increase faster than the interest income from the loan book and it will be equally interesting to see how the refinancing (or repayment) of the $300M in commercial loans due this year will be executed.
The stock is trading at about 11-12 times earnings and about 1.2 times its tangible book value. That’s not cheap and this likely indicates the market likes how TowneBank is dealing with the current uncertainty in the US banking sector. I currently have no position in TowneBank but I will be keeping close tabs on this regional bank and I am looking forward to see the bank’s Q2 update.
For further details see:
TowneBank: Trading At 12x Earnings And 1.2x Tangible Book Value