Farmers & Merchants Bank Of Long Beach Ticks Off Another Year Under The Radar

by The Compound Investor

As I mentioned in the last piece on First Hawaiian, a ‘safety first’ approach is definitely not the worst way to treat investing in bank stocks. I know Farmers & Merchants Bank of Long Beach (FMBL) isn’t for everyone (and that really is understating it), but it does dovetail nicely with that sentiment, and it’s just about as rock solid as you can ask for given its profile (a Southern Californian bank with a market-cap in the $1b area). Heck, at this point I will just let its dividend record do the talking: 517 consecutive payments, unbroken since 1916, and its quarterly dividend has never decreased in value. It’s a real gem of a stock.

I last covered the bank just under a year ago. Up around 20% since then with dividends, the stock has lagged the regional bank index on its trip back to its pre-COVID share price region. In a way, that kind of sums up the overall deal here. Look back over three, five or even ten years and you’ll not see much other than underperformance. Take things back longer, though, incorporating some real banking busts along the way, and the picture looks quite a bit different. Slow and steady can win the race, and is probably the name of the game for long-term bank stock investing in general.

While that does leave the stock more expensive than it was, we are still way below tangible book value (“TBV”) here. The bears will counter that it will always trade at a discount given what it is (overcapitalized, family owned and with no incentive to be anything other than a steady ship). That’s a fair point, but again, I don’t think investors should mind that, and not being subjected to the whims of Wall Street also has its plusses.

Strong Year-on-Year Growth In Revenue And Core Earnings

As with a lot of its interest-income-dependent peers, lower rates have put pressure on margins at the bank, though it has also seen strong offsetting growth in earning assets. Tighter recent costs, particularly on labor, and lower provisioning have also helped the bottom line vis-a-vis 2020. We don’t have up-to-date results out yet (third quarter financials will have to do), but it’s been a while since I last covered it so there’s still plenty to chew on.

Revenue through the first nine months of the year came in at $237.4m, good for ‘low-teens’ year-on-year growth. On a year-to-date basis, average interest earning assets were $10.3b though the third quarter, up from around $8.7b in 2020, though lower yields pushed its net interest margin down 16bps to 2.89% over that time. That comp does include some pre-COVID months, though, and the third quarter NIM of 2.90% was up 10bps on 2020.

Management also appears to have done a pretty solid job on the expenses side, certainly relative to the other banks I follow. Operating expenses increased around half a point year-on-year (6% sequentially) in the third quarter to $44m, and were down 2.5% year-on-year through the first nine months. Quarterly pre-provision operating profit (“PPOP”) dipped around 2% sequentially in the third quarter (to $37.7m), but was up over 40% year-on-year. PPOP also increased 40% (to $110m) through the first nine months of 2021 versus the same period in 2020. TBV per share was around $9,390, up from around $8,925 at the start of the year.

Loan Growth Flattens, But Core Deposit Franchise Helps Out

I think it’s fair to say management did a good job during in 2020, with what looks to me like good loan growth (even excluding PPP loans) and 7% growth in TBV per share. The recent environment probably hasn’t been great, however, and gross loans dipped 2% sequentially in the third quarter (to $5.35b) as PPP loans continue to fall off the balance sheet. Underlying loan growth did come in positive, though, increasing by around $150m versus the prior quarter. The bank had around $140m of PPP loans still outstanding at the end of its fiscal third quarter.

Unsurprisingly then, deposit growth comfortably outpaced loan growth, with deposit balances increasing another 7% or so sequentially in the third quarter to $8.95b. That represented an acceleration on the previous quarter, and was up from around $7.6b at the start of last year.

The core deposit franchise has always formed a large part of the investment case here, and non-interest-bearing deposits inched up a couple of points through the first three quarters to around 40% of the mix. With that, deposit costs are still very cheap, and the bank’s quarterly interest expense fell another 3.5% sequentially to just under $3m. Interest expense through the first nine months of last year was around $9.5m, down from just over $20m in 2020 and circa $24.5m in the 2019 period. I make that somewhere in the 0.15% area in terms of annualized costs.

Without much loan demand, the investment securities and cash balances rose, and that helped contributed to interest income growth. Net interest income increased 17% year-on-year in the third quarter (and nearly 3% sequentially). Non-interest income was up around 8% through the first three quarters (to $15.5m), although it’s really only a tiny slice of the pie.

Still Flush With Cash

I won’t really say too much about asset quality at this point. It continues to be pristine, as it was during the global financial crisis over a decade ago. The allowance for loan losses stood at around $73.9m at the end of the third quarter, or 1.4% of gross loans, which is probably around average (give or take) versus the wider bank universe and covers current NPAs several times over.

The bank’s CET1 ratio came in at a typically fat 17.7% in the third quarter. That will probably elicit groans from a few readers, but the bank is what it is – flush with cash and absurdly well capitalized. I would like to see more on the capital returns front going forward (absent organic growth opportunities), although it has quietly carried on with its share buyback program since it last appeared here, retiring another 1,000 or so shares through the first three quarters of 2021. That’s on top of the circa 1,900 shares retired in 2020, and near enough brings the bank up to its $20m authorization.

Stock Still Looks On The Cheap Side, But That’s Nothing New

Farmers & Merchants Bank of Long Beach stock currently trades around the $8,040 per share mark. While I do think that makes it look somewhat cheap based on a ROTE-driven P/TBV, I’m also wary of treating this like a ‘normal’ bank. Let’s face it, trading out on the “pink sheets” with volume as thin as it is means that kind of situation can persist for some time. The stock’s detractors would also highlight some other things – family ownership, overcapitalization, uninspiring capital returns action and so on – but I tend to disagree with most of these points. What I would say is that the bank is really set up to shine during downturns, and that means stock returns and profitability can look pedestrian in bull markets.

Looking ahead, a lot obviously depends on the SoCal economy, especially in-and-around Long Beach and Orange County. I am also keeping an eye on operating expense growth. More of the same would probably work here longer-term, though, with 6-7% annualized TBV per share growth good for high single-digit total returns overall. It’s clearly not as compelling as it was the last couple of times I covered it, but then again not much is. This remains an exceptionally well-run bank for those that like this sort of thing.

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