With interest rates rising, basic loan growth strong and credit quality still holding up well, these are not the worst times for the income statements of small, asset-sensitive banks like Farmers & Merchants Bancorp (OTCQX: FMCB) (“F&M”). Equity returns have been a bit more pedestrian, though I guess not too bad compared to broader stock returns this year, with F&M holding roughly so far in 2022.
F&M doesn’t provide a detailed breakdown of its interest rate sensitivity like most other banks, but between the nature of its deposit base, loan mix, and past performance, it was a fair bet to assume it would get a good deal. recent rate increase. walks. Indeed, that is showing up on the income statement, with the bank racking up record levels of net income both in the third quarter and so far this year.
Talk of a recession has obviously gotten louder in recent quarters, although a domestic recession might not be as certain as it seems. F&M’s agricultural bent probably puts it on a slightly different economic plane in any case, while credit quality has also always been a standout feature of the bank.
With that, I stand by a ‘buy’ rating on this one. These stocks don’t look particularly cheap on a P/TBV basis, though I’ll reiterate from my last article that there are some mitigating features here that warrant a higher valuation.
A higher interest rate winner
A strong central deposit franchise (about 36.5% of its $4.9 billion deposit base is non-interest bearing) and a mix of loans (about 45% adjustable rate) meant there was a good chance F&M would be one. of the best placed banks in an environment of rising interest rates, and the financial results published to date support this. Net interest income for the nine months ended September 30 was $137.4 million, up 15% from $119.7 million in the same period last year, while third quarter NII was $50.5 million, an increase of more than 28% year over year and just under 13% versus Q2.
Looking under the hood, NII’s growth was a function of an increase in interest-earning assets (up 11% year-over-year and 0.8% sequentially to $5.1 billion), while the bank was also able to take advantage of its strong core deposit franchise to produce higher margins. F&M’s funding rate was only 0.1% in the third quarter, 1 bp more than in the same period of the previous year and 2 bp more sequentially, while the yield obtained on its investment securities (1. 96%) and loans and leases (5.06%) increased 20 bps and 39 bps in the previous year. -in-year respectively. The net interest margin was 3.95% in the third quarter, compared to 3.26% in the same period of the previous year and 3.53% in the second quarter.
This helped offset lower non-interest income (where the bank posted a $3 million loss on the sale of a portion of its investment securities) and higher operating expenses, which increased 18% year-over-year to $24.4 millions. Pre-provision operating profit was $27.6 million, up 18% year over year and 10% sequentially. EPS was $25.20, up 14% year over year and 7% sequentially, while tangible book value per share (“TBVPS”) came in at just over $590 at the end of the third quarter, up more than 5% year-over-year and 2.3% sequentially.
Loan growth has been strong year-to-date, with core loans (ie excluding PPP balances) up 4.5% year-to-date and 9.5% year-over-year. I expect this to moderate somewhat going forward due to a cooling economy, although higher rates will continue to be a driver for earnings through higher net interest margins.
Credit quality is perhaps a more interesting topic. F&M obviously has a track record of running a very tight ship – you can’t be a Dividend King as a bank without a strong long-term track record in lending practices, so it will be interesting to see how it performs through this cycle. . . The bank’s Central Valley base in and around Lodi and Modesto is obviously quite skewed toward agriculture, and that perhaps puts it on a slightly different economic footing than its peers.
That said, agricultural loans have fallen somewhat as a proportion of the total loan portfolio since the last financial crisis (around 29% today vs. over 35% in 2009), and it will be interesting to see if the bank’s expansion to the East The Bay Area opens you up to the technological recession that is currently taking place. I’m not too worried: provisioning is strong (loan loss provision is about 2% of total loans) as is its capital position, though it may be something to watch in the coming quarters.
Stocks Still Worth Looking For Long-Term Accounts
F&M shares are currently trading at around $975 per share, which puts them at around 1.65x TBVPS and largely unchanged from my first article covering the bank in April.
That doesn’t look particularly cheap given F&M’s profitability profile, although I will reiterate the point I made last time that particular attention should be paid to the bank’s strong performance over the cycle. F&M has posted a low average teen return on equity for the past fifteen years, a period that incorporates the last major economic downturn, while increasing the TBVPS at a CAGR of around 9% over the same period. These stocks are not really suitable for short-term trading due to their low volume on the pink sheets, but for long-term accounts they are still a fair value. To buy.