Although very active since my last update on the company in September of 2017, the shares of First Bancshares (FBMS) have been a relatively average performer over that span of time, with a return close to that of regional banks in general and in the middle of a comp group including ServisFirst (SFBS), Renasant (RNST), MidSouth (MSL), and National Commerce (NCOM). While the company has executed on two M&A deals entirely consistent with the growth plan I expected here, operating performance has been a little lumpy.
I continue to believe that First Bancshares offers an above-average level of earnings growth potential, return potential, and risk. Integrating its acquisitions should drive meaningful operating leverage in 2019 and beyond, and loan growth should likewise drive good earnings momentum. With plenty of acquisition opportunities left in its core operating footprint (and/or target footprint), I expect additional M&A in the years to come.
Executing On The Plan
When I wrote about First Bancshares in September, I said that, Im expecting the bank to acquire another $300 million to $500 million in assets over the next 18 months. Between the announced acquisition of Southwest Banc Shares ($398 million in assets) in October and the subsequent December announcement of the acquisition of Sunshine Financial ($194 million), First Bancshares has pretty much done exactly that.
Both of these transactions are being done at reasonable multiples and offer more geographic coverage in areas of interest to First Bancshares adding over $350 million in deposits along Alabamas Gulf Coast and close to $150 million in deposits in Tallahassee, Florida. Both businesses have familiar loan and deposit profiles, and the anticipated cost savings from the deals look reasonable and achievable.
Deals like these make too much sense to me not to do. There is always risk when it comes to acquiring a bank the loan book may not be what you think it is and you may see greater deposit attrition than you expect but the opportunity to expand the core deposit base at a reasonable price and drive back-office synergies (running more revenue through an existing infrastructure) generally makes these deals attractively accretive for the acquirer.
One of the limiting factors to serial M&A is having the capital on hand to pay for the transactions, and here too First Bancshares is acting more or less in line with my prior expectations. I had said that, Capital is a little low, though, so future M&A may require a return to the equity market to raise funds. In conjunction with the Southwest Banc deal, First Bancshares announced a 2 million share offering and earlier this month issued $66 million in subordinated debt. Equity is not a cheap form of capital for banks, and FBMSs new debt is going to cost a little more than 6% on average, but the double-digit internal return prospects from the deals should leave the company comfortably ahead for having done these deals.
Some Operating Turbulence
Although First Bancsharess execution of its M&A plan has been what I expected, the companys operating performance has been a little choppier and a little underwhelming relative to my expectations.
The companys pre-provision operating profits have been a little wobbly relative to my expectations, growing 69% in the third quarter, 85% in the fourth quarter and 38% in the first quarter, but missing expectations in two of those three periods (Q317 and Q118). Expenses have been fine, but revenue has been a little soft, and particularly at the net interest income line.
In both Q3 and Q1 net interest margin was a little softer than expected, though there was some loan yield improvement in the first quarter. Like many banks, First Bancshares is starting to see its deposit beta head higher, with the beta moving from 12% in Q317 to 19% in the first quarter a level that is still pretty good overall, but still represents rising deposit costs. Purchase accretion will help the reported spreads, but First Bancshares remains vulnerable to higher funding costs.
Loan growth has also been okay-but-not-great. Management expects loan growth to improve as 2018 continues on (a familiar theme in the banking sector at all market cap tiers), and I would note that the nearly 3% qoq organic growth in lending annualizes out to a pretty nice figure. First Bancshares has plenty of deposits to cover lending growth (a loan/deposit ratio around 76%) and the companys CRE lending portfolio is still comfortably below the 300% threshold (at around 217%).
I am a little concerned, though, about the construction loan portfolio at over 80% of capital, theres a little less room here and the 14% portfolio allocation is fairly high compared to your average bank. C&D lending is a complicated thing to evaluate. A lot of banks have done well lending in this category, but when the economy/real estate markets turn south, C&D lending loss rates are typically much higher than other kinds of loans. At this point Id call this a yellow flag, and Id like to see growth in other categories outpace this one in the coming quarters.
The Opportunity
I fully expect First Bancshares to do more M&A, and the company may well announce another deal before year-end. I could see the company looking to build a bigger presence in Mississippi (perhaps in the Jackson MSA) and Louisiana, as well as Floridas panhandle/Gulf Coast. While I do believe M&A is a good use of capital at this point for First Bancshares, I also want to see that the company is sticking to its knitting Id like to see better performance with spreads and pre-provision profits.
I still expect strong double-digit earnings growth from First Bancshares over the next decade, with high teens growth over the next five years. Using three different approaches (discounted earnings, ROTE-driven P/TBV, and P/E), I believe the shares can still generate a double-digit annualized return for shareholders.
The Bottom Line
First Bancshares is by no means a suitable idea for all investors. Management is executing on an aggressive growth plan and the companys regional concentration is likewise a risk. While the Gulf Coast of Alabama, Mississippi, and Florida is an increasingly popular retirement destination, and various companies/industries are back-filling the economy in areas like Jackson, there are still risks related to weather, specific industries (like energy), and just simple regional variability. Likewise, growth-by-acquisition strategies carry their own risks its easy to point to the successes, but not as many people remember the failures. In any case, while I dont think First Bancshares is the right stock for everyone, I believe its still worth consideration from investors who want a more aggressive growth story in small-cap banking.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
