FMBL - Farmers and Merchants Bank of Long Beach

[ScottHall]

It is largely a business bank based in Long Beach, CA, managed by the controlling Walker family who started the bank over 100 years ago. The bank is run very conservatively, and has capital ratios at something like double the regulatory minimum. Because of this and their very strict lending policy, they like to call themselves "California's Strongest Bank." It's a plain vanilla deposit/lending institution; no crazy derivatives or anything of the like.

 

The lending policy is pretty interesting, by itself. So, as a community business bank, most of its loans are for commercial real estate. But its take to lending is quite odd. FMBL basically refuses to lend purely on the basis of cash flows; in a profile written about the company a few years ago in the LA TImes, it was pointed out that unless you've been a good customer of the bank for a long time, they won't loan you more than 50% of a commercial real estate property's worth. This is the majority of their loan book.

 

There's some residential real estate in there too, but apparently FMBL primarily has this business line to help some of their better customers who don't want to deal with another financial institution. As a result of this, this is a pretty small percentage of the loan portfolio and they typically do a 65% LTV on this business. So, very safe lending, generally. The bank had no provisions for loan losses last year; of the 3,000 loans on its books, only 6 were 30+ days delinquent.

 

But probably the most interesting thing about this bank is its base of deposits. 38% - 39% of them are non-interest bearing, and this seems to be pretty consistent through the years. My understanding is that this has to do with its status primarily as a business bank; I was reading that in many cases business checking accounts pay nothing. I don't know why this is, but it apparently is. I believe this is also a big reason for WFC's low cost deposit base, but it should be noted that WFC has a lower percentage of non-interest bearing deposits than FMBL does. FMBL is the highest I've personally seen, though there are probably companies with a higher percentage that I've missed.

 

So, as you can imagine, the low interest rate environment has killed profitability. As interest rates have gone down, the bank's net interest margin has compressed from the mid-to-high 4% range to about 3.5% today.

 

That means, over the past few years, profits haven't grown that much. Ordinarily profits would decline, all else being equal, but the bank has done a great job at gathering assets. Both loans and deposits have grown at about a 7% annual rate since 2008, which has helped keep profitability consistent despite the lower margins. In my view, this is essentially a coiled spring. When (if?) interest rates move higher, this company's earnings power should explode.

 

I did some back-of-the-napkin math and figured that with a 100 basis point increase in NIM, the company's 2014 earnings would rise by 61% to $767 per share, or so. It probably wouldn't be quite that much, because I imagine the bank would give employees raises or something, but needless to say a rather small rise in interest rates would end up increasing the bank's earnings power substantially as it redeployed its cash. In the meantime, you have a bank that is growing deposits like clockwork.

 

The one thing that concerns me a bit is the increase in the efficiency ratio over the past few years; it was in the 30s in 2010, and has risen to about 57% today. That's still perfectly reasonable for a bank, but the primary driver behind that was an increase in employee salary and benefits. I don't know if it's to handle the larger asset base/for expansion, whether they're just sharing prosperity with the employees, or whether the founding family decided to give themselves an "extra" dividend. Sort of odd but not a deal breaker to me.

 

Shares trade at a little over 12x earnings and at about 95% of book value. ROE hovers at around 8% because the bank is extremely overcapitalized, but in theory the bank could take half of the equity out and dividend it to shareholders. It would have a very high ROE, then. Not likely to happen, given the bank's history with dissident heirs, but it "could." The more interest thing is that the business keeps gathering assets, and should probably grow earnings roughly in line with that from here, all else being equal. If interest rates go up, ROE will skyrocket and today's prices will reflect a single digit ratio of normalized earnings.

 

Here are some articles about the bank. This is definitely a "sleep well" investment, which should provide decent returns without an interest rate spike and pretty attractive returns with one. I bought a stake recently.

 

http://articles.latimes.com/2008/mar/30/business/fi-sunprofile30

 

http://www.latimes.com/business/la-fi-stock-spotlight-farmers-20140811-story.html

 

http://articles.latimes.com/2004/mar/18/business/fi-bank18

[thepupil]

are you posting this because you bought my share yesterday?  ;D

[ScottHall]

are you posting this because you bought my share yesterday?  ;D

 

What made you sell? My cost basis is $6,199, so I bought a few days before that. :)

[thepupil]

nothing specific to FMBL...building an outsized position something else...try to keep all OTC 100% margin stuff in the unlevered IRA's and it was in taxable...will probably buy it back later

[Spekulatius]

I have owned this for years. Earnings have grown quite a bit recently, as has the asset base. I think the increased cost are basically a result of them building out the asset base. The lower interest rates have reduced their profitability ratios but overall profits still have increased. I agree that higher interest rates would do them good.

 

I also own QUCT, another Walker company. I think it was spun of from FMBL as their asset management business in the 70's, but they own other interesting stuff. All the Companies run by the Walker family are ridiculously overcapitalized.

 

 

[Simple Investor]

I'v owned for years.  I may hold it for decades.  I'm not sure if it will outperform the S&P over a long time frame but i don't worry about the investment.  Thanks for the write up.

 

Risk - Major earthquake?  Cali falls into the ocean.  haha

[EricSchleien]

I have owned this for years. Earnings have grown quite a bit recently, as has the asset base. I think the increased cost are basically a result of them building out the asset base. The lower interest rates have reduced their profitability ratios but overall profits still have increased. I agree that higher interest rates would do them good.

 

I also own QUCT, another Walker company. I think it was spun of from FMBL as their asset management business in the 70's, but they own other interesting stuff. All the Companies run by the Walker family are ridiculously overcapitalized.

 

Speaking of QUCT - I did a podcast episode on this company recently with our very own Spekulatius. You can listen to the episode, here: https://intelligentinvesting.podbean.com/e/queen-city-investments-quct/

[John Hjorth]

Og, who are you, posting here on CoBF? Are you the provider & interviewer on this podcast? [Please leave Spekulatius out of this question.]

[thepupil]

since beginning of thread, this has returned about 7.6% / year, grown its BVPS from $6500-->$8300, grown its BVPS dividend by about the same high single digits per annum. Deposits/loans/earnings have all grown nicely despite rates not really going up, 2015 EPS: $496, LTM EPS: $681, though a lot of that is tax reform

 

It's about 15% off peak. I think the relative value of something safe and stodgy like this has improved today. For context the S&P 500 is up 13.6% / year and the Russell 3000 Growth has returned 15.6% / year over the same time frame. Meanwhile this still trades for 1.1x tangible book and 11.5x earnings and is still the "safest bank in california".

 

This is a good rate hedge as well.

[thepupil]

https://seekingalpha.com/article/4313360-farmers-merchants-bank-of-long-beach-is-significantly-undervalued

 

Summary

FMBL is a top-tier bank within its peer group, yet its price to tangible book multiple is the lowest.

 

Unlike its peers, FMBL has demonstrated its ability to generate consistent profitability and steady ROA over a full economic cycle.

 

At less than 1x tangible book value, FMBL is worth significantly more and offers limited downside.

 

Editor's note: Seeking Alpha is proud to welcome Maverick Value, LLC as a new contributor. It's easy to become a Seeking Alpha contributor and earn money for your best investment ideas. Active contributors also get free access to SA PREMIUM. Click here to find out more »

 

Editor's note: Seeking Alpha is proud to welcome Maverick Value, LLC as a new contributor. It's easy to become a Seeking Alpha contributor and earn money for your best investment ideas. Active contributors also get free access to SA PREMIUM. Click here to find out more »

 

Editor's note: Seeking Alpha is proud to welcome Maverick Value, LLC as a new contributor. It's easy to become a Seeking Alpha contributor and earn money for your best investment ideas. Active contributors also get free access to SA PREMIUM. Click here to find out more »

 

A High Quality Bank

If I were to tell you the following about a community bank, what price to tangible book valuation multiple would you assign it?

 

Has the 2nd lowest cost of funds

Generated return on assets (ROA) that was:

2nd best among peers from 2008-2018, encompassing both bear and bull markets

Best during the depths of the banking crisis from 2008-2011

Middle of its peer group during the last 12 months ending 9/30/2019

Consistently profitable over a full cycle and specifically outperforms during downturns

Best capitalized and with the highest quality loan book

Grows its business organically instead of relying on acquisitions and share issuances

Low volatility stock price

Low Cost of Funds

In banking, the real differentiator between the good and the bad banks is the liability side of their balance sheet rather than the asset side. The banks with the lowest cost of funds are at a competitive advantage for a number of reasons: First, these banks have loyal customers who aren’t shopping around for the highest interest rate on their deposits. In addition to providing the bank with a cheap source of funds, these deposits are stable and therefore long-term in nature. Finally, banks with low funding costs are able to fund their loans more cheaply and therefore earn a greater profit. There’s no magic formula to earning more on your assets as a bank. You either take on greater credit risk (Risk that the borrower won’t make their payments) or duration risk (Maturing at a later date). This is why the main differentiator is the cost of funds. Here’s how FMBL stacks up:

 

 

 

Source: Maverick Value, LLC

 

FMBL’s cost of funds is 0.49% vs. its peer median of 1.40%. That’s nearly 1/3 the rate of its peers and a difference of 0.91%!

 

Considering that the average 30-year fixed rate mortgage is only 3.76%, this is a significant advantage for FMBL. A lower cost of funds generally leads to a higher P/TBV multiple, with a correlation of -76%. The only other bank with a lower cost of funds than FMBL is CVB Financial (CVBF) and it trades at the highest P/TBV multiple of 2.5x.

 

Consistent Profitability and Steady ROA

A common metric many investors use to assess the quality and efficiency of a bank is its return on assets or ROA. This is calculated as the bank’s net income divided by its average assets. A bank with a higher ROA demonstrates that is more profitable relative to its asset level versus another bank. Because banks can earn more income on their assets by taking on greater credit risk, this ratio is not perfect. However, it is still a decent way to tell the good banks from the not so good ones. Here’s how FMBL performed over the last 12 months:

 

Source: Maverick Value, LLC

 

For the last 12 months ending 9/30/2019, FMBL has performed just above its peer median. However, this is just the last 12 months and does not show how a bank performed over a full economic cycle, especially during the industry trough. Here’s how FMBL and its peers have performed from 2008 - 2018 and during the industry downturn from 2008 – 2011:

 

Source: Maverick Value, LLC

 

FMBL’s ROA over the long term, from 2008-2018, was 2nd best

 

 

 

Source: Maverick Value, LLC

 

FMBL maintained the highest ROA during the Great Recession, which was significantly above the peer median….And this is compared to the banks that actually survived!

 

These charts illustrate that FMBL’s ROA and overall profitability has been consistent over the years, unlike its competitors. Its ROA over the last 12 months is not much different from its 2008-2018 average or its 2008-2011 average. This just goes to show you that Farmers and Merchants is a strong performer during the good times AND during the bad times. Most of its competitors, the ones that actually made it through the Great Recession, performed well when the economy was good, only to later crash when the economy crashed.

 

 

 

Source: Maverick Value, LLC

 

ROA has a 76% correlation with P/TBV multiples. The higher the ROA, the higher the valuation multiple

 

The top 4 banks ranked by ROA have the highest 4 valuation multiples, while the bottom 5 banks ranked by ROA sport the 5 lowest P/TBV multiples. It therefore seems reasonable to conclude that the higher the ROA, the higher the P/TBV multiple.

 

The Safest Bank

Companies that are safer are generally valued at a higher multiple relative to their riskier peers. As risk increases, investors demand a higher return (lower valuation multiple), to compensate them for the greater uncertainty. In no other industry is safety more important than in banking. During the Great Recession it was the banks’ low capital ratios that led to their failure. Those with the highest capital ratios survived. Many banks had tangible equity (tangible book value) to tangible asset ratios of 5% or less. This meant that a decline in the value of their assets of only 5% wiped out their entire equity. Today the banking system is much better capitalized and here is how FMBL stacks up:

 

 

 

Source: Maverick Value, LLC

 

FMBL, by far, is the best capitalized!

 

Another way to assess a bank’s safety is to compare the percentage of loans that are noncurrent to its total loans as well as to look at how much the bank has reserved for potential loan losses. Noncurrent loans are those where the borrower is 90 days or more delinquent on their scheduled interest or principal payments.

 

 

 

Source: Maverick Value, LLC

 

 

 

 

Source: Maverick Value, LLC

 

FMBL’s loans are performing the best AND….it has accrued the most reserves to cover these loans!

 

Noncurrent loans as a percentage of total loans has a negative 73% correlation with P/TBV multiples and allowance for loan losses as a percentage of noncurrent loans has an 84% correlation with P/TBV multiples. This makes sense since it indicates a bank’s accounting is conservative and there is a lower likelihood of negative earnings surprises from problem loans in the future.

 

What Valuation Multiple Does FMBL Deserve?

Taking a high-level view of the data I’ve presented there are a few takeaways:

 

FMBL’s and CVB Financial’s (CVBF) metrics consistently ranked best or 2nd best

On only one metric did FMBL not rank in the top 2. It ranked 5th on LTM ROA

Banc of California’s (BANC) and Hanmi Financial’s (HAFC) metrics consistently ranked near the bottom

These metrics are highly correlated with P/TBV multiples

Here’s how FMBL’s peers are valued:

 

 

 

*Source: SEC filings

 

It is no wonder that the top performing bank, CVBF, has the highest valuation multiple, while the bottom performing banks, BANC and HAFC, have the lowest valuation multiples!

 

So FMBL is likely valued somewhere between 1.52x to 1.95x?

 

 

 

Source: Maverick Value, LLC

 

Wrong! FMBL’s Valuation Multiple is DEAD LAST!

 

To emphasize how absurd this is, here’s how the bottom 5 banks look:

 

 

 

Source: Maverick Value, LLC

 

Each of FMBL’s metrics is by far better than any one of these banks, yet they trade at a P/TBV multiple that is 36% higher than FMBL!

 

What is FMBL Worth?

FMBL’s share price today is $7,850 per share and its tangible book value per share is $8,311. Here’s how much it should be worth:

 

 

 

Source: Maverick Value, LLC

 

FMBL is a top tier bank and is worth $16,166 / share or 106% higher than where it trades today!

 

Possible Reasons for FMBL’s Undervaluation

There are a few reasons why FMBL is undervalued, most of which have nothing to do with the fundamentals of the actual business:

 

Not covered by Wall Street research analysts

Trades on the OTC Market instead of on a major exchange, such as the NASDAQ

Low liquidity, especially for day trading. Each share costs nearly $8,000

Family controlled

Overcapitalized

Just because FMBL lacks Wall Street coverage and doesn’t trade on a major stock exchange doesn’t mean the business is worth less than a well-covered, NASDAQ-trading bank. In fact, this allows it to go under the radar and not be bid up. Throughout history, the best investment opportunities seem to be the ones where others were not looking.

 

One of the biggest reasons for FMBL’s undervaluation is that it is misunderstood and not appreciated by investors for being defensively positioned and almost countercyclical. While its high capital ratios reduce its return on equity (ROE), they also act as a buffer during economic declines. This positions the bank to take advantage of opportunities when other banks are pulling back from lending and allows it to shine in good times and in bad times. This is especially clear from its performance, during the 2008-2011 market downturn. In 2008 alone, FMBL grew its loans by 27 percent and its deposits by 33 percent! It did this also while repurchasing 14 percent of its shares outstanding. I don’t think you need to be reminded how Southern California banks performed in 2008.

 

None of FMBL’s peers were able to perform so well. Certainly not organically and certainly not also having the capital to repurchase shares too. With fears that we are late in the economic cycle and talk about a recession around the corner, shouldn’t FMBL be the bank to own? If the banking industry pulls back on lending because of elevated loan losses and other factors, FMBL would only benefit as it would have the capacity to lend on attractive terms and develop and/or expand relationships on the lending and the deposit side at the expense of its competitors. Shouldn’t such a bank trade at a premium multiple to its peers, or at least trade in line with its peers, NOT dead last in its peer group?

 

Conclusion

To conclude, Maverick Value owns shares of FMBL because:

 

FMBL is a top tier Southern California bank

Top tier banks trade at 1.9x TBV

FMBL trades at a multiple that is not only bottom tier, but last among its peers

Even if FMBL traded at a median multiple it would still be worth 61% more

All its metrics are better than even the median valued bank

Under the radar due to lack of Wall Street coverage.... Potential opportunity?

FMBL should trade at 1.9x TBV, or 106% higher than where it trades today!

Disclosure: I am/we are long

[Foreign Tuffett]

Weighted-average diluted shares outstanding:

 

2018         Q1 2019 Q2 2019 Q3 2019

130,928 130,681 129,936 132,370

 

They started repurchasing shares in Q1, but the diluted sharecount is higher than it was at YE 2018.

 

Did they start using stock-based comp again, or am I missing something here?

[mjm]

they claim per website that actual # shares 9/19 is 128,528.  http://www.snl.com/IRW/FinancialHighlights/1014752?keyReport=-58

[Foreign Tuffett]

they claim per website that actual # shares 9/19 is 128,528.  http://www.snl.com/IRW/FinancialHighlights/1014752?keyReport=-58

 

That is basic shares outstanding, I am referring specifically to diluted.

[thepupil]

I would just like to take this opportunity to note that covid can't stop the safest bank in California from paying that Christmas dividend!

 

In these uncertain times, it's good to know that some things truly are sacred.

 

I will try not to spend my $84 (divvy for 2 shares) in one place.

 

everyone else out there still using this company's results as an effective sleep aid?

 

 

 

 

Press Release: Farmers & Merchants Bank of Long Beach Declares Fourth Quarter Cash Dividend of $27 Per Share, Declares Special Christmas Dividend of $15 Per Share

 

Farmers & Merchants Bank of Long Beach Declares Fourth Quarter Cash Dividend of $27 Per Share, Declares Special Christmas Dividend of $15 Per Share

 

--Declaration Represents 510(th) Dividend Payment to Shareholders Since 1916-- LONG BEACH, Calif.--(BUSINESS WIRE)--November 16, 2020--

Farmers & Merchants Bank of Long Beach today announced that its board of directors has declared regular quarterly cash dividend of $27 per share and a special Christmas dividend of $15 per share on the Bank's common stock.

Both the quarterly and special dividends are payable on December 15, 2020 to shareholders of record as of November 30, 2020. The declaration represents F&M's 510th dividend payment, including special dividends. F&M has paid a dividend each year to shareholders since 1916, and the value of F&M's quarterly dividend has never decreased.

 

[Ulrich]

Company is at 74% Book. Check

Very safe , strong capital buffer. Check

Good geographic area. They re operating in one of the richest neigbourhoods worldwide. Check

 

And they are buying back stock at these valuations. check

 

I think this stock has an easy upside of 40 percent + x.

 

This stock is an long term no brainer and very, very safe.

[kab60]

Value looks pretty fair to me... Sub 10 pct. ROE even before covid equals sub 1xTBV fair value? I don't disagree that this could easily rerate, like a ton of other financials, and it looks relatively safe (for a bank) yadayada, but what do you expect to gain longer term?

[thepupil]

I expect to make a 7-8%/ year  return from owning this with very low risk of permanent impairment of capital. I think stocks like this have a role in a portfolio. The ROE is only sub 10% because it’s so excessively capitalized; it will very likely remain so. It’s a stay rich stock rather than a get rich stock.

[Ulrich]

I bought NWLI and ANAT too. (the mindset is the same)

 

Farmers is a bank, the other two are mostly life insurance companies. All three are overcapitalized. Like thepupil said, the low profitability comes from the crazy high capital ratios.

 

Farmers and Merchant seems do know of the discount. They buy back stock. Because of the low trading volume these buybacks are limited. But it makes the downside very limited too :)

 

I bought ANAT at 70 Dollars not long ago and NWLI at 190. I think these stocks have a very good risk/reward in times of such heavy discounts to tangible book. Even a rerating to something like 60Percent tangible book value is a double. Plus these companies add tangible book value and are profitable year after year.

[thepupil]

http://www.snl.com/IRW/file/1014752/Index?KeyFile=406672743

 

Results out. They're really growing. I need to do a little more work to decide if that's a good thing.

 

EDIT: from what I can gather, I think it's the PPP loans on their balance sheet, their huge loan growth is in C&I and it appears there are bills to let community banks not count those in assets, but I can't find whether or not that passed. this gives me more comfort that they're not going too crazy with the lending.

 

EDIT 2: I'm 99% sure its PPP. the biggest jump was in Q2 in C&I. their call reports differ from the annual, but call reports said C&I went from $50mm-->$500mm+. And their 2019 annual letter said they processed $700mm of PPP loans, all this jives and leads me to conclude that the loan growth isn't as scary as it seems.