THE ODDBALL STOCKS NEWSLETTER

19

The Banking Corner

SFB Bancorp
Ticker: SFBK Last trade: $25
All banking data tables sourced from CompleteBankData.com

Different investors have different thresholds for what constitutes a small bank. Common
Wall Street wisdom is that banks with $1b in assets are small, and any bank with less than
$1b in assets is to be disregarded. Ive heard it said that banks with less than $1b in assets
cant overcome their costs and earn a profit. While regulators might like this to be true it
isnt currently. There are 5,734 banks with less than $1b in assets that are profitable. And
there are 1,800 banks with $100m or less in assets that are profitable; SFB Bancorp is one
of them. There were 6,739 banks in the US at the end of the first quarter.
These numbers are interesting because it shows just how prevalent community banks are.
The majority of the banks in the US have under $1b in assets. There are only 703 banks
with more than $1b in assets and of those 275 are publicly traded. Over 1,000 banks are
publicly traded that have assets under $1b. Considering the markets arbitrary $1b size
threshold it stands to reason that there will be many overlooked opportunities in the
1,000+ banks with less than $1b in assets.
SFB Bancorp is the holding company for a small two branch Tennessee bank, Security
Federal Bank, located in Elizabethton, Tennessee. Elizabethton is a small town with a
population of 14,000 that borders Johnson City (population ~60,000). Elizabethton is part
of the larger Johnson City metro area that in total has a population of 195,000 people.
The bank has $57m in assets and earned $574k in their last fiscal year. They have a book
value of approximately $14m as of the last quarter. I used approximately because the
company doesnt send out quarterly communications. The bank reports its financials
quarterly, which are accessible on CompleteBankData.com, but the parent holding
company only reports twice a year, in December and June. As of the last filing period the
parent holding company had $846k in cash, and $521k in other assets against $4k in
liabilities. The holding companys cash increased by $2k between 2012 and 2013, and
other assets decreased most likely due to depreciation. Given the stability of their cash
and other assets their overall equity value can be extrapolated with their banks Q1
numbers. For the rest of this report the banks underlying numbers will be used, as the
parent holding company has almost no income or expenses outside of the underlying bank
itself.
The bank is attractive for a number of reasons, the first being their discount to tangible
book value. The banks tangible book value is $36.71 per share, against a recent price of
$25. Additionally the bank has no preferred stock outstanding. The bank is profitable and
earned $1.50 last year. Management is also shareholder friendly, theyve repurchased
383,839 shares of stock over the past 16 years. This equates to roughly 50% of their initial
shares outstanding. Management continues to buy back shares when possible, but have
found it difficult to find larger willing sellers anymore. The banks largest shareholders
have all indicated they have no plans on shrinking their positions.

Copyright Red River Research Inc. 2014

THE ODDBALL STOCKS NEWSLETTER 20

The banks largest shareholder is the Peter W Hampton Marital Trust with a 13.5%
ownership stake. Peter Hampton himself owns an additional 6.2% of the company. The
company ESOP owns 8.4% and Black River BancVenture Inc owns 5.5%. There are a
number of other local investors who own close to 5% of the bank, but have not crossed the
reporting threshold.
The bank earned .96% on their assets, and 4.3% on their equity. Earning .96% on assets
puts the bank in the top 1/3 of all banks in the US when ranked by ROA. The difference
between an acceptable ROA and their low ROE indicates that the bank is overcapitalized.
The bank has a 22.45% core capital ratio, a 22% equity to assets ratio and an astonishing
41.96% Tier 1 capital ratio. The FDIC considers a bank to be well capitalized if it has a
4% Tier 1 and an 8% Total Capital ratio. SFB Bancorp exceeds both of those with ease.
In spite of being overcapitalized the bank has a respectable net interest margin (NIM) of
4.27%. A snapshot of the banks operating statistics for the last five quarters is shown
below:
Asset Statistics
Average assets
Average loans
Yield on earning assets
Cost of funding earning assets
Net loans & leases to deposits
Net loans & leases to core deposits
Average earning assets
Earnings Statistics
Return on assets (ROA)
Pre-tax ROA
Return on equity (ROE)
Non-interest income to earning assets
Non-interest expense to earning assets
Retained earnings to average equity
Net interest margin
Net operating income to assets
Cash dividends to net income (YTD)
Efficiency ratio
Capital Statistics
Core capital ratio
Tier 1 risk based capital ratio
Total risk based capital ratio
Average equity
Equity to assets

2014 Q1

2013 Q4

2013 Q3

2013 Q2

2013 Q1

56,617
38,120
4.86%
0.58%
87.47%
95.00%
52,783

56,043
38,585
4.87%
0.62%
87.02%
92.27%
53,272

56,016
38,786
4.97%
0.62%
89.48%
94.94%
53,165

56,144
38,962
5.05%
0.63%
87.34%
92.53%
53,326

56,086
39,325
5.11%
0.64%
88.69%
93.94%
53,274

0.96%
1.37%
4.30%
0.25%
2.92%
4.30%
4.27%
0.96%
0
69.12%

1.11%
1.69%
5.03%
0.32%
2.97%
3.33%
4.26%
1.11%
34
68.03%

0.90%
1.35%
4.08%
0.30%
3.02%
2.62%
4.35%
0.90%
36
68.30%

1.05%
1.58%
4.78%
0.35%
2.90%
4.78%
4.42%
1.05%
0
63.66%

0.86%
1.24%
3.91%
0.35%
3.00%
3.91%
4.47%
0.86%
0
65.22%

22.45%
41.96%
43.22%
12,637
22.27%

22.51%
43.44%
44.70%
12,396
22.35%

22.17%
42.72%
43.98%
12,359
22.29%

22.20%
47.61%
48.88%
12,344
22.18%

21.90%
45.75%
47.02%
12,278
21.89%

SFB Bancorps flaw is their size and their lack of lending. Banks grow and become more
efficient with size. A larger bank is a more profitable bank, not only in nominal terms, but
also in relative terms. Banking is a business of scale. A small banks costs are much higher
in both fixed and relative terms compared to a larger bank. A large bank can spread back
office costs across many branches, whereas a small bank might only have a few branches

Copyright Red River Research Inc. 2014

THE ODDBALL STOCKS NEWSLETTER 21

or even just one branch to spread costs across. For many small banks compensation is an
outsized component of their expenses as well.
SFB Bancorp has done a remarkable job keeping expenses low. The companys efficiency
ratio is 69%, a very low number given the banks size.
Many times the source of value creation for shareholders comes from operational
improvements at a company either by expense reduction or profit creation. SFB Bancorp
would be hard-pressed to cut expenses any significant amount without dramatically
affecting their business. This leaves profit creation as the other lever that the banks
management can work with to increase value.
A bank can increase profits by engaging in more lending, lending at higher rates,
diversifying their lending mix, or entering into new lines of business. Given SFB Bancorps
size its unlikely they could expand into a different product line meaning their most likely
avenue of action is an increase in lending.
The following table shows the banks loan portfolio for the past nine years:
Real Estate Loans
1-4 Family
1-4 Family Construction
Multi-Family Residential
Commercial Owner
Occupied
Other Commercial Nonfarm, Non-residential
All Real Estate Loans
Consumer Loans
Auto
Credit Card
Unsecured
Loans to Individuals
Other Individual
Related Party
Commercial
Commercial & Industrial
Construction & Land
Farm
Farmland
Other Loans
State & Government
Other Construction, Land,
Development
All Other
Total Loans
Allowance for Loan Losses
Net Loans Leases

2013

2012

2011

2010

2009

2008

2007

2006

2005

24,192
937
2,299

25,318
1,079
2,526

27,206
1,203
2,738

29,796
1,184
2,942

31,606
1,333
2,487

31,013
1,197
2,753

31,695
679
3,294

32,287
0
3,796

31,785
0
3,374

4,711
34,172

5,728
37,074

0
39,153

0
40,916

0
43,576

0
43,108

0
43,780

0
44,977

0
40,075

736
0
0
1,554
818
0

642
0
0
1,518
876
0

629
0
0
1,891
1,262
0

0
0
0
1,937
1,937
0

0
0
0
2,456
2,456
0

0
0
0
2,475
2,475
0

0
0
0
2,207
2,207
0

0
0
0
2,448
2,448
0

0
0
0
2,273
2,273
0

2,059
2,970
0
0

1,162
3,502
0
0

2,936
3,465
0
0

3,204
2,505
0
0

3,601
2,735
0
0

3,523
3,358
0
0

3,400
2,673
0
0

2,987
3,842
0
0

4,709
2,717
0
0

2,033
5
37,790
365
37,246

2,423
1
39,755
344
39,172

2,262
11
43,991
408
43,385

1,321
3
46,060
420
45,390

1,402
4
49,637
421
49,216

2,161
6
49,112
407
48,705

1,994
3
49,390
433
48,957

0
0
50,412
451
49,961

0
0
47,057
441
46,606

The majority of the banks lending is for 1-4 family residential loans. These are typical
home loans. Of the banks funds 35% are lent to multi-family residential borrowers,
individual borrowers (auto loans, individual loans), or commercial borrowers.

Copyright Red River Research Inc. 2014

THE ODDBALL STOCKS NEWSLETTER 22

Typically 1-4 family residential borrowers pay the lowest rate of all types of borrowers.
The reason that SFB Bancorp is able to earn an above average interest rate on their
portfolio is because a large percentage of their loan portfolio is lent at higher rates.
The risk with higher yielding loans is that theyre typically riskier for a bank. The banks
non-current loans broken down by category is shown below:
2014 Q1
% Loans Noncurrent: 1-4 family residential

2.54%

% Loans Noncurrent: Multifamily residential

0.00%

% Loans Noncurrent: Home equity loans

20.69%

Percent of loans noncurrent - All other family

2.17%

% Loans Noncurrent: Real estate loans

4.88%

% Loans Noncurrent: Commercial real estate

21.27%

% Loans noncurrent: Commercial and industrial loans

1.17%

% Loans Noncurrent: Construction & land development

3.61%

% Loans Noncurrent: Commercial RE not secured by RE

0.00%

% Loans Noncurrent: Loans to individuals

0.00%

% Loans Noncurrent: Other loans to individuals

0.00%

% Loans Noncurrent: Credit card loans

0.00%

Wholly or partially US Gov. guaranteed noncurrent loans as percent of

noncurrent

0.00%

% Loans Noncurrent: All other loans and leases

0.00%

Noncurrent loans to loans

4.51%

I talked with the banks President, Carmella Price, a few months back and one of the issues
I raised was the profile of their troubled assets. When we talked the only large outstanding
troubled asset was a commercial real estate credit. Price said this credit consists of one
loan to a local homebuilder. The loan is for a strip mall and storage units. The loan was
made right before the recession; the builder built hoping for a recovery and demand for
their buildings never materialized. The builder also did significant business with another
local bank that decided to act quickly and foreclose on the builders partially built homes.
The foreclosures resulted in losses for that bank.
In contrast Price said that SFB Bancorp decided to work with the borrower to re-negotiate
the loan using outside collateral consisting of the builders house, a boat and his cars. The
banks patience has been rewarded. The builder sold four of his seven storefront units and
used the proceeds to repay debt. Price believes that if they bank were to seize the
collateral and units and sell them at an auction today the bank would realize full value on
the loan.
The bank also had a home equity loan go bad in the most recent quarter. Home equity
loans pay at much higher rates when compared to firstmortgage loans, but they are also
much riskier. Its difficult for a bank to collect on a home equity loan because home
equity loans are a second lien after the first mortgage. The bank had $493k in home equity
Copyright Red River Research Inc. 2014

THE ODDBALL STOCKS NEWSLETTER 23

loans in the last quarter, of which 20.69% ($102k) are non-current. The banks loan loss
reserve is $381k, which would easily cover a home equity loan write-down if it were to
occur.
If the bank were able to increase their lending from the current level of $37m to $44m they
could earn an addition ~$450k in interest income. The bank would still be well
capitalized with a capital ratio of over 10%. And funding costs would remain the same;
the bank would simply be turning idle cash and low yielding securities into higher yielding
loans. The majority of the additional $450k in interest income would fall straight to the
bottom line. Using the banks current tax rate this would mean an approximate increase to
earnings in the amount of $300k, a 50% increase. Under this scenario EPS would rise to
$2.41 per share, up from the current $1.50 per share.
The above scenario seems very simple when presented above; its the execution thats
difficult. I discussed with Price the companys loan generation and she said that was the
largest issue they faced. She is helping to generate loan growth, but said that the bank is
battling credit unions that can offer lower rates. My suspicion is that the bank isnt doing
much marketing either. Many banks leave their branch doors open waiting for borrowers
to walk in and ask for money. A bank needs to be aggressive in marketing and generating
loan demand.
The only thing I dont like about this company is their under-utilized assets. The company
is run efficiently for their size, keeps expenses low, keeps asset quality in check, but is
unable to generate new loan demand. The shares sell for 68% of book value. If the bank
were lending and growing assets I dont believe the bank would trade for this sort of
valuation.
The bank recognizes that it needs to increase their lending and net income. The catalyst
for this could be the recent promotion of Price to Bank President. In our conversation
Price recognized what needed to be done and had a plan to accomplish it. The question is
whether the bank can execute on this plan. It remains to be seen if she can be successful,
but if so I think SFB Bancorp is worth at least book value, even with its small size. If the
bank is unable to execute on their plans for loan growth they could be seen as valuable to
a potential acquirer who might have the expertise in growing a loan book.

Copyright Red River Research Inc. 2014

THE ODDBALL STOCKS NEWSLETTER 25

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About The Author

Nate Tobik is the writer and researcher of the Oddball Stocks Newsletter. Nate lives
with his wife and two sons in Pittsburgh, Pennsylvania. He enjoys hunting for unusual
stocks in the dark corners of the market. In addition to writing this newsletter and a free
blog at http://www.oddballstocks.com, he runs http://www.completebankdata.com,
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Copyright Red River Research Inc. 2014