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Over the last few weeks we have been pretty strong recommending our members start buying financials. More specifically, we really are encouraging buying regional banks here and on any further weakness. This is because we believe they are well-positioned for growth over the next few years in a world of rising interest rates. The reasons are numerous but their easy-to-understand balance sheets and operations make it simple even for novice investors to understand their operations, strengths, and weaknesses. The simpler balance sheets means these banks tend to benefit strongly from traditional banking, that is, taking in deposits, paying a small amount of interest, and then lending those deposits out to other customers at higher rates. We have covered a number of regional banks, and today, after hours, FNCB Bancorp (NASDAQ:FNCB), which is a bit of an under-the-radar regional bank, just reported its Q3 earnings. This is a bank doing business with consumers and businesses is Northeastern Pennsylvania, and has room to grow. We think that the bank, and subsequently the stock, are setup to do very well in 2023 and 2024 as rates will be much higher on the loans they make. This bank is operationally healthy and just bumped its dividend yet again, now paying $0.09 per quarter. There is a nice history of growth. So, you are paid to wait. In fact, you are earning a solid 4.7% dividend yield to wait. We think this is a fine bank as indicated by the critical metrics. We see the stock as a buy in the $7 range because the return metrics are solid, loans and deposits are growing, the valuation is rather attractive, and asset quality is improving.
Q3 2022 performance strong
The headline numbers were relatively strong in the just reported quarter. There was growth on both the top line but the bottom line dipped from last year. FNCB Bancorp reported out a top line that grew 10.3% to $16.08 million. The strong increase in revenues year-over-year was unfortunately offset by a high degree of noninterest expenses as well as an increase in loan loss provisions. There was however some strong net interest income. Overall, FNCB reported net income of $5.4 million for the quarter compared to net income of $6.4 million for the quarter a year ago, falling 15.6%. On a per share basis, this was $0.28 this quarter, down from $0.31 last year. While there was higher noninterest expenses and loan loss provisions, there was strong growth in loans and deposits.
Both loans and deposits grew this year
Loans are up from the start of the year and from a year ago. Growth in loans and deposits is key for any bank to see growth. Total assets are $1.705 billion which rose from $1.664 billion to start the year. Total loans were up 13.5% from the start of the year, and now total $1.097 billion. Despite the rising rate environment loan demand for residential mortgage products remained strong but there was very large demand in the commercial sector for equipment loans as well. The bank is seeing benefits too from its late Q3 acquisition of Chiaro Investment Services, LLC which combined with FNCB’s Wealth Management team has become 1st Investment Services. This should boost non-interest income longer-term.
On top of this merger and the new loan activity, there was an increase in total deposits. Total deposits came in at $1.503 billion at quarter end, up 3.3% from the start of the year. This comes despite a very competitive landscape for deposits as generally speaking the cost of funds is rising as banks try to pay better rates. But with higher rates on new loans, margins expanded and this bodes well for future quarter earnings as well.
Margins have yet to start widening meaningfully but will
So the cost of funds was up 36 basis points to 0.59% compared to last year’s 0.23% as a result of higher rates. But net interest margin only widened 1 basis point from Q2 to 3.43%. While new loans are going out at a higher rate, the impact was offset by the higher costs of funds. We predict margins will widen more meaningfully in coming quarters. As a result, we saw that net interest income rose slightly. Interest income increased by $1.3 million for Q3 2023 or 9.8% versus last year.
Return metrics here are mixed
So, one critical area to watch is the return metrics for a bank. It is critical to know whether the return metrics, specifically return on average assets and return on average equity, are improving. These are key measures of efficiency. Well, the return on average assets actually contract to 1.26% from 1.58% a year ago, while the return on average equity expanded to 16.95% from 15.61%. Further, the bank became less efficient, with the efficiency ratio actually rising heavily to 54.88% from 51.32% a year ago. What about asset quality?
Asset quality has improved
You should also be aware of the quality of assets. We saw mostly strong trends in asset quality metrics here and expect this will continue as rates rise further and new loans are made. The provision for loan losses was $0.513 million versus a credit a year ago. Nonperforming loans decreased by $1.7 million, or 27.9%, to $4.7 million representing 0.25% of total loans, a big improvement from 0.47% of all loans a year ago. Finally, the allowance for loan losses was $13.8 million, which was 1.24% of total loans, versus 1.27% of all loans a year ago. We expect continued improvement here, and like the that these quality metrics were trending in the right direction.
Valuation metrics
We also like the valuation of FNCB despite mixed performance in the quarter. With a share price of $7.63 at the time of this writing, we have a stock trading at 7.3X trailing twelve-month earnings, which is attractive on its own. What about on a forward basis? We are going to assume (rather conservatively) that earnings will grow 10% in 2023 over 2022 so that would suggest a sub 7X FWD EPS.
The stock is also pretty attractive relative to book value. Most banks are trading well above their book values now, and FNCB Bancorp does too, but the price-to-book is not egregious. FNCB is attractive trading at 1.3X book value. Both book and tangible book value are 5.67. This is not overpriced in anyway, particularly for a dividend growth stock that has some potential for capital appreciation.
Take home
This was a mixed quarter. We thought it would be better to be honest, but the rising cost of funds from more deposits weighed some, however new loans are being issued at better rates and we expect margin improvement in the coming quarters. Asset quality has improved, and the stock is offering a 4.7% dividend yield to wait for shares to appreciate.
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