Update to SFB Bancorp, Inc. $SFBK

We first mentioned SFBK a year ago [1,2] at $23, when it was at a huge discount to its book value then of ~$37. The stock has come a long way and is now $32.50 x $32.95.

Thought an update post would be in order. The end of 2014 book value was $14,151,000 which was $38.73 per share. They bought back $394,000 of stock in 2014 (average price of $22.16) and paid $148,000 of dividends (20 cents per share). So, adding those numbers back to book value for the purpose of calculating return on equity for the year, we see that ROE for 2014 was 5.8%.

The company paid a 25 cent dividend in June 2015 and is apparently planning to pay a 25 cent dividend tomorrow, for a total of 50 cents returned to shareholders in 2015. (Not known whether they have repurchased any shares in 2015.)

Here's an estimate, based on 2014 year end data and interim call reports, of current (or year-end 2015) book value per share:

Subsidiary equity, 12/31/2014 (call report)	13,195
Net income Q1-Q3 (call report)	517
Q4 net income (estimate; average Q1-Q3)	172
Subsidiary equity, 12/31/15 (estimate)	13,884
Holding company cash, 12/31/14 (annual report)	371
Holding company other assets, 12/31/14 (annual report)	585
Dividends paid 2015 ($0.50*365,383)	-183
Holding company equity, 12/31/15 (estimate)	773.3
Total equity, sub & holdco, 12/31/15 (estimate)	14,658
Equity per share, 12/31/15 (estimate)	$40.12

If these estimates are correct, the stock is currently offered at 82% of book value. Management continues to invest in 5-15 year fixed income securities rather than buy back stock at a discount. As much as I dislike The Outsiders by William Thorndike, share buybacks can create value in many circumstances, and this is one of them. How can you buy a five year note at a 1.7% yield when buying your own stock "returns" 22% instantly, with no interest rate risk?

As every bank investor knows, the banking industry is consolidating. People are not founding new banks, and small ones are merging in order to gain economies of scale. Just follow Phil Timyan on Twitter to see a constant stream of merger and acquisition announcements.

And to give one example, there is TriSummit Bancorp, Inc. in Kingsport, TN that is 33 miles away from SFB Bancorp headquarters in Elizabethton, TN. Last year TriSummit acquired Community National Bank of the Lakeway Area, so you know that even in east Tennessee, bankers are in an acquisitive mood.

WSJ: "The Demise of the Small American Bank"

Today's WSJ:

"[D]odd-Frank, a law intended to take on the systemic risk of 'too-big-to-fail' banks, is multiplying the problem. 'The big banks that are too big to fail are bigger now than ever, but the regulations have trickled down to the smaller banks that didn’t cause the financial crisis' Mr. Hill says. As a result, community banks are disappearing. 'When I started my first bank in the 1970s there were 24,000 banks in America,' he says. 'There are now 7,000 banks. It may soon be 500 or even fewer.' [...]

He laments that the Community Reinvestment Act, a catalyst of the 2008 subprime mortgage crisis, still hasn’t been repealed. 'We are literally required to make loans that we know are going to fail.'"

A correspondent writes, "It's driven in part by politics and regulation and in part due to technological change and market competition. I say the latter only because different tech platforms are allowing traditional roles of banks to be decentralized across time and space (payment platforms, loan intermediation, escrowing, etc)."

Note that this is actually bullish for cheap small banks: those trading below the value they would receive in a merger, and especially those trading below book value.

"Why Your Bank Is Going To Be Worth A Lot of Money"

Article:

"The new bank application department at the FDIC was a little slow in 2014. Before the recession, it was common for the FDIC to get 250 applications per year and approve 159 of those. In 2014, only Primary Bank (in organization) filed an application (still pending). Part of the issue is that if you are crazy enough to want to start a bank you are probably too dysfunctional to handle the management of a bank. Given average ROE below the cost of capital, tight margins, low interest rates, tough competition and too many banks, it is no wonder why more bankers have not applied."

SFB Bancorp, Inc. Call Report For Q2 2014 $SFBK

Wrote about SFBK in July - a small community bank in eastern Tennessee. At the current market price of $23, that is a market capitalization of $8.8 million. At year end 2013, the book value of the company (assets minus all liabilities) was $13,892,000. That was $36.26 per share.

The company does not file reports with the SEC and does not send quarterly reports to shareholders (just an annual report). However, we can obtain an FDIC report ("call report") showing the quarterly results of the company's regulated bank subsidiary. For the first quarter of 2014, net income was $136,000, up from $120,000 in the first quarter of 2013. According to the Q2 call report, net income was $155,000 compared with $175,000 the prior year.

Book value of the bank should now be about $37 per share. The price-to-book is still about 62%. The annualized return on equity right now is an anemic 4.2%. Factoring in the discount to book value, you are earning about 6.8% (earnings yield).

Assets almost unchanged year over year, at $56 million. Loans are also roughly unchanged at $38 million. However, a significant amount of cash was shifted from interest bearing deposits to the available-for-sale securities portfolio. The biggest increase was $5 million in munis. SFBK likes the same muni trade that I do! And they were buying in the 5-15 year duration bucket, the same part of the curve that I have liked!

There's been an uptick in past due and nonaccrual loans year over year. If management has reserved properly, then this should already be reflected in the financial statements. I would not ordinarily give a bank management that much credit, however management seems to make conservative loans, judging by the profitable years during the housing crash and also by investments in munis at the top of the economic cycle instead of growing the loan portfolio.

SFB Bancorp, Inc. $SFBK

I've found what may be our next Conrad on the pink sheets. SFB Bancorp, Inc. (OTC: SFBK) is a small community bank in eastern Tennessee.

This is a "dark" company, like the ones that Oddball Stocks finds. They do not file with the SEC, but they do mail annual reports to shareholders. From those, I discovered that Yahoo Finance and OTC Markets are both way off on the share count. The actual number of outstanding shares is 383,161.

At the current market price of $23, that is a market capitalization of $8.8 million. At year end 2013, the book value of the company (assets minus all liabilities) was $13,892,000. That is $36.26 per share. The company is currently trading at 63 percent of book value.

Normally, a bank would only trade at a 37 percent discount to book value if there were substantial concern about the quality of its assets. However, SFBK is profitable and was profitable every year of the Great Recession.

Since 2005, the bank subsidiary has earned a total of $5.6 million, an average of $627,000 annually, which amounts to a 6.5% earnings yield on the current market price.

The bank is run by “owner-operators,” management with equity stakes and not free options. The bank is impressively profitable for its small size - return on assets, net interest margin, and efficiency ratio are all very strong considering the lack of economies of scale.

The company does not file reports with the SEC and does not send quarterly reports to shareholders (just an annual report). However, we can obtain an FDIC report showing the quarterly results of the company's regulated bank subsidiary. For the first quarter of 2014, net income was $136,000, up from $120,000 in the first quarter of 2013. If that pace continued through the second quarter, then book value of the bank should now be more like $37.