1st Century
Bancshares is a commercial bank trading at 88% of tangible book value with a Tier
1 risk-based capital ratio of 27%, sound credit quality, an attractive deposit
base, positive net income, and strong relationships in the Los Angeles business community. 1stCentury is a logical beneficiary of the well-known demise of and unprecedented
turmoil surrounding numerous financial services institutions in Southern California.
1st Century
Bancshares (Pink Sheets: FCTY) offers a very compelling opportunity to earn
between three and six times the initial investment over a five year period with
strong downside protection. If the
management team and the Board execute, 1st Century shares could
appreciate to $17 to $31 per share by the end of 2013.
Background:
1st Century was founded in 2003 by Chairman and CEO Alan Rothenberg,
a well-respected business and civic leader in Los Angeles. 1st Century went
public in a ‘de-novo’ formation in March 2004 in a highly oversubscribed
offering at $5.00 per share led by investment banking firm Carpenter and
Company based in Irvine, California. 1st Century raised
$26.4 million from investors, which at the time was the single largest amount
of money ever raised by a startup bank in California.
1st Century
targets an upscale customer base of family-owned and closely held businesses,
real estate investors, and professionals, entertainment industry professionals,
and professional service firms including law firms, business management firms,
medical practices, and financial services companies.
Business loan products
include commercial and industrial loans (C&I), commercial real estate
loans, construction loans, working capital lines of credit, and equipment
loans. The bank offers mortgage products to its customers as an accommodation,
but it is not the primary focus of the bank’s lending strategy. 1st
Century aims to gain market share from Wells Fargo, Bank of America, Union Bank
of California,
and City National Bank by providing superior service to meet the banking needs
of its customers.
Loan Portfolio:
Below is 1st
Century’s loan composition (3/31/2008, 10-Q)
C&I 57%
Commercial Real
Estate 26%
Construction 8%
Home Equity 5%
Consumer
3%
Residential Real
Estate 1%
1st Century has
ZERO non-performing assets in its C&I, commercial real estate, or
construction loan portfolios.
1st Century has
ZERO subprime loans, ZERO subprime CDOs, SIVs, or structured investments, and ZERO
exposure to Fannie Mae or Freddie Mac common or preferred stock.
1st Century has
two foreclosed real estate properties on the books with a loan balance of
$727,000 relative to a loan portfolio of $177 million. The Company foreclosed
on these properties in the first quarter of 2008, charging off $149,000.
Management and the Board:
Alan Rothenberg, a retired
partner of Latham and Watkins, is best known for organizing the 1994 World Cup
of Soccer in the United States—one of the most successful and highly attended
sporting events in modern athletic history with 3.5 million attendees. In
addition, Rothenberg was an Organizing Director at First Los Angeles Bank from
1973 to 1984 during the turbulent economic environment of stagflation and
escalated energy prices, political uncertainty, three recessions, and the worst
bear market in 75+ years. First Los Angeles Bank was ultimately sold to City
National Bank (1st Century’s most significant competitor) in 1995.
Rothenberg has no prior
operational / management experience in the banking industry. However,
Rothenberg does have an extensive ‘Rolodex’ of contacts in the legal, entertainment,
real estate, and financial service industries due to his unique background. If
Rothenberg demonstrates the ability to fully leverage the relationships of 1st
Century’s high-powered and well-connected Board of Directors, 1st
Century stockholders will be rewarded.
In order
for ‘de-novo’ banks to become successful, the Board of Directors need to have a
very active role and fully utilize their contacts and business acumen to
generate business for the bank in the form of loans and core deposits. Board
members are usually local business leaders who are supposed to have a
significant financial and personal interest in the bank’s success. 1st
Century’s management and the Board
of Directors currently own 11% of outstanding shares.
1st Century’s
outside shareholder base consists predominantly of high-net-worth individuals
in Southern California, many of whom are
customers of the bank. Based on a review of publicly available information, it
does not appear that the bank has many unaffiliated institutional investors as
shareholders.
According to 1st
Century’s investment banker Ed Carpenter of Carpenter and Company, "You only sell stock to people who you think will do
business with the bank," he says. "And the people who will do
business with the bank are the people in the community. So every body on the
outside is frozen out because all these offerings are oversubscribed.”
Financial Performance:
Below is the financial
performance of FCTY since its inception.
FY2004 FY2005 FY2006 FY2007
3/31/2007 3/31/2008
Assets $86
mm $161 mm $201 mm $224 mm
$222 mm $259 mm
Net Loans $33
mm $85 mm $126 mm $170 mm
$121 mm $175 mm
Pro-Forma Deposits $64 mm $107 mm $145 mm
$161 mm $165 mm $170 mm
Total Equity $22 mm $53 mm $54 mm
$59 mm $54 mm $59 mm
ROAA -4.22% -1.37% 0.07% 0.36% 0.30% 0.32%
ROAE -16.86% -23.76% 0.27% 1.44% 1.21% 1.40%
Tangible Equity / 25% 33% 27% 26% 25% 23%
Tangible Assets
Tier 1 risk-adjusted ratio
45% 50% 36% 29% 36% 27%
Tangible Book Value
$4.12 $5.47 $5.53 $5.91 $5.54 $5.98
Non-performing assets 0.00% 0.00% 0.00%
0.00% 0.00% 0.33%
Loan Loss Reserves 1.00% 1.35% 1.30% 1.38%
1.35% 1.35%
Timely Opportunity: As demonstrated above, 1st Century is in an enviable
position as one of the only banks in California with a Tier 1 risk-based capital
ratio exceeding 25%, positive net income, and di minimis net charge offs and
non-performing assets. Currently, 1st Century has only one branch
located in Century City, a business district in West
Los Angeles.
1st Century grew
slowly from 2004 to 2007—under-leveraging its balance sheet. 1st
Century did not participate in the irresponsible lending environment that has
already crippled many financial institutions including Washington Mutual, First
Federal Bank, PFF Bancorp, Vineyard National Bancorp, Guaranty Financial Group,
Downey Financial, IndyMac Bancorp, Countrywide, New Century, UCBH, East West
Bancorp, etc—many of which have been written up on VIC previously on the long
and short sides.
In July 2005, 1st
Century raised $35 million in a secondary offering at $8.00 per share. The
secondary offering resulted in a 25% accretion to book value per share. At the
Annual Meeting, management indicated that they operated the bank very
conservatively during the boom times, foresaw a difficult economic environment,
and opportunistically raised capital since it was available on attractive
terms.
More specifically, 1st
Century should benefit in the foreseeable future (12 to 24 months) as many
commercial banks in California with average to weak capital positions
are significantly impacted by deteriorating C&I and commercial real estate
loans. During this period, most of 1st Century’s competitors are
likely to be focused on fixing their businesses—restraining balance sheet and
operational growth. As evidenced in the 1990-1991 recession, managements are
historically reluctant to record charge offs (and even in some cases accurately
report NPAs) early in the credit correctional cycle, which gives uninformed customers
a false sense of confidence and allows banks to temporarily retain core
deposits.
Over the next 12 to 24 months
as the credit cycle continues to deepen, an increasing number of potential customers
will reevaluate their banking relationships and be more willing than usual to
switch to 1stCentury. It is clear that 1st Century will
have a much better opportunity to gain market share away from incumbent commercial
banks by making loans characterized by attractive pricing, which should concurrently
drive core deposit growth.
Proxy Contest: Palisair Capital Partners, a hedge fund based in Los Angeles, owns 6.0% of
the shares outstanding. Palisair began accumulating a position in February 2008
once the broader market and economic environment had deteriorated. In May 2008,
Palisair initiated a proxy contest to seek representation on the Board of
Directors.
Among
other things, Palisair indicated in its proxy statement that it did not “believe the Company’s poor stock performance can be
attributed to weak fundamentals or unfavorable market and industry
conditions. Unlike many of its peers, who are capital constrained and at
an elevated risk of continued deposit losses and devastating loan-portfolio
write-downs, 1st Century has an overcapitalized balance sheet, positive net
income, and a steadily-growing loan portfolio with no write-offs. As such,
despite the current financial services downturn, 1st Century’s competitive
position has improved dramatically. We therefore question why senior
management and the Board have not taken advantage of its position in the
banking industry to improve the Company’s stock price through a variety of
strategies including, growing its deposits and loans and expanding through the
acquisition of other banks facing liquidity issues and/or lacking sufficient
scale.”
Palisair
pushed the Board to publicly retain an investment banking firm to pursue a
range of strategic alternatives to maximize stockholder value including an
opportunistic acquisition and/or stock repurchase. Moreover, Palisair urged the
Company to hire new loan officers to appropriately leverage the balance sheet,
develop a legitimate investor relations strategy that includes conference calls,
a relationship with sell-side analysts, and presence at industry conferences.
Palisair also encouraged senior management to formally provide financial and
strategic guidance to the investment community for metrics commonly used in the
banking industry. Palisair was
unsuccessful in its effort to elect a Director to 1st Century’s
Board of Directors.
At the
Bank’s Annual Meeting, management provided a formal update on the Company and
its future plans for the first time since the 2004 IPO. The presentation is
available at www.1stcenturybank.com
in the Investor Relations section of the website.
* 5 Year Financial
Projections and Price Target *
Over the
next five years, 1st Century has the potential to grow its balance
sheet significantly, resulting in improved profitability assuming a normalized economic environment.
1st
Century could be one of the few growth stories among publicly traded financial
services companies in California,
which would undoubtedly attract investors. Below is a list of rough financial
projections for 1st Century compared to current results. Over the
long run, 1st Century is in a position to generate superior returns
relative to its peer group, small thrifts, and most commercial banks because of
its business model that emphasizes relationship banking catering to well-heeled
customers.
Q1 2008 FY2013
Adjusted Return on
Tangible Assets 0.32% 1.25% - 1.50%
Adjusted Return on
Tangible Equity 1.40% 15% -
20%
Tangible Assets /
Tangible Equity 4.3x 12x to 16x
Tier 1 Leverage
Capital Ratio 27% 6.5% to 8.5%
Efficiency Ratio 81% 40% to 60%
Adjusted Diluted
EPS $0.08 $1.25 to $1.75
Total Assets
(excluding goodwill) $259 mm $1.0 Billion +
Total Gross Loans $177
mm $750 mm to $1 Billion
Deposits $170
mm $750 mm to $1 Billion
Tangible Book
Value $5.98 $8.50 - $10.50
Valuation 0.88x
TBV 2.0x to 3.0x TBV
Price Target $17
to $31 Per Share
A $17 to $31 Price Target is contingent on Management
and the Board capitalizing on many of the opportunities mentioned below to
generate stockholder value.
1) Listing on NASDAQ: The Company intends to list on NASDAQ by the end of
2008. With a stock price in excess of $5.00 a share and a market capitalization
over $50 million, 1st Century meets all requirements for listing on the NASDAQ
Global Market. It is likely current and prospective investors would benefit
from increased trading volume, enhanced liquidity, and a higher public profile.
A listing on NASDAQ could result in sell-side coverage and attract a greater
number of institutional investors—many of whom cannot invest in an over-the-counter
bulletin board security.
2) Approving a Stock Buyback:Management believes that the stock is undervalued and
plans to initiate a stock buyback, pending Board approval. Since FCTY trades at
a discount to tangible book value and has an overcapitalized balance sheet,
management will likely receive approval from the regulators to repurchase stock
in the open market despite the bank’s short operating history. Any shares
purchased at a discount to tangible book value would be accretive to tangible
book value and provide strong support for the stock.
Finally, in the last few
months, Rothenberg purchased 11,950 shares at an average price of $5.71 a
share, which is a positive vote of confidence in the bank’s future.
3) Recruiting New Loan Officers and Opening New
Regional Branches:With
approximately $60 mm of stockholder equity, FCTY needs to grow its balance
sheet to over $900 mm (15x tangible equity) to generate an optimal ROE. In its
proxy statement, Palisair encouraged 1st Century to “hire at least
15 to 20 loan officers over the next three to five years.”
In a letter to stockholders,
management clearly indicated that “because of opportunities being created due
to upheaval within some of our competitors, we believe we will be able to
acquire talented personnel.” Many experienced, relationship-based loan officers
working at competitors of FCTY may be particularly interested in exploring
other opportunities due to underwater stock options and lack of job security.
On the same front, FCTY is
evaluating opportunities to develop a branch network in the Los Angeles metropolitan area. FCTY is considering opening up new branches
in Santa Monica, Downtown Los Angeles, San
Fernando Valley, and the South
Bay regions. In the
Annual Letter, management indicated that the “primary focus will be to continue
to build the bank through solid organic growth, both in our Century City
office and through opening Regional offices.”
According to industry
experts, it costs approximately $1 million to develop a new branch, including
initial capital investments and operational losses expected in the first 12 –
18 months. With a strong capital position, FCTY has the flexibility to open new
branches in strategic locations and absorb near-term startup costs. It is not
unreasonable to expect 1st Century to have at least five branches by
2013.
If FCTY can successfully
expand its footprint throughout the Southern California
region, it is likely that there will be a lengthy list of potential acquirers
down the road willing to acquire the Company at a rich premium.
4) Acquiring Business Boutique Banks: From Jan 2004 to July 2008, over 75 ‘de-novo’ banks
were formed in California,
according to SNL Financial. Most of these small business boutique banks are
overcapitalized and generating poor financial returns because of insufficient
scale, inferior product offerings, and a lack of clearly defined long-term
growth plans. In addition, most investors in these banks are likely frustrated as
the trading price of a high majority of these banks is well below the offering
price.
M&A activity is currently
non-existent in the community banking industry because of a wide gap of
expectations between buyers and sellers. However, as the credit crisis
continues to deepen and spread into commercial real estate and C&I loans,
it is likely that deal activity will increase once sellers adjust pricing
expectations to reflect the new environment. The same phenomenon occurred
during and after the consumer-led recession of 1990 to 1991.
FCTY is currently working
with Sandler O’ Neill and KBW in New
York and Carpenter and Company, investment bankers
that specialize in financial services, to seek out available growth
opportunities. Management understands that many business boutique banks in the Los Angeles area with
assets under $500 million and publicly listed on the Pink Sheets are trading
below tangible book value.
In spite of negative
headlines, there are many small, digestible acquisition targets that are not
burdened by subprime loans, CDOs, SIVs, shaky customer perception, expensive
retail deposits, risky construction loans, and/or excessive leverage and
wholesale borrowing. These targets offer
attractive cost-synergies, access to core deposits, a higher loan limit to
cater to new and larger customers, increased managerial talent, broader product
offerings and improved technology, and an increased profile among customers and
prospective investors.
FCTY is one of the few banks
in Southern California with the financial
flexibility to grow via acquisition of a smaller bank. A successful acquisition
via a merger-of-equals (MOE) or an outright purchase could generate significant
value for stockholders. An acquisition by FCTY is equally likely at any point
in the next five years.
5) Acquiring Individual Branches of Failed Banks:The OCC and FDIC are aware that FCTY is interested and
capable of acquiring individual branches of failed banks in industry auctions.
With the FDIC seizure of IndyMac Bancorp and possible insolvencies of FirstFed
Financial and Downey Financial as well as many smaller California banks on the radar screen of the
FDIC, there are likely to be many opportunities for FCTY to purchase pockets of
healthy loans, attract core deposits, and/or secure real estate leases in
strategic areas at attractive prices.
For example, Maryland based
CapitalSource Inc. (NYSE: CSE) acquired 22 retail branch locations in Southern
California from bankrupt Fremont General, representing $5.6 billion in deposits
for a modest premium of 2% of deposits and $58 million of cash. For only $170
million, CapitalSource Inc. acquired a legitimate footprint in one of the most
desirable markets for banking in the United States.
In the aftermath of the SNL
crisis and the consumer-led recession from 1990 to 1991, many banks with a
well-capitalized balance sheet were able to generate long-term value for
stockholders by acquiring individual branches or certain business units of
undercapitalized banks at significantly under economic value.
FCTY is one of the few banks
in Southern California with the financial
flexibility and access to capital to grow via acquisition of failed bank
branches. At the Annual Meeting, management indicated that they are working
with investment bankers and regulators to review various opportunities. Any
event is likely to occur in the next 12 to 24 months.
6) Developing a Wealth Management Platform: 1st Century focuses on high net worth
individuals, professionals, entrepreneurs and closely held and family owned
businesses. FCTY aims to secure the entire relationship with a customer, which
includes loans, deposits, and cash management. As a result, FCTY needs to
develop a complete platform which includes brokerage services and a variety of
fund products. FCTY would clearly benefit from the increased non-interest
income and enhanced customer experience that would result from wealth
management.
In
January 2008, FCTY amended its lease in the Century
City office to add additional square
feet for the Bank’s Private
Banking Center.
However, 1st Century’s expansion into wealth management is more likely
to occur in the medium term (24—48 months)
See above.