First Financial: Great Footprint And Earnings Power Sets Up A Solid Long-Term Buy (NASDAQ:FFIN)

Investment Thesis

Headquartered in Abilene, Texas, First Financial Bankshares (FFIN) just crossed the ever important $10 billion threshold. The company operates multiple banking regions with its 78 locations and 9 trust company offices. The FFIN footprint stretches from Hereford, Texas, throughout the Panhandle to Orange, located in southeast Texas.

Bank investors need to beware of the Durbin amendment and what happens once a bank crosses that dreaded $10 billion line. The Durbin amendment is part of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which limits a few key noninterest income segments.

More specifically, interchange fees collected by the bank from debit transactions take the biggest hit. Since FFIN just crossed the $10 billion threshold in the second quarter, starting next year, management will need to start complying with yearly examinations from the Consumer Financial Protection Bureau. When its all said and done, FFIN will likely need to find a way to fill this $10 million gap in fee income (i.e., the loss of interchange fees).

That being said, FFIN is one of the most profitable banks in the country, courtesy of an economically strong Texas footprint, conservative credit culture, large core deposit base and efficient cost structure. The company has also been a highly disciplined acquirer of community banks. If you are investing for the long term, rather than trading in today’s choppy markets, I believe current valuation is a once-in-a-cycle opportunity.

ChartData by YCharts

As one can see from the chart above, the last time the shares had this level of a discounted on valuation was in 2012. While it lasted about a year, I would recommend potential long-term shareholders to start averaging in today.

Revenue Outlook

In the second quarter, net interest income rose 11% relative to the first quarter levels. This was largely driven by outsized PPP lending, solid securities growth and lower deposit costs. On a reported basis, total loans increased 13% from the first quarter, all of which was from PPP-related lending activities, while deposits increased 13% as well. FFIN funded about $700 million in PPP loans in the second quarter.

Noninterest income also rose sharply from robust mortgage lending. The company had a $1.5 million securities gain, down from $2.0 million in the first quarter, along with lower overdraft fees and trust income.

I believe paydowns and payoffs were a little heavier in the first half of the year, limiting total loan growth. However, given some recent commentary by Texas peers, loan demand has now likely resumed to a more normal level. Residential construction and residential mortgage loan demand are particularly strong. Consumer recreational equipment demand is robust.

(Source: SEC Filing and Author’s Estimates)

When I think about future loan growth, I expect management to be selective in terms of credit exposure. This management team is best-in-class, and the bank’s valuation proves it. While the net interest margin (NIM) is likely to work a little lower from here as the higher-than-average loan yield works down, I foresee a NIM floor in the not-too-distant future. I am modeling the core NIM to be around 3.70% for FY21. Overall profitability should remain strong and more then supportive of above-peer valuations.

Expenses Remain Well-Managed

During the second quarter, expenses declined almost 4% from the first-quarter levels, which included $583,000 of conversion costs, higher mortgage lending commissions, and annual merit increases. Some of these increased expenses were offset by $3.6 million of deferred expenses for PPP. Personnel costs were flattish, while the other line item expenses were down.

(Source: SEC Filing and Author’s Estimates)

Recall, the $631 million asset TB&T Bancshares acquisition closed on January 1, so some cost savings were realized during the second quarter.

Going forward, I would expect management to be able to stay well below the 50% threshold on the efficiency ratio (expenses / revenue). I think overall revenue is likely to be a little bit of a drag as the NIM compresses a little. That said, the earnings power of the bank should not be mis-categorized – FFIN is an earnings powerhouse that will likely have a significant valuation premium to peer banks.

Picturesque Credit

The long and short of it: asset quality continues to hold up very well. The second-quarter provision was $8.7 million, versus $9.9 million in the first quarter. This continually elevated provision was reflective of weaker energy prices and economic uncertainty, not loan slippage. The current loan loss reserve is now 1.52% of non-PPP loans.

Based on the 10-Q, it was noted the company will covert to CECL loan loss methodology in late 2020, which could have one quarter elevated provision. Net charge-offs (NCOs) were just $193,000 in the second quarter. As you can see from the chart below, FFIN is arguably one of the best credit managers out of all the United States-based banks.

(Source: SEC Filing)

In the second quarter, nonperforming assets were flattish and continue hold steady near 0.75% of total loans. Classified loans are now $200 million, versus $190 million in the first quarter, which is 4% of total loans. About 10% of loans held for investment were under deferral agreements, which I would expect to be very limited in the near future.

(Source: SEC Filing)

Loans in the higher-risk subcategories like restaurant, hospitality and retail sectors are now $339 million, or 7% of total non PPP loans. These loans are about $16 million of classified loans (8% of the total classified loans) and $6 million of nonperforming loans. Of the $193,000 NCOs in the second quarter, these high-risk lender areas accounted for $178,000.

While the bank does have some areas of potential improvement, I am expecting management to address these lingering credit one-offs over the next couple quarters.


While it might be difficult to invest in a bank that trades at roughly 3.0x Price-to-Tangible Book Value, especially while peers are closer to 1.0x, I would remind would-be investors to look at the bigger picture.

FFIN has almost always had a NIM that was 60+ basis points stronger then peers. The credit profile experienced only one-fourth of the pain that the average bank did in the last recession. Finally, the branch network dots nearly every suburb in Texas, a state destined to continue to grow via its 0% state income tax.

If you look at the first chart, a fair valuation of FFIN would be nearly 4.0x Price-to-Tangible Book Value per share. If the one were to invest today, and the price increased to the 5-year median (~4.0x Price/TBV), share price return would be 33%, in addition to the 2% dividend yield, setting the stage for 35% upside.

(Source: SEC Filing and Author’s Estimates)

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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