Banks have been the victims of the COVID-19 pandemic. Rather than having an uneventful year, most banks had to step up their loan loss provisions and keep an eye on how this would impact their earnings and dividend coverage ratio. Most banks kept on paying dividends (although some had to cut their shareholder rewards) but there are very few banks that actually increased the dividend during a crisis year. The Bank of South Carolina (BKSC) is an exception: It announced in September it was increasing its dividend by one cent per share to $0.17. Exceptional, and I wanted to check up on the bank’s health and dividend sustainability.
Strong Q3 results confirm it was safe to hike the dividend
The Bank of South Carolina is a small bank. With a market capitalization of less than $100M and a balance sheet total of just more than $500M (including the recently added $66M in PPP loans), it should perhaps be described as a nanocap. This also means the margin of error is perhaps a bit thinner than at other, larger financial institutions: If (purely hypothetical!) a $2M loan goes sour, about 4% of the bank’s equity would evaporate.
Fortunately the bank’s management seems to know what it’s doing, and in the third quarter of this year, the focus was predominantly on damage control. The low-yield environment has reduced the total interest income by in excess of $0.5M and the problem was the interest expense already was very low at just $0.2M in Q3 2019, so there wasn’t exactly much room for improvement there. Although the interest expenses fell by in excess of 60%, the net interest income still decreased by approximately 10% to $4.2M.
Source: SEC filings
After deducting the net non-interest expenses of approximately $1.95M, the pre-tax and pre-loan loss provision in Q3 came in at $2.26M. A decent result, and considering the loan loss provision remained limited to just $40,00, the pre-tax income of $2.22M resulted in a net income of $1.7M or $0.31 per share.
This means that even after the recent dividend hike when Bank of South Carolina decided to increase the quarterly payment from $0.16 to $0.17 per share, the dividend is handsomely covered with a coverage ratio of 182%.
The $40,000 loan loss allowance may appear to be low, it’s perhaps even more surprising this was the first time in the current financial year BKSC actually did record a provision. The loan loss provisions in the first nine months of the year fell to $40,000, coming from $155,000. In the first three quarters of the year, the EPS came in at $0.85 (while the increased dividend would result in dividend per share of $0.51 in the same time frame).
A closer look at the loan book
So now we have established the quarterly dividend of 17 cents per share – which results in a dividend yield of 4.2% based on the current share price – is sustainable, I also wanted to make sure the quality of the loan book will continue to support the profitability and the dividend payments of this small local bank.
Looking at the asset side of the bank, we see about $44M is held in cash which poses very little risk. Additionally, the $135M in “investment securities available for sale” represent in excess of 25% of the total asset side of the balance sheet and also have a below-average risk as these securities consist of US Treasury notes, municipal securities and securities issued by government-sponsored enterprises.
Source: SEC filings
This means my attention was zooming in on the actual loan book, which represents about 60% of the assets.
It looks like the loan book is geared toward real estate. $70M has been invested in consumer real estate (residential mortgages) while an additional $146M is classified as “commercial real estate” with an additional $14M CRE that’s currently under construction.
Source: SEC filings
The total loan loss provision of $4M on a total loan portfolio of almost $321M may seem to be rather low, but you should keep in mind the loan book is very much overweight in real estate. If the LTV ratios are acceptable, the risks tend to be relatively low for a bank. And I’m positively surprised by the low amount of loans past due as of the end of September. On a total of $321M in loans (before taking the loan loss allowance into account), only $1.55M of the loans (less than 0.5%) are past due.
Source: SEC filings
And being past due obviously doesn’t mean these loans are a “total loss” for the bank. I couldn’t find the average LTV ratios, but considering BKSC is maintaining a ceiling LTV of 80%, its safe to assume there’s at least $2M in collateral against the $1.55M in loans past due, and if these loans don’t become performing again, the loss attributable to the bank should be low.
The Bank of South Carolina appears to have a good grip on the situation and it’s one of the very few banks that has actually increased the dividend in 2020. As I explained in this article, the dividend is still handsomely covered although BKSC will have to keep an eye on its net interest margins. Its interest expenses already are less than $0.1M per quarter, so there’s no way the bank can cover additional blows to the interest income by cutting the interest expenses. So that’s something to keep an eye on.
Despite the strong financial performance and a balance sheet where less than 0.5% of the loans are past due, I’m not a buyer at the current share price. The book value per share as of the end of September was just $9.87 indicating the company is trading at 1.6X its book value (and about 13 times earnings). I understand a premium may perhaps be warranted and the apparently safe 4.2% dividend yield may be attractive to income-oriented investors, but I’m standing on the sidelines here.
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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.