United Bancorporation of Alabama (OTCPK:UBAB) has been one of our top tier community banks over the last two years since our initial article on the company. The shares at the time traded at a significant discount to our estimate of their intrinsic value – simultaneously providing exceptional return potential and a sizable margin of safety – despite the company’s strong operating performance and the lack of trade related risks to major agricultural commodities in the company’s market area.
However, as the company has largely met or exceeded our expectations over the last two years, the resulting increase in the share price (which has nearly doubled) has closed much of the valuation gap and we have trimmed positions in the last month.
United Bancorporation has exhibited superior performance over the last two years with earnings per share and returns on assets and equity far exceeding those of most community banks. The performance was driven, in large part, by the company’s receipt of New Markets Tax Credit (OTCQB:NMTC) allocations which boosted the bank’s capital and provided a platform for expanded lending. However, the underlying operations also continued to perform well with deposits and loans exhibiting strong growth. In the meantime, investment securities balances have continued to decline as a percentage of interest earning assets, as we expected, further boosting the company’s net interest margin. The company’s equity-to-asset ratio is also above average for community banks and will support additional growth.
Notably, the growth in deposits has also not diluted the company’s favorable deposit mix with a full 44% of the company’s deposit base in noninterest bearing accounts. The unusually high concentration of deposits in noninterest bearing accounts for a community bank was and remains one of the key attractions of the company.
On the other hand, the company has taken a few actions which have tempered our enthusiasm. The first was the issuance last year of additional shares to raise equity capital – roughly 50% of the company’s previously outstanding shares. The issuance, at a price which we considered significantly below the company’s intrinsic value – diluted existing shareholders (and the company’s potential) to an excessive degree. The additional equity, we grant, placed the company in a better position to support growth and reversed what had been a relatively low equity-to-assets ratio, but the lack of communication and excessive size of the placement was nonetheless disappointing from our perspective as a leading shareholder.
Lender to Investor
Second, we were somewhat less than enthused about the company’s announcement in the third quarter report that United Bancorporation had taken an equity tax credit position in one of its New Markets Tax Credit transactions. The equity position will allow the company to take tax credit against earnings over seven years as a recovery mechanism against potential losses in New Markets Tax Credit investments. In general, the acquisition of tax credits is not in itself a particularly troubling event but experience has shown that banks which pursue tax credits can become overly focused on tax credit based investments and loans at the expense of the larger business. NBC Bank, a Louisiana bank which we grant is not particularly similar to United Bancorporation, is perhaps one of the most extreme cautionary tales.
Regardless, the decision to move towards being an investor rather than simply a lender warrants attention.
A Lack of Responsiveness
Finally, we’ve been somewhat disappointed in the relative lack of responsiveness of management to our inquiries despite representing a significant consolidated interest in the company’s. In our experience, community banks consistently fall into one of two categories with regard to management – either responsive or unresponsive – with very few institutions starting in one category and moving into another over time. In the case of United Bancorporation, the company falls into the unresponsive category. A better effort to community with investors – and markets – would likely benefit the company and shareholders.
Our projections suggest the company’s performance will continue into the coming year although the short term benefits associated with tax credit program fees somewhat obscures the company’s underlying performance.
We project earnings per share for the current year of about $2.85 to $2.95 per share, roughly flat from the prior year due to higher net interest income being offset by reduced tax credit related fees and higher provisions for loan losses. The projection suggests a return on equity of around 12.9%, maintaining the company’s above average return on equity, allowing the company to continue to build equity while, hopefully, encouraging further increases to the dividend.
United Bancorporation still represents a compelling opportunity in the community banking sector for many of the same reasons that we have discussed in our prior articles though forward prospects are more modest. The valuation remains reasonable relative to peers with similar operating performance metrics at around 1.2 times book value and 9.0 times projected forward earnings. The potential for additional tax credit program grants, and the associated fees, due to the company’s existing experience and unusual position in its regional market adds to the company’s potential performance. The company’s deposit and loan portfolios continue to grow at a fast clip while retaining favorable deposit mix. However, the company has experienced erosion in overall asset quality which likely presages elevated provisions for credit losses and the volatility around noninterest income associated with tax credit program fees, etc., adds to uncertainty about the longer term sustainability of noninterest income.
The combination of these factors, as well as the fact that the company’s share price has quickly closed much of the valuation gap we identified in our earlier articles has led us to trim – but not close – our position in the company in favor of other opportunities.
Disclosure: I am/we are long UBAB. 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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