Eagle Bancorp Montana Stock: On the Sidelines (NASDAQ:EBMT)
Eagle Bancorp Montana, Inc. (EBMT), d/b/a Opportunity Bank of Montana, is a $1.4 billion commercial bank based in Montana. It offers residential mortgages for 1 to 4 families, such as residential mortgages and building residential properties; commercial real estate loans, including multi-family dwellings, non-residential property, commercial construction and development, and loans for agricultural land; and home equity loans. As of December 31, 2021, it operates 23 branches and 26 ATMs.
From a loan portfolio perspective, the bank is a commercial retail lender with strong mortgage origination services. The bank has always maintained strong credit quality, but in fiscal year 2020 the % NPL reached 1% as the bank’s credit quality was challenged by the COVID 19 pandemic In terms of loan mix, real estate accounts for ¾ of the total loan portfolio, while C&I and consumer loans round out the rest of the loan portfolio.
In terms of funding mix, the bank has reduced its reliance on term deposit funding over time. We generally like to consider improving the funding mix as one of the essential steps in improving the banking franchise, and the management team is taking the right steps to build a funding base.
Historically, the bank has used acquisitions to add shareholder value. In the last three deals that have closed, given the relatively cheap stock price, Eagle Bancorp Montana is using a fair amount of cash for deal considerations. The details are as follows:
- Oct-01-2021 First Community Bancorp, Inc.: Expand lending products to agriculture and commercial lenders and strengthen footprint as agriculture’s preferred lender in the state of Montana;
- August 09, 2019 Western Holding Company of Wolf Point: Expanding Presence in Northeastern Montana. Management sees both revenue and cost synergy opportunities. The deal is 50% cash/50% stock, helping Opportunity Bank become the 4th largest bank by deposit size in the state of Montana; and
- August 21, 2018 Big Muddy Bancorp, Inc.: Expand into the attractive markets of Broadwater, Fergus and Teton counties. The acquisitions help the bank surpass $1 billion in total assets.
Eagle Bancorp Montana, Inc. (EBMT) reported net income of $14.4 million for fiscal 2021, compared to $21.2 million for the prior year. Earnings per share were $2.17 versus $3.11 a year earlier. Revenue for the year increased to $93.4 million from $89.1 million in fiscal 2020. During the fourth quarter, Eagle Bancorp Montana, Inc. reported an ROA and ROE of 0 .5% and 4.4%, respectively. The efficiency ratio is 83.9% and the net interest income/income is 56.1%. NIM is 3.75%.
From a profitability perspective, the bank has consistently generated a return on investment above 1% over the past three years, particularly in FY20, in which mortgage fees generate significant fee income . While revenue was down from FY21 to FY20, operating expenses were up, primarily due to a $10 million increase in payroll and benefits expenses. As most bankers would say, the wage increase will be one-sided and unlikely to come down. Without significant revenue growth prospects, the bank is stuck with a higher than necessary cost base.
The historical balance sheet growth has been impressive. Over the past six years, total assets, net income and EPS have increased by 16%, 23% and 10% respectively. In fact, most of the bank’s growth is driven by acquisitions aimed at expanding the asset base.
The stock is priced at 10.3x P/E and 1.1x P/TBV.
Lower mortgage activity will likely hurt earnings from a risk perspective. Mortgage origination deals rank fourth among the state of Montana and will likely experience lower volume given a higher interest rate environment. Additionally, the bank is stuck with a higher cost base due to a $10 million year-over-year increase in compensation, which is key from a corporate governance perspective. business (i.e. a higher cost base that is not justified).
From a compensation perspective, the bank will continue to drive asset growth through acquisitions, as this has historically been the primary means of improving shareholder returns. Despite some organic growth opportunities arising from the acquisition, in our view, the bank’s primary tool for creating long-term value would be to acquire smaller community banks in the region. While it may be unwise to use equities as currency from now on, the bank has shown an ability to use both cash and equities and retreat into smaller community banks adjacent to major banking markets. The bank’s NIM is stronger than its Midwest peers, given the more benign competitive dynamics within its core market. Eagle Bancorp Montana may be an acquisition target given its improved deposit franchise and industry-leading asset quality, and an acquirer may reduce the cost structure to improve the profitability of franchise. Given the relative size of the transaction that Eagle Bancorp of Montana is currently pursuing and the three transactions that have closed, the integration risk should be somewhat manageable. In bank mergers, the most important element of cost rationalization is the reduction of wages to gain efficiency. Investors should beware that Eagle Bancorp Montana is pursuing transactions that are too large to support.
In our view, while the valuation is attractive, we believe investors should be wary of the potential shortfall due to lower mortgage activity and, more importantly, a higher cost base for the bank. We believe Eagle Bancorp Montana is positioned in a market with a benign competitive environment. Improving cost of funding and industry-leading asset quality make it an acquisition target, although mergers and acquisitions are inherently uncertain in terms of timing and chances of success. We will be more excited about the bank’s growth prospects once the efficiency ratio achieves industry-leading status. For now, we are sitting on the sidelines.