The other day, Xenith released a lot of details on the figures related to its recent assumption of VBB and its purchase of Paragon’s Richmond loans and deposits. My rough guestimates outlined in my write up the other month were accurate and a shade below reality. While the proforma balance sheet puts Xenith very close to break even, it will be interesting to see what progress has been made organically over the past quarter as well.
The details on the Paragon acquisition are positive. Xenith is getting $23m in non-interest bearing deposits from Paragon, which is great. Only $4m/78m in deposits are time deposits. Almost all the loans associated with Paragon are C&I or CRE lending. There are no credit metrics on the loan portfolio, but the lack of construction or development loans is one signal that the loan portfolio is solid, as is Xenith only acquiring performing loans. The combination of C&I lending and non-interest deposits indicates that Xenith actually purchased a decent commercial lending franchise that has profitable relationships.
Not only is Xenith acquiring an already profitable division, it can be incorporated into an existing infrastructure. Xenith’s cost calculated as the difference between the loan adjustment and core deposit intangible is $647k. The assets and liabilities earned that much in the first six months of 2011. This deal arose because Paragon wanted to leave the Richmond and focus on its North Carolina operations. There was nothing fundamentally wrong with Paragon's Richmond related balance sheet and Xenith got a good deal. They also took out what appears to have been a successful competitor.
The Virginia Business Bank (VBB) transaction doesn’t extend Xenith’s franchise, but it contributes $5.7m of equity to Xenith. Xenith got a pretty steep discount on VBB’s assets and the opportunity to take out a competitor for good. VBB’s deposits are almost exclusively jumbo time deposits. These will likely prove very transient, but the pro forma loan to deposit ratio is 83%. Xenith has some flexibility to secure additional deposits to cover the gap between VBB’s assets and liabilities if it emerges.
VBB’s loan portfolio is mostly C&I and CRE lending. The acquisition is being done with a built in $9.4m discount to the performing loans. This is not part of the initial gain recognized for assuming more assets than liabilities in the initial transactions of $5.7m. I don’t think it’s intellectually honest to think this way, but if you drop this $9.4m fully taxed through the income statement right now, TBV goes from $57m to $63m - it isn't going to happen like that. The discount will likely just accrete through interest income, which will somewhat mask any projected improvement in NIMs from the failed bank. Xenith is also not profitable currently, so clearly immediately recognizing the gain would be offset by some losses. I’m less concerned about when the bank becomes profitable only because it’s current losses stem from being a de novo bank and not from lax lending standards coming to roost. This reserve certainly lowers the hurdle even more.
Xenith issued preferred shares worth $8.3m to a government program for funding small businesses. Xenith is paying a 1% dividend, which is really a 1.53% yield since preferred dividends are taken out of aftertax earnings and I consider this a liability akin to a deposit. It’s a longer-term source of funding than the time deposits and its cheaper than debt. Initially I thought this issuance stemmed from Xenith encountering more loan demand than it could satisfy out of deposits, although this was sadly Panglossian. Now I believe that it is related to the need to maintain liquidity that might be hampered by a failure to rollover enough of VBB’s time deposits. This isn’t a static situation though and Xenith has shown discipline in restraining lending until deposits allow it. It isn't severe since Xenith also has plenty of cash to match any time deposits that don't get rolled over. The weighted average interest was 1.03% though, so Xenith won't exactly have to break the bank in offering a rate that will keep the deposit at the bank.
Xenith earned a 4.35% net interest margin in the last quarter on $263m of interest earning assets. Now they have pro forma interest earning assets of $356m in addition to the $74m in cash now on the balance sheet (clearly excessive amount). Annualized noninterest expenses are $14m based on the past 6 months and a 4.35% NIM would result in $15.5m in net interest income. This is contingent on a lot of things, so I wouldn't bank on this number, but clearly the threshold of profitability is very close to being crossed.
Xenith has done a great job at executing so far, but there is clearly a ways to go towards full profitability. They have wide NIMs, attracted quality deposits since late 2009, and taken advantage of some great opportunities. They are only halfway there. Proforma tangible book value and assets are $57m and $461m respectively, which results in a 12.3% leverage ratio. If Xenith grows over the next 2 years to have a 9% leverage ratio, its assets will be $633m, a 37% increase in assets. If the bank achieves a 1% ROA, which I believe is achievable, it would earn $6.3m. I’m less enamored by that than the fact that at 55% of TBV, a lot can go wrong before I lose money.
Xenith has proven they can grow the balance sheet already and their overall strategy is clearly focused on taking business from lenders currently providing subpar lending relationships to businesses. My confidence in management’s ability to execute this strategy well in the future stems from their historical record of already having done so and the presence of what I believe is a long term large shareholder. I haven’t seen anyone else talk about Xenith and management isn’t too chatty, so somewhat fortuitously I don’t believe I have an excessive bias in my assessment.
As it pertains to Xenith and my write up on State Bank & Trust (STBZ), these FDIC assisted transactions are very interesting. I need to rewrite my STBZ write up since it’s admittedly not the pinnacle of clarity, but they have since participated in 2 more FDIC assisted transactions, which I will try to post about this week. STBZ is well positioned regardless of the economy. If the economy worsens, they have the capital to assume more failed banks. If it improves, they will be well positioned to grow their balance sheet to a normalized size.
Some resources on FDIC assisted transactions that are useful (an offshoot of my post on scuttlebutt):
1. 3 Grant Thornton white papers on: 1) accounting and tax considerations of acquiring a whole bank 2) accounting for FDIC assisted acquisitions of loans and ASC 310-30 and 3) what you need to know about FDIC-assisted transactions:
2. FBR Capital Markets primer on FDIC assisted transactions:
3. Powerpoint on opportunities in failed bank acquisitions:
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