The First Of Long Island: Ready To Bounce Back And With A Huge Dividend Yield (FLIC)

The First of Long Island (NASDAQ:FLIC) is a bank with nearly 100 years of history and is headquartered in Melville, New York. Its recent history has been marked by significant challenges mainly due to the rapid rise in the Fed Funds Rate. In fact, in early 2022 FLIC was trading at about $22 per share; today we are below $10 per share.

This is a huge drop, which occurred among other things at a time when FLIC was already far from its all-time high of $31 per share at the end of 2017. Certainly, the TBV per share has stalled in recent years, but the bank remains solid in spite of everything. Its valuation multiples are at historic lows and the dividend yield has never been higher, 8.58%.

In my last article on FLIC I assumed that the bottom was near, yet since then the stock has lost an additional 16%. My valuation was wrong, but in my opinion the fundamentals remain good and this further slump has only made the bank cheaper. I believe the potential upside is far greater than the potential downside, which is why my rating is no longer a hold, as I am upgrading it to a buy.

What triggered the collapse

To understand what the future scenarios are for this bank, I think it is useful to summarize what triggered this collapse.

The primary determinant of a bank’s price per share is TBV per share, and the growth of the latter has been a problem for FLIC.

From 2022 (when there was the first-rate hike) to the present, TBV per share has not moved much and is still below the high reached in 2021. Still, FLIC has generated profits every year, so it has fueled retained earnings. The problem lies in the devaluation of AFS securities, since changes in their fair value must be accounted for within equity.

The amortized cost of these securities is $750.78 million, but due to their unrealized losses of $74.87 million, their fair value has dropped to $677.11 million. Investing years ago in such fixed-rate securities proved to be a serious mistake, since as T-bond yields rose, they lost a good portion of their value. Obviously, if the bank held these securities to maturity no loss would be realized, but it would take years before that happens, barring a sharp unexpected reduction in the Fed Funds Rate.

Considering that equity amounts to $377 million, because of the AFS securities, about 15% of this bank’s potential is still unexpressed.

The second determinant that fueled pessimism toward FLIC was its declining profitability.

After several years of rising net interest income, shareholders have been caught off guard by such a rapid deterioration. From 2022 to 2023 there was a decline of about $29 million, and in the last 12 months the situation has not improved. The rising cost of deposits has not been covered at all by the improvement in loan yields. In addition, demand for loans has come to an abrupt halt because of rising rates, and there has been no opportunity to increase total loans.

Several quarters ago I expected a change in the trend, which there has not been yet. The net interest margin has reached 1.79% while last year it was 2.34%.

I don’t doubt that in front of such results, FLIC’s price per share deserved to go down, but I think the market reaction was excessive. The LTM Price/TBV per share is only 0.58x, yet the loan portfolio remains solid and the net interest margin is unlikely to get any worse.

Over the past month I have analyzed many small banks, but none were trading at a TBV this low. Many have recovered from their mid-2023 lows, others are on the road to recovery, but for FLIC the market is discounting a disaster scenario. Still, FLIC’s problems seem similar to those of its peers, although the valuation is different.

Why I am optimistic about FLIC

As anticipated, I think the market is undervaluing FLIC too much, or rather, not discounting its guidance in the current price.

Management expects low-single digit loan portfolio growth in 2024, certainly not exciting, but no different from many other regional banks: interest rates are high for everyone, not just FLIC. Moreover, the cost of deposits could arrest its growth in the coming quarters and let the net interest margin breathe again. The bottom of the latter seems really close this time:

Barring any significant changes in our funding mix or short-term rates moving higher, we believe our margin should be at the bottom. We expect it will fluctuate within a narrow band for the remainder of 2024, although continued improvement in our funding mix or a more favorable yield curve may improve margin in the second half of the year.

CEO Chris Becker, Q1 2024 conference call.

After reaching 1.79%, it is really hard to do worse. On both the asset and liability side, there are important growth drivers:

• On the asset side, the loan portfolio and investment portfolio generate about $80-$90 million per month, which means decent reinvestment opportunities. These cash flows can be invested at money market rates or used to make new loans. In either case, the yield difference with maturing loans/securities is large, sometimes as much as 3-4%.
• On the liability side, the cost of deposits seems to be slowing down. Until there is the first rate cut, the problem will not be completely solved, but at least today we can see light at the end of the tunnel. In Q1 2023 the cost of deposits was increasing by about 17 basis points per month, today only 7 basis points per month. Since rates will almost certainly not be raised, it is difficult to foresee a scenario in which the trend will revert. It is much more likely to expect a gradual decline in the cost of deposits. By the way, the most important inflation figure (Core PCE YoY) was released a few hours ago, and the results were encouraging: estimates of just 2.6% were met.

For these two reasons, I trust management’s expectations regarding the bottom of the net interest margin. In the event of more Fed Funds Rate cuts in 2024, estimates of slight NIM growth are quite conservative.

Taking a look at the various rate shock scenarios, it is evident that FLIC is waiting for nothing more than the first rate cut to return to growth.

A reduction of 100 basis points would roughly cause the economic value of equity to increase by 7.2% and net interest income to rise by 2.6%. In the first case, unrealized losses would be reduced, giving a boost to TBV per share; in the second case, the cost of deposits would cease to rise, giving a boost to the net interest margin.

Overall, the last two years have not been easy at all, but the worst seems to be behind us. In my opinion, it is more likely that the situation will improve rather than deteriorate further, after all, there is not much room for the NIM to fall: it is already very low.

Waiting until there is a recovery in profitability before buying FLIC might be a good conservative move, but the total return would become significantly less attractive. At the current price, I believe there is the potential for both a good capital gain and a high and sustainable dividend yield.

The dividend yield is currently 8.58%, almost at an all-time high and considerably higher than the sector median of 3.62%. It is rare to find a bank with such a high dividend yield; moreover, I believe it is also sustainable.

As you can see, dividend per share has increased year after year, even during the Great Financial Crisis, and has always been largely covered by EPS. Certainly the recent slump has questioned its sustainability, but I do not believe that such a risk is present. While it is undeniable that EPS has collapsed a great deal, I have already highlighted the reasons why I believe their recovery is likely in the coming quarters.

The Fed Funds Rate hike had not happened with such rapidity for decades, and this has disoriented FLIC’s management. However, the bank seems on the road to recovery and has largely paid for its missteps; in fact, its valuation has never been so depressed.

The LTM Price/TBV per share has never been so low, even in the most difficult times for the economy since 2008. Paying a TBV of only 0.58x is really cheap, especially considering that the historical average is 1.43x.

The loan portfolio is not growing but remains stable in non-performing loans; the cost of deposits is stabilizing and non-interest-bearing deposits are about 33% of total deposits. Throughout its long history FLIC has forged decades-long relationships with its customers and has proven to be a reliable bank even in complicated times where many have struggled.

In my opinion pricing TBV at such a low value is unjustified, which is why I consider this bank a buy. The dividend is a plus, as is the buyback.

In Q1 2024 167,526 shares were purchased for $2 million and it will probably continue since the price per share is so discounted. Obviously, the bank cannot overdo this maneuver, otherwise the TBV per share would have additional downward pressure on top of the unrealized losses.

Conclusion

FLIC is a bank with an extensive history behind it, albeit its market capitalization is very low. Undoubtedly in recent years the rise in the Fed Funds Rate has put it in trouble, but it seems that the net interest margin has finally stabilized. A more expansionary Fed than expected would lead to a faster recovery since the TBV per share would shake off the burden of unrealized losses, otherwise a more gradual recovery is the scenario I think is most likely.

The dividend yield is very high and the Price/TBV per share has never been so low, both signs of strong undervaluation. This bank’s assets remain high quality, as do its deposits and capital ratios, which is why I find its collapse unwarranted: below $10 per share FLIC is a buy.