The Long and Short
Finding index-eligible community bank paper
Dan Bruzzo, CFA | July 29, 2022
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
Most bonds outstanding from investment grade community banks come with a 10-year maturity and 5-year non-call period, and the vast majority fall below the $300 million face amount needed to qualify for a market index. The 2032 notes issued by Home BancShares earlier this year include the 5-year call typical of these deals but have an index-eligible size of $300 million. This looks like a unique opportunity to pick up exposure to community banks with liquidity, and HOMB is solid bank credit with robust capital and stable funding.
Most community bank deals have a minimum of $50 million outstanding but are not index eligible while large regional bank deals are almost all index-eligible.
Exhibit 1:10NC5 community bank notes and large regional bank bullets
HOMB 3.125% 1/30/32-27
Pricing: $90.00, YTC 5.68%, 296/5-year Treasury
Issuer: Home BancShares Inc. (Hold of Centennial Bank.)
Amout Outstanding: $300 million (index-eligible)
Senior Rating: Kroll – BBB+/Stable
Subordinated HoldCo Issue rating: Kroll – BBB/Stable
Callable at par 1/30/27
Coupon: 3.125% to 1/30/27; TSFR3M +182 after call date
Home BancShares Inc. is the holding company of the bank operating company Centennial Bank. Headquartered in Arkansas, HOMB provides commercial and retail banking throughout its home state and all along the Florida panhandle to the Florida Keys. The bank has 229 locations following a string of mergers throughout the past decade. The bank currently has just under $18.6 billion in total assets, $14.5 billion in deposits, and $10.1 billion in total loans. Some of the more notable, recent acquisitions include last year’s purchase of Happy Bancshares, the 2018 purchase of Shore Premier Finance, which added niche consumer lending lines, and the 2017 purchase of Stonegate Bank, which added $3 billion in total assets. HOMB has doubled in size since 2017, as it continued its expansion into Florida. The bank stood at just $2 billion in total assets at the beginning of 2007.
HOMB’s lending profile is weighted toward commercial loans with 38% of total loans in commercial real estate (CRE), 18.5% in construction and development and 15% in commercial and industrial (C&I) loans. Within CRE lending, owner-occupied properties are outnumbered by non-owner occupied, which typically carry higher risk. The remainder of loans is in residential at 12% and consumer at 11%. As demonstrated by their strategy over the past decade, HOMB management is very comfortable targeting and adding depreciated loans, most notably taking advantage of depressed market values in Florida in the years following the Great Financial Crisis. They have added both individual loan portfolios as well as entire community banks where they found compelling value.
HOMB maintains robust capital ratios. The Tier 1 Common (CET1) ratio stood at 14.87% as of the first quarter of this year, with a total risk-based capital of 21.58%.
The bank has made significant improvements to establish a more stable funding profile. Deposits are now enough to fully fund the loan book with a current loan/deposit ratio of approximately 69% at the holding company, down from more than 100% back in 2018. The use of brokered deposits is just over 4%, which has been reduced from nearly 10% several years ago through the addition of core-deposit-rich acquisitions. Reliance on wholesale funding overall is down to less than 12% from over 20% as recently as 2018. The use of shorter-term money markets and time deposits has also been reduced to negligible levels from over 18% in 2018, and over 40% before the bank began the bigger phase of its expansion.
For a bank that targets assets with depreciated values, they maintain very low levels of classified loans (since marks on loans are usually taken aggressively at time of an acquisition closes). Non-performing assets (NPA) are at a negligible level of 0.28% of total assets as of March. The bank has booked enough reserves to cover over 450% of those loans classified as non-performing. The Texas Ratio—which measures NPAs and 90-day past-due loans as a percentage of all reserves as well as equity—is less than 3%. For banks of this size/stature we consider any reading below 20% as typically manageable.
HOMB generates highly consistent return on average equity (ROAE). Returns have been mostly in the 11% to 14% range dating back to 2011, with the exception of 2017 due to heavy acquisition activity. The Bank’s Efficiency Ratio (operating expenses vs operating revenue) is extremely impressive wrapped around 40% in most years, demonstrating consistent expense management. The bank typically generates strong net interest margin (NIM) levels north of 4%, although they have been in the mid-to-high 3% range since 2021.
Dan Bruzzo, CFA
1 (646) 776-7749