1st Century Bancshares FCTY
August 06, 2008 - 7:18pm EST by
tbzeej825
2008 2009
Price: 5.25 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 52 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

1st Century Bancshares is a commercial bank trading at 88% of tangible book value with a Tier 1 risk-based capital ratio of 27%, sound credit quality, an attractive deposit base, positive net income, and strong relationships in the Los Angeles business community. 1stCentury is a logical beneficiary of the well-known demise of and unprecedented turmoil surrounding numerous financial services institutions in Southern California.

1st Century Bancshares (Pink Sheets: FCTY) offers a very compelling opportunity to earn between three and six times the initial investment over a five year period with strong downside protection. If the management team and the Board execute, 1st Century shares could appreciate to $17 to $31 per share by the end of 2013.
 
Background: 1st Century was founded in 2003 by Chairman and CEO Alan Rothenberg, a well-respected business and civic leader in Los Angeles. 1st Century went public in a ‘de-novo’ formation in March 2004 in a highly oversubscribed offering at $5.00 per share led by investment banking firm Carpenter and Company based in Irvine, California. 1st Century raised $26.4 million from investors, which at the time was the single largest amount of money ever raised by a startup bank in California.  
 
1st Century targets an upscale customer base of family-owned and closely held businesses, real estate investors, and professionals, entertainment industry professionals, and professional service firms including law firms, business management firms, medical practices, and financial services companies.
 
Business loan products include commercial and industrial loans (C&I), commercial real estate loans, construction loans, working capital lines of credit, and equipment loans. The bank offers mortgage products to its customers as an accommodation, but it is not the primary focus of the bank’s lending strategy. 1st Century aims to gain market share from Wells Fargo, Bank of America, Union Bank of California, and City National Bank by providing superior service to meet the banking needs of its customers.
 
Loan Portfolio:
 
Below is 1st Century’s loan composition (3/31/2008, 10-Q)
 
C&I                                                                57%
Commercial Real Estate                              26%
Construction                                                 8%
Home Equity                                                  5%
Consumer                                                       3%
Residential Real Estate                                1%
 
1st Century has ZERO non-performing assets in its C&I, commercial real estate, or construction loan portfolios.

1st Century has ZERO subprime loans, ZERO subprime CDOs, SIVs, or structured investments, and ZERO exposure to Fannie Mae or Freddie Mac common or preferred stock.
 
1st Century has two foreclosed real estate properties on the books with a loan balance of $727,000 relative to a loan portfolio of $177 million. The Company foreclosed on these properties in the first quarter of 2008, charging off $149,000.
 
Management and the Board:
 
Alan Rothenberg, a retired partner of Latham and Watkins, is best known for organizing the 1994 World Cup of Soccer in the United States—one of the most successful and highly attended sporting events in modern athletic history with 3.5 million attendees. In addition, Rothenberg was an Organizing Director at First Los Angeles Bank from 1973 to 1984 during the turbulent economic environment of stagflation and escalated energy prices, political uncertainty, three recessions, and the worst bear market in 75+ years. First Los Angeles Bank was ultimately sold to City National Bank (1st Century’s most significant competitor) in 1995.
 
Rothenberg has no prior operational / management experience in the banking industry. However, Rothenberg does have an extensive ‘Rolodex’ of contacts in the legal, entertainment, real estate, and financial service industries due to his unique background. If Rothenberg demonstrates the ability to fully leverage the relationships of 1st Century’s high-powered and well-connected Board of Directors, 1st Century stockholders will be rewarded.
 
http://www.1stcenturybank.com/about/bod.aspx.
 
In order for ‘de-novo’ banks to become successful, the Board of Directors need to have a very active role and fully utilize their contacts and business acumen to generate business for the bank in the form of loans and core deposits. Board members are usually local business leaders who are supposed to have a significant financial and personal interest in the bank’s success. 1st Century’s management and the Board of Directors currently own 11% of outstanding shares.
 
1st Century’s outside shareholder base consists predominantly of high-net-worth individuals in Southern California, many of whom are customers of the bank. Based on a review of publicly available information, it does not appear that the bank has many unaffiliated institutional investors as shareholders.
 
According to 1st Century’s investment banker Ed Carpenter of Carpenter and Company, "You only sell stock to people who you think will do business with the bank," he says. "And the people who will do business with the bank are the people in the community. So every body on the outside is frozen out because all these offerings are oversubscribed.”

Financial Performance:
 
Below is the financial performance of FCTY since its inception.                                                                
 
FY2004     FY2005        FY2006      FY2007     3/31/2007    3/31/2008
                                                                               
Assets                                                   $86 mm     $161 mm      $201 mm     $224 mm    $222 mm     $259 mm
Net Loans                                              $33 mm       $85 mm      $126 mm     $170 mm    $121 mm     $175 mm
Pro-Forma Deposits                             $64 mm      $107 mm     $145 mm     $161 mm    $165 mm     $170 mm
Total Equity                                          $22 mm       $53 mm       $54 mm       $59 mm      $54 mm       $59 mm
ROAA                                                    -4.22%        -1.37%         0.07%          0.36%         0.30%           0.32%
ROAE                                                     -16.86%     -23.76%        0.27%          1.44%         1.21%           1.40%
Tangible Equity /                                  25%                 33%           27%            26%            25%              23%
Tangible Assets
Tier 1 risk-adjusted ratio                    45%                 50%          36%               29%            36%             27%
Tangible Book Value                            $4.12              $5.47         $5.53         $5.91            $5.54            $5.98
Non-performing assets                       0.00%              0.00%        0.00%      0.00%           0.00%             0.33%
Loan Loss Reserves                            1.00%               1.35%        1.30%        1.38%          1.35%           1.35%
 
Timely Opportunity: As demonstrated above, 1st Century is in an enviable position as one of the only banks in California with a Tier 1 risk-based capital ratio exceeding 25%, positive net income, and di minimis net charge offs and non-performing assets. Currently, 1st Century has only one branch located in Century City, a business district in West Los Angeles.
 
1st Century grew slowly from 2004 to 2007—under-leveraging its balance sheet. 1st Century did not participate in the irresponsible lending environment that has already crippled many financial institutions including Washington Mutual, First Federal Bank, PFF Bancorp, Vineyard National Bancorp, Guaranty Financial Group, Downey Financial, IndyMac Bancorp, Countrywide, New Century, UCBH, East West Bancorp, etc—many of which have been written up on VIC previously on the long and short sides.
 
In July 2005, 1st Century raised $35 million in a secondary offering at $8.00 per share. The secondary offering resulted in a 25% accretion to book value per share. At the Annual Meeting, management indicated that they operated the bank very conservatively during the boom times, foresaw a difficult economic environment, and opportunistically raised capital since it was available on attractive terms.
 
More specifically, 1st Century should benefit in the foreseeable future (12 to 24 months) as many commercial banks in California with average to weak capital positions are significantly impacted by deteriorating C&I and commercial real estate loans. During this period, most of 1st Century’s competitors are likely to be focused on fixing their businesses—restraining balance sheet and operational growth. As evidenced in the 1990-1991 recession, managements are historically reluctant to record charge offs (and even in some cases accurately report NPAs) early in the credit correctional cycle, which gives uninformed customers a false sense of confidence and allows banks to temporarily retain core deposits.
 
Over the next 12 to 24 months as the credit cycle continues to deepen, an increasing number of potential customers will reevaluate their banking relationships and be more willing than usual to switch to 1stCentury. It is clear that 1st Century will have a much better opportunity to gain market share away from incumbent commercial banks by making loans characterized by attractive pricing, which should concurrently drive core deposit growth.
 
Proxy Contest: Palisair Capital Partners, a hedge fund based in Los Angeles, owns 6.0% of the shares outstanding. Palisair began accumulating a position in February 2008 once the broader market and economic environment had deteriorated. In May 2008, Palisair initiated a proxy contest to seek representation on the Board of Directors.
 
Among other things, Palisair indicated in its proxy statement that it did not “believe the Company’s poor stock performance can be attributed to weak fundamentals or unfavorable market and industry conditions. Unlike many of its peers, who are capital constrained and at an elevated risk of continued deposit losses and devastating loan-portfolio write-downs, 1st Century has an overcapitalized balance sheet, positive net income, and a steadily-growing loan portfolio with no write-offs. As such, despite the current financial services downturn, 1st Century’s competitive position has improved dramatically.  We therefore question why senior management and the Board have not taken advantage of its position in the banking industry to improve the Company’s stock price through a variety of strategies including, growing its deposits and loans and expanding through the acquisition of other banks facing liquidity issues and/or lacking sufficient scale.”
 
Palisair pushed the Board to publicly retain an investment banking firm to pursue a range of strategic alternatives to maximize stockholder value including an opportunistic acquisition and/or stock repurchase. Moreover, Palisair urged the Company to hire new loan officers to appropriately leverage the balance sheet, develop a legitimate investor relations strategy that includes conference calls, a relationship with sell-side analysts, and presence at industry conferences. Palisair also encouraged senior management to formally provide financial and strategic guidance to the investment community for metrics commonly used in the banking industry.  Palisair was unsuccessful in its effort to elect a Director to 1st Century’s Board of Directors.
 
At the Bank’s Annual Meeting, management provided a formal update on the Company and its future plans for the first time since the 2004 IPO. The presentation is available at www.1stcenturybank.com in the Investor Relations section of the website.
 
* 5 Year Financial Projections and Price Target *
 
Over the next five years, 1st Century has the potential to grow its balance sheet significantly, resulting in improved profitability assuming a normalized economic environment.
 
1st Century could be one of the few growth stories among publicly traded financial services companies in California, which would undoubtedly attract investors. Below is a list of rough financial projections for 1st Century compared to current results. Over the long run, 1st Century is in a position to generate superior returns relative to its peer group, small thrifts, and most commercial banks because of its business model that emphasizes relationship banking catering to well-heeled customers.
 

                                                                                    Q1 2008                  FY2013
 
Adjusted Return on Tangible Assets                 0.32%                   1.25% - 1.50%
Adjusted Return on Tangible Equity                  1.40%                     15% - 20%
Tangible Assets / Tangible Equity                    4.3x                            12x to 16x
Tier 1 Leverage Capital Ratio                               27%                         6.5% to 8.5%
Efficiency Ratio                                                    81%                            40% to 60%
Adjusted Diluted EPS                                         $0.08                         $1.25 to $1.75
Total Assets (excluding goodwill)                    $259 mm                 $1.0 Billion +
Total Gross Loans                                               $177 mm                 $750 mm to $1 Billion
Deposits                                                                $170 mm                 $750 mm to $1 Billion 
Tangible Book Value                                           $5.98                       $8.50 - $10.50
Valuation                                                               0.88x TBV                2.0x to 3.0x TBV
Price Target                                                                                      $17 to $31 Per Share
 
A $17 to $31 Price Target is contingent on Management and the Board capitalizing on many of the opportunities mentioned below to generate stockholder value.
 
1) Listing on NASDAQ: The Company intends to list on NASDAQ by the end of 2008. With a stock price in excess of $5.00 a share and a market capitalization over $50 million, 1st Century meets all requirements for listing on the NASDAQ Global Market. It is likely current and prospective investors would benefit from increased trading volume, enhanced liquidity, and a higher public profile. A listing on NASDAQ could result in sell-side coverage and attract a greater number of institutional investors—many of whom cannot invest in an over-the-counter bulletin board security.
 
2) Approving a Stock Buyback:Management believes that the stock is undervalued and plans to initiate a stock buyback, pending Board approval. Since FCTY trades at a discount to tangible book value and has an overcapitalized balance sheet, management will likely receive approval from the regulators to repurchase stock in the open market despite the bank’s short operating history. Any shares purchased at a discount to tangible book value would be accretive to tangible book value and provide strong support for the stock.
 
Finally, in the last few months, Rothenberg purchased 11,950 shares at an average price of $5.71 a share, which is a positive vote of confidence in the bank’s future.
 
3) Recruiting New Loan Officers and Opening New Regional Branches:With approximately $60 mm of stockholder equity, FCTY needs to grow its balance sheet to over $900 mm (15x tangible equity) to generate an optimal ROE. In its proxy statement, Palisair encouraged 1st Century to “hire at least 15 to 20 loan officers over the next three to five years.”
 
In a letter to stockholders, management clearly indicated that “because of opportunities being created due to upheaval within some of our competitors, we believe we will be able to acquire talented personnel.” Many experienced, relationship-based loan officers working at competitors of FCTY may be particularly interested in exploring other opportunities due to underwater stock options and lack of job security.
 
On the same front, FCTY is evaluating opportunities to develop a branch network in the Los Angeles metropolitan area.  FCTY is considering opening up new branches in Santa Monica, Downtown Los Angeles, San Fernando Valley, and the South Bay regions. In the Annual Letter, management indicated that the “primary focus will be to continue to build the bank through solid organic growth, both in our Century City office and through opening Regional offices.”
 
According to industry experts, it costs approximately $1 million to develop a new branch, including initial capital investments and operational losses expected in the first 12 – 18 months. With a strong capital position, FCTY has the flexibility to open new branches in strategic locations and absorb near-term startup costs. It is not unreasonable to expect 1st Century to have at least five branches by 2013.
 
If FCTY can successfully expand its footprint throughout the Southern California region, it is likely that there will be a lengthy list of potential acquirers down the road willing to acquire the Company at a rich premium. 
 
4) Acquiring Business Boutique Banks: From Jan 2004 to July 2008, over 75 ‘de-novo’ banks were formed in California, according to SNL Financial. Most of these small business boutique banks are overcapitalized and generating poor financial returns because of insufficient scale, inferior product offerings, and a lack of clearly defined long-term growth plans. In addition, most investors in these banks are likely frustrated as the trading price of a high majority of these banks is well below the offering price.  
 
M&A activity is currently non-existent in the community banking industry because of a wide gap of expectations between buyers and sellers. However, as the credit crisis continues to deepen and spread into commercial real estate and C&I loans, it is likely that deal activity will increase once sellers adjust pricing expectations to reflect the new environment. The same phenomenon occurred during and after the consumer-led recession of 1990 to 1991.
 
FCTY is currently working with Sandler O’ Neill and KBW in New York and Carpenter and Company, investment bankers that specialize in financial services, to seek out available growth opportunities. Management understands that many business boutique banks in the Los Angeles area with assets under $500 million and publicly listed on the Pink Sheets are trading below tangible book value.
 
In spite of negative headlines, there are many small, digestible acquisition targets that are not burdened by subprime loans, CDOs, SIVs, shaky customer perception, expensive retail deposits, risky construction loans, and/or excessive leverage and wholesale borrowing.  These targets offer attractive cost-synergies, access to core deposits, a higher loan limit to cater to new and larger customers, increased managerial talent, broader product offerings and improved technology, and an increased profile among customers and prospective investors.
 
FCTY is one of the few banks in Southern California with the financial flexibility to grow via acquisition of a smaller bank. A successful acquisition via a merger-of-equals (MOE) or an outright purchase could generate significant value for stockholders. An acquisition by FCTY is equally likely at any point in the next five years.
 
5) Acquiring Individual Branches of Failed Banks:The OCC and FDIC are aware that FCTY is interested and capable of acquiring individual branches of failed banks in industry auctions. With the FDIC seizure of IndyMac Bancorp and possible insolvencies of FirstFed Financial and Downey Financial as well as many smaller California banks on the radar screen of the FDIC, there are likely to be many opportunities for FCTY to purchase pockets of healthy loans, attract core deposits, and/or secure real estate leases in strategic areas at attractive prices.
 
For example, Maryland based CapitalSource Inc. (NYSE: CSE) acquired 22 retail branch locations in Southern California from bankrupt Fremont General, representing $5.6 billion in deposits for a modest premium of 2% of deposits and $58 million of cash. For only $170 million, CapitalSource Inc. acquired a legitimate footprint in one of the most desirable markets for banking in the United States.
 
In the aftermath of the SNL crisis and the consumer-led recession from 1990 to 1991, many banks with a well-capitalized balance sheet were able to generate long-term value for stockholders by acquiring individual branches or certain business units of undercapitalized banks at significantly under economic value.
 
FCTY is one of the few banks in Southern California with the financial flexibility and access to capital to grow via acquisition of failed bank branches. At the Annual Meeting, management indicated that they are working with investment bankers and regulators to review various opportunities. Any event is likely to occur in the next 12 to 24 months.
 
6) Developing a Wealth Management Platform: 1st Century focuses on high net worth individuals, professionals, entrepreneurs and closely held and family owned businesses. FCTY aims to secure the entire relationship with a customer, which includes loans, deposits, and cash management. As a result, FCTY needs to develop a complete platform which includes brokerage services and a variety of fund products. FCTY would clearly benefit from the increased non-interest income and enhanced customer experience that would result from wealth management.
 
In January 2008, FCTY amended its lease in the Century City office to add additional square feet for the Bank’s Private Banking Center. However, 1st Century’s expansion into wealth management is more likely to occur in the medium term (24—48 months) 
 
 
 
 
 
 
 
 
 
 
 

Catalyst

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