Freedom Bank of Virginia reported 3Q20 net income of $2.6 million, up 68.9% compared to the $1.5 million posted in 2Q20 and up 176.2% over the $932k recorded in the year-ago period.
This translates to 3Q20 earnings per share of $0.35 compared to $0.21 in 2Q20 and $0.13 in 3Q19. The posted results exceeded our $0.19 EPS estimate by $0.16. Higher gains on the sale of mortgage loans, a higher net higher-than-expected noninterest expenses to generate the outperformance relative to our projection.
Highlights from the quarter include:
- Gross loans held-for-investment (excluding PPP loans) declined $11.9 million or 2.9% sequentially to $397.2 million. Driven by higher mortgage loan originations, loans held-forsale climbed $35.7 million or 111.9% linked-quarter. Meanwhile, PPP loans grew $2.8 million or 2.6% sequentially.
- Freedom’s asset mix became slightly less favorable in 3Q20, as low-yielding interest bearing deposits with other financial institutions and the bank’s AFS investment portfolio continued to grow, but this quarter they were accompanied by investments in held-to-maturity securities. As a result, loans declined to 76.1% of total assets from 78.3% at the prior quarter-end. Total assets increased to $751.6 million, a $53.8 million or 7.7% sequential increase from 2Q20.
- Total deposits climbed $47.0 million or 9.6% sequentially. Noninterest bearing accounts advanced $22.4 million or 14.6% sequentially, while interest bearing demand deposits rose $28.7 million or 19.1%. Partially offsetting these movements was a $0.5 million or 14.4% sequential decrease in savings deposits and a $3.6 million or 2.0% decline in time deposits. The growth in deposits was supplemented by $2.7 million in incremental PPP Liquidity Facility funds. The increases in deposit and PPPLF funding supported the growth in total loans as well as growth in cash and AFS & HTM securities.
- Net interest income increased $243k or 4.8% linked-quarter, driven by a 6.1% advance in average earning assets and 20 bps of NIM expansion to 3.13% (on a tax equivalent basis). The yield on average earning assets rose by 6 bps sequentially, driven by an 81 bps jump in average yields on securities, which offset a 25 bps drop in average loan yields, and a slight increase in the average proportion of loans in the average asset mix. Low yielding PPP loans (which carry an interest rate of 1.0%) remain a drag on average loan yields. Loan forgiveness on a handful of the PPP loans has already been approved, but we still expect the bulk of PPP loan forgiveness, and the accelerated fee income that will accompany forgiveness, to occur in early 2021. Meanwhile, other loans are being originated or repriced at lower yields. Still, Freedom was able to deploy excess cash into a mix of corporate bonds municipal bonds and MBS that have helped drive tax-equivalent securities yields up substantially in 3Q20. The cost of interest bearing liabilities dipped 21 bps on a 23 bps drop in average interest bearing deposit costs and a 9 bps decline in the average cost of borrowings. We still anticipate further reductions in funding costs as CDs mature and get replaced by lower cost deposits.
- Noninterest income increased $2.2 million or 76.9% compared to 2Q20, rising to $5.1 million. The primary driver was a $2.3 million rise in mortgage banking revenues due to higher mortgage origination volumes.
- Noninterest expenses increased $1.8 million or 33.6% sequentially. Much of the rise occurred in employee compensation, which climbed $1.6 million or 47.6% sequentially driven by higher mortgage commission compensation. Mortgage fee settlement costs also increased, rising $146k or 32.0% LQ due to higher refinance activity.
- Freedom recorded negligible net charge-offs of 0.00% of average loans, compared to net charge-offs of 0.02% in 2Q20. As a result of the lack of charge-offs and a slight decline in loans held-for-investment, coupled with modest declines in NPAs, Freedom did not record a loan loss provision in 3Q20. Loans on deferral declined to 90 borrowers totaling $73 million, down from 96 borrowers on loans totaling $89 million in response to the pandemic. All of the deferrals are scheduled to end in 4Q20.
- Nonperforming loans fell roughly $284k or 7.1% in 3Q20. There were no performing TDRs and the company’s balance sheet remained free of OREO at September 30, 2020. Meanwhile, loans 90 days past due and still accruing fell $80k or 100.0% sequentially to $0. As a result, NPLS/Loans fell from 0.90% at June 30, 2020 to 0.79% at September 30, 2020 (excluding PPP loans). NPAs/Assets (including 90-days past due) declined from 0.58% at June 30, 2020 to 0.49% at September 30, 2020. The loan loss reserve climbed to 1.32% of total loans (excluding PPP loans) at September 30, 2020 from 1.28% at June 30, 2020.
- FDVA’s regulatory capital ratios advanced modestly compared to the prior quarter-end. The Total capital ratio, Tier 1 ratio and CET1 ratio all rose 18 bps-20 bps, while the Leverage ratio climbed 34 bps to 11.57%. All of the regulatory capital ratios remain far above the minimum levels needed to be considered “well capitalized”.
- The tangible common equity ratio dropped to 9.38% at September 30, 2020 from 9.68% at June 30, 2020. Meanwhile, tangible book value per share climbed to $9.75 from $9.33.
Earnings Estimates:
The most obvious driver of Freedom Bank’s better-than-expected 3Q20 results was the strong performance of the mortgage banking segment. However, the bank also posted NIM expansion, improved asset quality, and strong capital levels. We continue to believe that FDVA’s geographic location – in the suburbs of Washington DC – and its heavy concentration in commercial clients, particularly government contractors, will mitigate some of the unfavorable effects of the pandemic. We expect low single-digit growth in loans held-for-investment as PPP loans start to decline due to forgiveness and gradual paydowns. We expect mortgage originations to remain robust due to the low interest rate environment, but we are projecting that originations over the next few quarters will not reach as high as 3Q20 production, and that loans held-for-sale and mortgage banking revenues decline from 3Q20 levels while still remaining high relative to historical trends at FDVA. We still expect to see noticeable asset quality deterioration in coming quarters, but there are no signs of it yet, and the bank has built up considerable reserves already that should cover much of the expected deterioration. We have reduced our provision expectations slightly as a result.
We are projecting modest NIM compression going forward as maturing wholesale funding is replaced at lower cost while reduced yields on newly originated and repriced loans are offset partially by declines in the low-yielding PPP portfolio that is accompanied by accelerated origination fee income. Given the higher-than-expected expenses and increased mortgage banking expectations, we have boosted our estimates for noninterest expenses going forward.
After making the preceding adjustments to our model, we are raising our EPS estimates for 2020 from $0.65 to $0.89. We are raising our 2021 EPS estimate from $0.50 to $0.84 and our 2022 estimate from $0.54 to $0.85.
Outlook:
Despite a difficult economic environment, Freedom Bank has continued to show improvements in a number of areas. The bank has gained a significant number of new customers through the PPP program, the funding mix and funding costs have improved and should continue to do so. Asset quality remains good and reserve levels are strong. Efficiency and profitability have risen steadily. Capital levels are also strong, and should the bank continue to generate significant earnings, we believe management will consider returning capital to shareholders through either a dividend or a buyback program. We still believe Freedom’s geographic location and commercial emphasis will serve the bank well and help it perform better than many similar small banks throughout the country.
FDVA currently trades at only 80.4% of tangible book value. This valuation is in-line with similar-size peer banks in the region. However, as we note above, we believe that Freedom has a good chance to outperform these peer institutions due to its location, its business focus, and the recently completed restructuring of the bank that has boosted results in recent quarters, making this an attractive investment.
While we have enjoyed covering Freedom Bank of Virginia, shifting corporate responsibilities do not allow us time to provide the same level of diligence to our equity research as we would like. Consequently, we are discontinuing coverage of Freedom Bank of Virginia.