Atlantic Capital: Lots Of Risky Loans Keep Me On The Sidelines (NASDAQ:ACBI)

Investment Thesis Headquartered in Atlanta, Georgia, and with about $3 billion in assets, Atlantic Capital Bancshares, Inc. (ACBI) is a commercially focused bank with specialties in specialty corporate lending, private banking, and commercial real estate finance solutions. The company has the 13th largest deposit market share in the greater Atlanta […]

Investment Thesis

Headquartered in Atlanta, Georgia, and with about $3 billion in assets, Atlantic Capital Bancshares, Inc. (ACBI) is a commercially focused bank with specialties in specialty corporate lending, private banking, and commercial real estate finance solutions. The company has the 13th largest deposit market share in the greater Atlanta MSA, just behind Cadence Bancorp (CADE), Renasant (RNST), and Bank OZK (OZK).

I am a little more constructive on the bank since the first quarter update. The exposure to economically sensitive loans has narrowed to 9% of total loans (from ~30%). To me, this means that potential realized losses could be lower than previously expected and roughly in line with other regional bank peers. The core net interest margin (NIM) remains under pressure but expense control should help profitability over the near term.

When weighing out the puts and takes, I am still neutral on the stock. This partially is due to ACBI’s valuation, which is roughly in line with its peer group. While I believe the company should be a beneficiary of competitive disruption in the Atlanta market, I think there are more pressing issues over the next few quarters.

When mixing in valuation relative to the riskier credit profile, I suggest potential shareholder remain on the sidelines, at least until the third quarter update in a few weeks.

Data by YCharts

Revenue Outlook

In the second quarter, ACBI reported EPS from continuing operations of $0.09 versus consensus expectations of $0.13, relative to its $0.10 in the first quarter. The second quarter downside came primarily from elevated provisioning offset partially by higher revenue and lower expenses. The company’s pre-provision net revenue was $11.1 million, compared to $10.5 million in the first quarter and $9.7 million in the second quarter of last year.

In the second quarter, net interest income increased 10% from the second quarter of last year and was up over 3% from the first quarter of 2020. The company also had 1% sequential loan growth, excluding PPP loans. There were $234 million in PPP loans added in the quarter and consumer loans increased by $55 million from the growth in a fintech partnership.

However, the NIM declined 18 basis points as lower loan yields and PPP yields more than offset lower deposit costs. The addition of PPP loans in the quarter negatively impacted the NIM by 14 bps, while the cost of deposits decreased 22 bps in the quarter.

Source: SEC Filings and Author’s Estimates

Loan growth is difficult to predict with economic visibility so low, but deposit growth is expected to be solid. Management indicated that they are expecting continued pressure on loan yields going forward, excluding the impact from PPP loans. The decline in deposits should somewhat offset lower asset yields, but the core NIM will likely continue to compress further over the next few quarters.

While I am modeling the continuation of core loan growth, I also expect the reported number of loans to shrink as PPP loans are forgiven. This forgiveness effect will cause the NIM to jump higher, at least temporarily (as seen above). Longer term, I think the NIM comes down and drops a little lower than current levels before flattening out in mid 2021.

Credit Concerns

In the second quarter, the provision increased to almost $9 million (including the provision for unfunded commitments) due to updated CECL economic forecast assumptions. Net charge-offs (NCOs) increased to $1.5 million, or 0.29% of average loans, in the second quarter. Nonperforming assets were relatively stable at $6.3 million, or 0.32% of loans. At the end of the second quarter, the total loan loss reserve was 1.61% to total loans, which compares to 1.43% seen in the first quarter.

In the second quarter, ACBI granted total deferrals on $515 million of loans, or an astoundingly high level of 24% of total loans. Approximately 78% of initial deferrals expired at the end of July and 53% of deferral borrowers had PPP loans. At the time of the second quarter earnings release in late July, only 3% of deferred loans have requested a second 90-day deferral period and management is expecting that the most requests will come from hotel borrowers.

Management reviewed the company’s exposure to economically sensitive industries and narrowed down a more accurate level of exposure. The company’s exposure to hotels, excluding SBA and USDA guarantees, now represents 4% of total loans. Retail exposure is 4% of total loans and full service restaurants make up another 1%. To me, it sounded like management has no material concerns in the company’s retail exposure overall, but hotels are more vulnerable as average occupancy levels are still below breakeven rates.

Source: SEC Filings

While the CET1 ratio ended the quarter at 11.6%, which is above most peers, I think that ACBI is likely to have a worse than average experience in this credit environment. On one hand, management tries to paint the picture of being in control of the situation; reminding the market that the reserve level is fairly high. On the other hand, it is difficult to get excited about a bank that has seen its criticized loans more than double in the past six months.

As readers have seen from my past examinations of the credit profile, I prefer banks to have ~2.0x (or less) criticized loans to total reserves, any more and I usually disqualify them from being a potential investment. ACBI has just over 5.0x, meaning that if just one quarter of criticized loans go bad and get charged off, management would need to raise capital in order to satisfy the loss (since it would more than wipe out the entire loan loss reserve).

Conclusion

In short, it’s hard to get past the rapid pace of credit deterioration. To me, that is where any hope of getting bullish in the near term stops. While the reserve level looked fine six months ago, the economic environment turned quickly and ACBI got caught rather flat-footed.

While it’s easy to pick on a bank that has credit problems, one thing that investor must do is look past them (unless they are really bad) and see what the bank “could be” if things get better quickly. With that, I think ACBI still has some heavy lifting in the coming quarters to get things back on track.

While not my base case, if the economic landscape becomes much more positive in rather short order, I could see ACBI outperforming peers because it has the most room to improve (in terms of credit).

Source: SEC Filings and Author’s Estimates

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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