Description

Citizens Bancshares Corporation: A Well-Managed Bank Trading For Less Than Six Times Earnings, With Significant Earnings Growth Upside

Brief Summary

Citizens Bancshares Corporation, the holding company for Citizens Trust Bank, is a publicly traded bank based in Atlanta, Georgia. The ticker is CZBS. Citizens is a well-managed bank with a shareholder-friendly and conservative management team. At the recent share price of $45, it is trading for less than six times its current earnings and just 64% of its adjusted tangible book value. Furthermore, its EPS has the potential to grow meaningfully in the next several years driven by multiple tailwinds and significant share buybacks. 

Background

Citizens has several unique attributes:  

• It is one of the most overcapitalized banks in the United States. 

• The bank is minority-owned, minority-managed, and caters to minority customers. They are a Minority Depository Institution (MDI) and a member of the Community Development Financial Institutions Fund (CDFI Fund). 

• It is the recipient of funds from the Emergency Capital Investment Program (ECIP).

• The bank is over 100 years old and has been profitable every year for at least the last 30 years (including 2008/09) and has only lost money two years since its founding in 1921. The management team is conservative. 

• The bank was founded with $500,000 in total capital in 1921 by five African Americans with the goal to primarily serve the African American community as an African American-managed bank. In 1934, they became the first African American-owned bank to become a member of the FDIC and, in 1947, it became the first African American bank to join the Federal Reserve System. In 1955, Martin Luther King, Sr. joined the bank’s board of directors!

Emergency Capital Investment Program (ECIP) and Perpetual Preferred from Large Corporates

In mid-2022, Citizens was the recipient of $95.7 million in funds from the United States Treasury as part of the Emergency Capital Investment Program (ECIP). The ECIP funds are in the form of preferred stock that Citizens issued to the Treasury with the following terms:  

• It is non-cumulative (i.e., missed payments do not accrue).

• It is perpetual (i.e., it never has to be paid back). 

• The interest rate on the preferred stock will be 0% in years one and two. From years 3-10, the rate will be between 0.5% and 2.0% based on how it is deployed (i.e., how much it is able to increase lending to minority groups). After year 10, the interest rate will be fixed in perpetuity at a rate equal to the average rate paid from years 3-10. 

• The Treasury will transfer its preferred investment in a merger/acquisition as long as the buyer is a CDFI or MDI. If the buyer is not a CDFI or MDI, then the Treasury may still transfer its investment, but prior approval is required.

• The Treasury has the right to sell this preferred security at any time. When the Treasury sells this security, the preferred stock is first required to be valued by an independent third party. Then, the issuing bank has the first right of refusal to buy back the preferred stock at that valuation. This preferred stock is worth a substantial discount to par because it is perpetual, yields just 0-2% and the investor has basically no ability to enforce payment (i.e., it is non-cumulative). In my view, it is worth ten – 25 cents on the dollar. The Treasury realizes this and has put in a stipulation that the preferred cannot be repurchased for below ten cents on the dollar. At some point in the future, this preferred stock may get redeemed at a large discount to par, which means it essentially turns into a grant. 

Here is an overview of the ECIP program from Investopedia and here is more information on it from the Department of Treasury: Emergency Capital Investment Program | U.S. Department of the Treasury. 

In addition to issuing $95.7 million of preferred stock to the US Treasury as part of the ECIP program, Citizens has also issued $27 million of non-cumulative preferred stock to two or more large national corporations (TD Bank is one of them) at a 1% fixed coupon. 

Trading For Less Than Six Times Earnings and About 64% of Adjusted Tangible Book Value

Citizens does not file with the SEC and is not required to file quarterly financials. Prior to the third quarter of 2023, the company chose to report earnings only once per year. In FY 2022, Citizens earned $4.51 in EPS. The ECIP preferred was issued during the middle of 2022 and thus, Citizens only earned interest income on this capital for a portion of 2022. Earnings have been dramatically higher in FY 2023 now that it is earning interest income on the $95.7 million of capital received as part of the ECIP program. 

Prior to the third quarter of 2023, Citizens did not publish quarterly earnings announcements. Fortunately, we can still get a good sense of Citizens’ quarterly earnings from the quarterly call reports required to be filed with the FDIC. Based on the first quarter 2023 and second quarter 2023 call reports Citizens has filed, I estimate the company earned $1.69 in EPS in the first quarter of 2023 and $1.83 in EPS in the second quarter of 2023. 

In the third quarter of 2023, Citizens published a quarterly earnings announcement for the first time in many years. I see this as a positive development in that it shows management’s willingness to engage with outside shareholders. During the third quarter there were two one-off items, (i) the bank received a grant of $500,000 as part of the CDFI Equitable Recovery Program, and (ii) it recorded a write-down of $3 million related to a participation loan with a banking consortium. The bank does not consider this bad loan to be an indicator of the credit quality of its broader portfolio. Adjusting for the loan write-down and the grant, Citizens earned approximately $3.5 million in net income in the third quarter ($1.81 in EPS).

In the fourth quarter of 2023, Citizens earned $4.007 million of quarterly net income at the bank subsidiary level (Source: December 31, 2023, call report). Therefore, based on the fourth quarter performance, I estimate a run rate of approximately $8 - $9 per share in annual earnings. Based on this estimate, Citizens is currently trading for five - six times its annual earnings. This is very cheap for a well-managed bank. 

Citizens is also undervalued on a book value basis. The bank has book value of approximately $30 per share ($54,227,000 / 1,786,501) based on the most recently filed Parent Company Only Financial Statements for Small Holding Companies report filed with the Federal Reserve for the period ending December 31, 2023 (link is below). Therefore, Citizens is trading at approximately 1.50 times book value ($45 / $30). I will note, the shares outstanding comes from the quote page for Citizens on the OTC Markets website (go to the tab that says “Security Details”). The share count is updated daily. 

However, that assumes the ECIP preferred is a liability at 100 cents on the dollar. Is it fair to value this liability at 100 cents on the dollar given how advantageous the terms are (to the issuing bank), and the fact that it may be redeemed for a fraction of par value in the future? My answer is no. I think it should be valued at a small fraction of its face value. If we value the ECIP preferred at 25 cents on the dollar, that adds another $71,775,000 to common equity or $40 per share ($71,775,000 / 1,786,501). Adjusted shareholders’ equity thus becomes $126,002,000 ($70.50 per share). This is a more accurate reflection of the equity value to shareholders. Based on this assessment, Citizens is trading at 64% of its adjusted book value, which, again, is very cheap for a well-run bank. 

As further supporting evidence that the ECIP preferred should be valued at a significant discount to face value, BankFirst Corp (an ECIP bank) recently purchased another ECIP bank called Mechanics Bank. As part of the acquisition, BankFirst was required to place a fair value estimate on Mechanics ECIP preferred. BankFirst valued the ECIP preferred at 21 cents on the dollar and the auditors blessed it. Here is their disclosure: 

Source: Page 59 of the BankFirst Corp 2022 annual Report

Importantly, I will note that Citizens does not have any securities that are accounted for as “held to maturity.” If it did, I would adjust book value downwards to account for any unrealized losses on such securities. 

At the current share price, Citizens is undervalued both on a book value basis and an earnings basis. That is despite my observation that smaller publicly traded community banks always tend to trade at lower valuations (in comparison to private valuation multiples for comparable banks or to larger public banks). 

I estimate that Citizens has normalized annual earnings of approximately $8 - $9 per share. Citizens is currently trading for less than six times net income and at 64% of its adjusted tangible book value. A well-run bank like Citizens should trade for a much higher multiple of earnings. In my view, a more appropriate earnings multiple is 9 – 12 times, and a more appropriate book value multiple would be 1 – 1.3 times (as illustrated in the following chart): 

I Expect Earnings To Grow

Citizens’ stock is significantly undervalued at its present level of earnings. However, this assessment ignores several opportunities for the bank to increase earnings per share over the next several years:

Increased Lending

Citizens is overcapitalized and has a surplus of capital earning a low rate of return (its excess capital is mostly invested in treasuries and held at the Fed). Citizens is focused on prudently lending this money out. As it does, the bank will earn a better rate of return on this capital than the risk-free rate (which is the return it is currently earning on this capital). 

The bank’s plan to grow the loan book and write loans in several new markets is very sound. It is expanding in a careful manner. It is hiring several highly experienced loan officers from larger banks that have deep connections in the community. It is allowing these new loan officers to work from home. So there will be no new offices or anything of the sort (at least initially). All loans need to be centrally approved. I feel very comfortable about Citizens’ plan to grow the loan book and expand in these new markets. It is expanding in a prudent manner. 

Converting assets invested at or near the risk-free rate (treasures, funds held at the Fed, agency MBS & CMBS) into loans that are yielding several hundred basis points more will be beneficial to earnings over time. 

Reinvesting Maturing Securities at Higher Rates

Citizens currently has ~$199 million of securities yielding just above 3%. The average duration of this securities portfolio is just 3.5 years. Every dollar of securities that is maturing is getting reinvested at 5% - 6%+ (treasuries, agency MBS, agency CMBS, etc.). Assuming rates stay roughly where they are now, this will add $3 - $4 million in additional annual pretax income over the next several years. 

Renewing Loans at Higher Rates

Citizens has approximately $150 million of loans maturing or repricing over the next 12 months. A large portion of these loans were made when rates were much lower. One-third of its loan book is comprised of variable rate loans that have already repriced higher. The other two-thirds are fixed rate loans that were written when rates were much lower. These fixed rate loans are being renewed at rates 200 - 300 basis points higher. I anticipate additional annual interest income on these loans of $2.5 million ($150 million multiplied by uplift of 250 basis points multiplied by 2/3rds = ~$2.5 million). 

Empowerment Fund

Citizens has partnered with JP Morgan on the Empowerment Fund. This is an ESG-focused money market fund, and it will generate fee income for Citizens. This could be very impactful for Citizens over time. Citizens’ CFO expects the fee income from this to grow to several million per year in the near future. Perhaps dramatically more! This will be reflected in non-interest income. 

Additional Grants, Partnerships With New And Existing Large Corporates, Etc.

Citizens has relationships with various Fortune 500 companies that have chosen to do business with the bank to further their ESG initiatives, including the NFL, JP Morgan, Tractor Supply, Coca Cola, Netflix, Delta Airlines, TD Ameritrade, and others. Citizens has done a good job attracting these partners due to the bank’s status as an MDI and CDFI. These partnerships have various forms, some of these national corporations have borrowed money from Citizens (such as the NFL), some of these companies have deposits with Citizens and, in the case of JP Morgan, Citizens has partnered with them on an ESG-focused money market fund. Citizens’ management team is bullish about doing further deals with large companies. If Citizens is successful in doing so, this will have a significant impact to its bottom line. 

Additionally, it is possible Citizens could secure additional low cost preferred and/or grants. In the 3rd quarter of 2023, it received another grant of $500,000. 

Share Repurchases

When I recently spoke to the management team, one of my main takeaways was that they intend to repurchase a lot of stock. Citizens is already buying back stock, which is extremely accretive to per share value at the present share price and demonstrates that the management team is shareholder friendly. In the first half of 2023, the bank repurchased 100,000 shares, equivalent to 5% of the shares outstanding. Additionally, in their third quarter 2023 earnings release, Citizens announced the board authorized a share repurchase of up to $4.5 million. On the OTC markets quote page, Citizens updates its shares outstanding daily (go to the “Security Details” tab). We can see that its share count is down to 1,786,501. Thus, in the fourth quarter of last year it repurchased a significant amount of stock. The bank is barely even getting its feet wet with the $4.5 million share buyback authorization that was announced. Based on my impressions from conversations with the management team, I anticipate that the bank may buy back at least 10 - 20% of shares outstanding on an annual basis going forward (if the stock price remains low), potentially more. The restrictions in the ECIP program will not prevent this. I also anticipate it will continue raising the dividend. 

Headwinds

I outlined above how Citizens has various opportunities to increase earnings. However, this is going to be offset somewhat by higher liability costs. Deposit costs will go up and it will begin paying a dividend on the ECIP capital (unless the zero-interest period gets extended by the Treasury). On a net basis, I anticipate these earnings tailwinds noted above will more than offset both the higher rates paid on deposits and the cost of the ECIP capital. Let’s explore these items in more detail: 

• Citizens is paying out approximately 100 bps in interest on their $312 million in interest bearing deposits (source: December 31, 2023, call report). I anticipate the bank will need to increase deposit rates meaningfully. Deposits at Citizens Trust Bank fell from $666,556,000 on March 31, 2023 to $617,416,000 on September 30, 2023 (a decline of 7.4%). However, in a positive sign, in the fourth quarter of 2023, both interest bearing and non-interest bearing deposits increased. Over time, the bank’s deposits have been roughly 40% non-interest bearing and 60% interest bearing. Management hopes to maintain this ratio going forward. One of the advantages that Citizens has is that its deposits are stickier than a typical bank. The non-interest-bearing deposits are primarily core local deposits from long-term customers with whom they have a strong relationship. The interest-bearing deposits are largely deposits from large national corporations that believe in Citizens’ mission and intend to be long-term partners with the bank. Despite the stickiness of their deposits, I assume it will end up paying much higher rates on interest-bearing deposits going forward to compete with other banks. The CFO told me that he anticipates it will need to raise deposit rates. If interest rates stay roughly where they are now, he anticipates needing to raise deposit rates over time and this will likely cost the bank an additional $1 - $2 million per year in interest expenses. 

• It will also have to pay approximately $2 million per year for the ECIP preferred (beginning in the second quarter of 2024). That is a total of $3 - $4 million per year in headwinds on the cost side. 

Overall, these headwinds will not be that detrimental. The CFO anticipates the increased interest income from its securities and loan book more than offsetting these headwinds. He expects their NIM to expand in the years ahead. 

Summary of Headwinds and Tailwinds

Here is a summary of some the headwinds and tailwinds I see going forward, along with an illustrative example of how much each of these items could impact annual pretax earnings: 

Headwinds

• Higher rates paid on deposits ($1 - $2 million per year)

• ECIP dividend kicking in during the second quarter of 2024 (approximately $2 million per year)

Total headwinds: $3 - $4 million per year.

Tailwinds

• Reinvesting maturing securities at higher rates ($4 - $5 million per year)

• Renewing loans at higher rates ($2.5 million per year)

• Converting risk-free securities into loans that yield meaningful more than the risk-free rate (I've given the bank no credit for this, but it will likely be very material) 

• Empowerment Fund ($1 - $2 million per year)

• Additional grants, partnerships with new and existing large corporations etc. (I give the bank no credit for this, but it may be material)

• Reducing shares outstanding (this doesn’t impact pre-tax earnings, but it will benefit EPS)

Total tailwinds: $7.5 - $9.5 million per year.

I do not anticipate loan losses growing a whole lot (unless we go into a deep recession). 

My expectation is that non-interest expense will grow with inflation or slightly ahead of inflation (even factoring in expansion plans).

Earnings are very likely to grow, and there is a strong chance it will be material. Adding up the items above, I calculate $3.5 - $6.5 million in additional annual pre-tax income (giving Citizens no credit for growing the loan book or additional grants or partnerships). After accounting for taxes at 23% and dividing by 1,786,501 shares outstanding, per share earnings could rise by $1.50 - $2.80 annually over the next few years (again, giving the bank no credit for loan growth or additional grants, partnerships, etc.). Also, this is prior to factoring in additional share repurchases. 

The bank’s earnings will be divided over a dramatically smaller number of shares outstanding (if it is successful in buying back stock) which means a much higher EPS. It is very possible it will reduce shares outstanding by 30% or more. Factoring in the earnings growth outline above divided over a smaller share base means EPS could grow to $13.50 - $16.90 per share. Imagine if Citizens’ stock trades at a more reasonable multiple of 9 – 12 times those earnings?  I see substantial upside from today's share price in the years ahead. To be clear, this should be considered a bull case. But I think this outcome has good odds of playing out in the next few years. Citizens’ stock is undervalued even if earnings do not grow from the current level. 

Why Is the Stock Undervalued?

Here are the reasons why I think Citizens is undervalued:  

Few investors have likely bothered to understand the ECIP program. How many people (including the senators that voted for it) have actually bothered to read this 2,124 page document that spells out the terms (go to PDF page 899): https://www.congress.gov/116/bills/hr133/BILLS-116hr133enr.pdf

Citizens has a small market capitalization and is under the radar. As further evidence that this bank is undiscovered, I was told only three shareholders bothered to show up to the annual shareholders meeting in 2023!

The company does not file financials with the SEC (they did until 2017) and until the third quarter of 2023 it did not file quarterly earnings updates for shareholders (this is why I need to use the call reports to estimate their quarterly earnings). In all four quarters of FY 2023, Citizens’ earnings have significantly risen year over year, yet this hadn’t been disclosed in any earnings release or other public documents (except for the call reports) until the third quarter release.

In general, banks are unloved right now after the recent failures of Silicon Valley Bank and Signature Bank. 

There are 204 ECIP recipient banks. Ten of these banks are publicly traded. Of those, most of them are poorly run banks. I have seen some online discussion of the ECIP banks by fund managers (on Twitter, etc.). It seems many of the public equity investors who have discovered how impactful the ECIP program is for these banks simply disregard the public ECIP banks as investment opportunities because most of these banks are poorly run. That is true for most of the ECIP banks, but I do not see any evidence that Citizens is poorly run. Citizens is an exception.

Risks and Other Considerations

Citizens took over a century to accumulate $50 million in equity (which is what the bank had just prior to being awarded ECIP funds). Common equity + preferred equity have now ballooned to over $170 million overnight as a result of the ECIP program. The management team will need to handle this growth properly. It is critical that they do not relax underwriting standards to get this windfall of money lent out. The key question is: will Citizens successfully grow and adapt to this new reality? To grow the loan book, it is lending in new states: Texas, Tennessee, and Louisiana, where the bank does not have any prior experience operating. I have confidence in the management team, but this expansion is something to continually monitor. 

It is well known that commercial real estate is going to face increasing pain in the future. Therefore, it is fair to assume that Citizens will face some loan losses on its commercial real estate book, which totals approximately $150 million out of a total loan book of $373 million. Citizens has proven over time to be good underwriters. I am comfortable with the loan book for the following reasons: 

1. All impressions I have demonstrate that the management team is conservative, disciplined, and risk-averse. 

2. The upper management team and board own a lot of stock, which incentivizes them to think like owners. 

3. Over time the bank has proven itself to be a good credit underwriter. Since 1997, the worst year for actual credit losses for the bank was 2011 when actual net credit losses were 2% of the loan book. This is quite remarkable given the segment it lends to tends to have higher loss rates and the fact that the Georgia had the second highest number of bank failures in the country. Additionally, Atlanta’s unemployment rate was twice the national average and property values were hit harder than average. Despite that, Citizens never lost money during the GFC and has not lost money in any of the last 30 years. In its 112-year history, Citizens has only lost money in two years. Their track record is good. 

4. I have spent a considerable amount of time discussing the loan book with the management team which has left me comfortable. The CFO is very confident that loan losses will remain steady going forward (even though the economy may be weakening). This management team is old school and conservative – just what you want to see. Every single loan the bank writes (over a certain threshold) is reviewed by the entire management team before they fund it. Loans below that threshold still need to be approved by the chief credit officer. This team is very careful. I pressed him about their commercial real estate exposure. The CFO knows every single loan on the books and said that the bank has no risky commercial real estate exposure. He said Citizens has just two office loans across the entire loan book. 

Another risk is falling interest rates. Citizens is an asset sensitive bank, and they are quite exposed to short-term rates because of all of the short-term securities on their balance sheet. If short-term rates were to fall dramatically, its earnings would take a hit in the near term. Over time the bank will be fine because it is slowly converting these short-term securities into loans, at which point it will be less impacted by changes in short term rates. The mitigants to this potential risk are: 

1. Citizens has been pushing out duration to protect the bank’s earnings if rates fall. 

2. Even if short-term risk-free rates were to fall 100-200 basis points, I do not think its earnings would go down because its fixed rate loans and securities portfolio are still at much lower rates (as noted earlier in the write-up). But it would take away the earnings upside I discussed. 

3. We are paying such a low price in comparison to current earnings and adjusted book value that even in the scenario where rates fall meaningfully, Citizens is still undervalued. 

Deposits have declined over the past year and continued deposit flight remains a risk. Based on conversations I have had with the management team, the reasons deposits have fallen are not related to customers seeking higher rates but rather a few one-off losses of deposits from several large clients (including Circle, a crypto firm). 

Links And Other Information:

Citizens Trust Bank RSSD ID: 680130

Link to access call reports: https://cdr.ffiec.gov/public/ManageFacsimiles.aspx

Link to the ECIP program information from the U.S. Department of Treasury’s website: Emergency Capital Investment Program | U.S. Department of the Treasury

SEC Filings from when Citizens Bancshares was SEC registered: https://www.sec.gov/edgar/browse/?CIK=813640

Citizens Bank 2022 annual report to shareholders: https://ctbconnect.com/wp-content/uploads/2023/04/2023-FULL4-17-23-Citizens-Bancshares-2022-Annual-Reportv4.pdf

Citizens Bancshares investor relations website: https://ctbconnect.com/investor-corporate-governance-information/

OTC Markets stock information on Citizens Bancshares: https://www.otcmarkets.com/stock/CZBS/overview

Citizens Trust Bank partnership with the NFL:  https://newsroom.bankofamerica.com/content/newsroom/press-releases/2023/06/the-nfl-secures--78-million-in-loans-from-minority-banks--streng.html

“Deputy Secretary of the Treasury Wally Adeyemo and SBA Administrator Isabella Casillas Guzman Meet with Black Small Business Owners and Entrepreneurs in Atlanta”: https://home.treasury.gov/news/press-releases/jy1283

“TD Bank invests $5 million in Citizens Trust Bank, a minority-owned financial institution serving the Atlanta region for over 100 years”: https://www.otcmarkets.com/stock/CZBS/news/TD-Bank-invests-5-million-in-Citizens-Trust-Bank-a-minority-owned-financial-institution-serving-the-Atlanta-region-for-o?id=382172

and

https://stories.td.com/us/en/article/td-bank-invests-5-million-in-citizens-trust-bank-a-minority-owned-financial-institution-serving-the-atlanta-region-for-over-100-years

“Delta, Citizens Trust Bank continue to build financial mobility in Atlanta’s underserved communities”: https://news.delta.com/delta-citizens-trust-bank-continue-build-financial-mobility-atlantas-underserved-communities

Citizens Bancshares board of directors: https://ctbconnect.com/learn-more-about-ctb/board-of-directors/

2,124 page bill which spells out the ECIP program (ECIP Program begins on page 899): https://www.congress.gov/116/bills/hr133/BILLS-116hr133enr.pdf

https://www.atlantafed.org/banking-and-payments/reporting/fry6 Search: “CITIZENS BSHRS CORP”

Citizens Trust Bank receives funds through the JP Morgan Empower class money market funds shares: https://news.delta.com/delta-citizens-trust-bank-continue-build-financial-mobility-atlantas-underserved-communities

“How Black Banks Are Tapping Into Banking Giant To Make A Difference”: https://www.blackenterprise.com/how-black-banks-are-tapping-into-banking-giant-to-make-a-difference/

Link to Citizens Bancshares’s parent only financial statements: https://www.ffiec.gov/npw/Institution/Profile/1078958?dt=20220920

Citizens Bancshares Balance Sheets 1997 – 2022: https://docs.google.com/spreadsheets/d/1ZCKphUMNjLD4XciWulyroWchDQ0am7oI/edit?usp=sharing&ouid=101187181140865215866&rtpof=true&sd=true

Citizens Bancshares Income Statements 1997 – 2022: https://docs.google.com/spreadsheets/d/1ZCZceHbxnjgL1nca_P7PmR3Rm-gmWUKu/edit?usp=sharing&ouid=101187181140865215866&rtpof=true&sd=true

Third Quarter 2023 Earnings Release: https://www.otcmarkets.com/otcapi/company/dns/news/document/70525/content

Disclosure

This has been prepared solely for informational purposes. Information herein is not intended to be complete, and such information is qualified in its entirety. This is not an offering or the solicitation of an offer to purchase an interest in any fund, and it is not an offer to buy or sell or a solicitation of an offer to buy or sell any security. Nothing herein should be construed as investment advice, an opinion regarding the appropriateness or suitability of any investment, on an investment recommendation. No representation is made that the objectives or goals of any investment or strategy will be met or that an investment or strategy will be profitable or will not incur losses. Past performance is no guarantee of future results. Reliable methods were used to obtain information for this presentation but the information herein cannot be guaranteed for accuracy or reliability; the information in this presentation may be out of date or inaccurate.

Catalyst

Share repurchases.

Increased dividend.

EPS growth.

Increased engagement with shareholders.

Improved sentiment for bank stocks.