Bottom of the Barrel: Watch for a Higher Fidelity National

Small community bank Fidelity National Corporation (LION) looks ready to roar.

This once-sleepy Atlanta-based bank -- now the ninth largest in metropolitan Atlanta -- is making strides in its strategy, with perfect timing. As the economy improves, a new wave of community bank consolidation is likely, and given the recent merger activity among Atlanta banks, Fidelity National could fetch a premium from the right suitor.

Rebuilding Credit

Chartered in 1974, Fidelity's early strategy was to build its credit card business. In 1995, the company aggressively sought credit card accounts by soliciting new homebuyers nationwide. Although the plan initially worked -- Fidelity earned $1.01 a share in 1995 -- bad credit card debt soared. The company took charge-offs of more than $14 million and reported a $1.24 per-share loss in 1996. On the brink, Fidelity reached an agreement with regulators to shrink its balance sheet, slash its dividend and raise additional capital.

Plus, the bank shifted its focus to non-credit card assets. Credit card loans now represent only 10% of its portfolio, vs. nearly 40% in 1995.

At a Glance Fidelity National (LION:Nasdaq)
Recent Price	$10.49
52-Week Range	$11.05-$5.65
P/E Ratio	17.20
Market Cap	91.3 million
Avg. Daily Volume	21,681
Institutional Ownership	15%
Dividend Yield	1.90%
Beta	0.72
Corporate Web site	www.fidelitynational.com
Source: Market Guide, TSC Research

However, in 1998, just as Fidelity was regaining its footing as well as favor with regulators, the bank uncovered an accounting error that caused Fidelity to restate 1997 earnings. Then in 1999, one of Fidelity's largest loan customers filed for bankruptcy, causing the bank to take significant write-offs and post lower-than-expected earnings.

The bank continues to operate under an agreement with bank regulators as a result of those and other minor regulatory issues. Though regulator involvement has weighed on the stock, Fidelity has responded to requests of regulators, and absent additional misdeeds, the bank should pass an upcoming compliance audit, allowing it to regain control of its operations and proceed with new growth initiatives. The bank now has $958 million in assets and about $800 million in deposits.

Profitable Opportunities

Fidelity's asset mix is what you'd expect from a community bank: Loans make up 87% of the earning assets, and interest income is 61% of total revenue. Its loan portfolio is about 50% consumer debt. Residential mortgages are about 20%, and commercial and construction loans are just over 20% of the portfolio.

Real opportunity lies in growing its commercial lending, primarily to middle markets. Commercial credits are typically $750,000 to $1 million, and construction loans are largely made to developers selling single-family homes for $150,000 to $250,000.

"Given the improving economy, low base of about $160 million [in commercial loans] and the large market opportunity in Atlanta, we are expecting 15%-plus growth in this category," says SunTrust Robinson Humphrey banking analyst Jennifer Demba. She rates the stock a buy with a $15 price target. Her firm has not provided banking services for Fidelity. Fidelity shares were lately trading at roughly $10.50.

"Operating revenue should increase 15% in 2002, based on solid loan growth, margin expansion and fee income enhancements," she adds. "Our operating earnings estimate for 2002 is 50 cents, implying almost 100% year-over-year growth in operating earnings per share." She also notes the company is evaluating a number of marginal and higher-risk business lines that may be jettisoned, further improving margins.

Banking on Growth Fidelity National gets ready to rumble
	Operating Revenue (in millions)	EPS
2000	$55.30	0.44
2001*	54.80	0.29
2002*	63.70	0.55
2003*	66.80	0.70
*Estimates. Source: Thomson Financial, SunTrust Robinson Humphrey, company reports.

As large mergers continue in the Atlanta banking market, Fidelity has an opportunity to steal some customers who are disenchanted with large, impersonal banks. "Wachovia's (WB) merger with First Union should present Georgia community banks with a golden opportunity to woo customers," Demba says. "There also may be opportunities to acquire divested branches. We think Wachovia will have to divest 50 or more branches in Atlanta next year."

If a new wave of community bank consolidation happens, which is quite likely, Fidelity will probably get a knock on its door. "We expect major bank holding companies like BB&T (BBT), Royal Bank of Canada (RY) and National Commerce Financial (NCF) will look for more acquisitions in Atlanta," says Demba.

Steering Clear

Of course, a prolonged economic slowdown could lead to decreased loan demand and more problem loans. In addition, potential shareholders should note two risks unique to Fidelity.

1. Regulatory risk: Although Fidelity seems to be near a clean bill of health, it has come close before only to find new problems. A late-summer or early-fall bank examination will be key to increasing Fidelity's attractiveness.

2. Indirect auto lending: The bank is a significant player in the business of buying auto loans from car dealers and packaging them for resale to large credit institutions. This type of consumer lending makes up 42% of the company's loan portfolio. Rising interest rates could affect both volume of auto lending and the margins at which Fidelity could resell loan portfolios.

   However, as Fidelity continues to rework the mix of its lending portfolio, the relative size of auto lending should decline.

Fidelity is part turnaround story, part growth story. Given the understood risks in this stock, I give Fidelity National three barrels. (For an explanation of our barrel rating system, see our description.)

Barrel Break

As I work on compiling the quarterly earnings of all stocks in the Barrel portfolio, Barrelology is taking a one-week hiatus. I'll be back next week with more insight and a slightly redesigned presentation of historical results. Stay tuned!

---

Do you have candidates for Bottom of the Barrel? If so, shoot me an email with the company's name, why you think it qualifies, and your full name and hometown. If I profile your suggestion, I'll send you a TSC gift to commemorate your pick.

Christopher S. Edmonds is president of Resource Dynamics, a private financial consulting firm based in Atlanta. At time of publication, neither Edmonds nor his firm held positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Edmonds cannot provide investment advice or recommendations, he welcomes your feedback and invites you to send it to Chris Edmonds.