Heightened gains on sales of mortgage and small business loans propelled the earnings of First Internet Bancorp (NASDAQ: INBK) this year. A normalization of mortgage banking revenue and lower gains from sales of small business loans will likely pressurize earnings next year. However, strong margin expansion will likely undermine the normalization of gains from sales of loans. A considerable number of costly Certificates of Deposits are scheduled to mature within a year, which will drive up the margin. Further, the average earning assets yield will likely increase as INBK will have the opportunity to deploy some of its excess cash into higher-yielding assets. Overall, I’m expecting INBK’s earnings to increase by 5% year-over-year to $2.86 per share in 2021, from an estimated $2.73 per share in 2020. INBK’s stock price is already quite close to the year-ahead target price, which shows that the prospects of earnings growth are already priced-in. Hence, I’m adopting a neutral rating on INBK.
Lower Gains on Sales of Loans to Drag Earnings
One of the major drivers for INBK’s earnings this year was heightened gains on sales of small business loans. The management appeared optimistic about small business loans that it can originate for sale in the third quarter’s conference call. Small business loans generally carry a partial guarantee from the Small Business Administration (“SBA”). INBK sells the government-guaranteed portion of the loans in the secondary market and retains the remaining loans and servicing rights, as mentioned in the third quarter’s 10-Q filing. The management mentioned in the conference call that it expected SBA loan production to exceed $235 million next year, translating into gain-on-sale revenue of $12 million to $14 million for 2021. The management’s target appears quite ambitious considering INBK booked gains on sales of loans of $5 million in the first nine months of 2020. Moreover, the outlook for small businesses does not appear bright. Immunization of the general population against the COVID-19 pandemic can take several months; hence, the economic growth will likely remain low next year, which will hurt small businesses. Further, the COVID relief bill recently passed by Congress allocates only $284 billion to the Paycheck Protection Program (“PPP”) for small businesses, as opposed to an allocation of $659 billion under the CARES Act. The recent bill was yet to be signed by the President at the time of the writing of this report.
Another driver of non-interest income and earnings this year was heightened mortgage banking revenue. As interest rates will likely remain stable next year, the incentive to refinance mortgages will taper off leading to lower refinance activity. The Mortgage Bankers’ Association expects refinancing volume to decline almost linearly to a normal level over a couple of years. Considering the expected drop in mortgage banking revenue and gains on sale from small business loans, I’m expecting non-interest income to drop by 14% year-over-year in 2021.
Loans held for investment (as opposed to sale) will also suffer from the slow economic recovery and lower government budget for PPP. Consequently, I’m expecting the loan portfolio to grow by 2.0% next year, which is below the historical trend. The following table shows my estimates for loans and other balance sheet items.
A Large Amount of Maturing Deposits Provide Opportunity to Increase Margins
INBK’s net interest income will likely trend upwards in the coming quarters because its deposit cost is in a position to significantly decline. Certificates and brokered deposits made up more than half of INBK’s total deposits at the end of the last quarter; hence, most of INBK’s deposits have not yet been re-priced. As mentioned in the third quarter’s investor presentation, $931 million of Certificates of Deposits (“CD”) with a weighted average cost of 2.02% will mature through the mid of October 2021. The replacement cost for CDs was around 0.5% at the time of the presentation. Consequently, according to my estimates, the maturity can reduce total deposit cost by around 40 basis points through the third quarter of 2021.
Further, the management sees an opportunity to increase yields in the coming quarters by redeploying excess cash and other lower-yielding assets into higher-yielding loans, as mentioned in the conference call. Even if INBK is unable to deploy excess liquidity into loans because of limited lending opportunities, I’m not too worried because the yield curve has gotten steeper and INBK can easily get higher yields by moving excess cash into longer tenor treasuries. The following chart shows the current yield curve (blue line) against historical yield curves at the end of the last three quarters. The Source of the data is the U.S. Treasury Department.
I’m not expecting the yield curve to get steeper in the future because the Federal Reserve intends to maintain its asset purchase program until the economy achieves maximum employment, as mentioned in the latest statement. Asset purchases by the Fed tend to keep yields low. Considering these factors, I’m expecting the average net interest margin (“NIM”) for 2021 to be 24 basis points above the average for 2020. Based on my projections for NIM, loans, and other earning assets, I’m expecting INBK’s net interest income to increase by around 20% year-over-year in 2021.
Expecting Earnings of $2.86 per Share in 2021
The margin expansion and low loan growth will likely drive earnings next year. On the other hand, the expected decline in mortgage banking revenue and a reduction in gain on sales of small business loans will likely limit the earnings growth. Overall, I’m expecting INBK to report earnings of $2.86 per share in 2021, up 5% from my expected earnings of $2.73 per share in 2020. The following table shows my income statement estimates.
Actual earnings may differ materially from estimates because of the risks and uncertainties related to the timing and efficacy of the general population’s immunization against COVID-19. However, the credit risk of INBK’s portfolio is quite low as loans requiring deferrals made up just 0.7% of total loans as of October 16, 2020, as opposed to a peak of 21.9% of total loans in mid-May, as mentioned in the presentation.
Earnings Growth Outlook Appears Somewhat Priced-in
I’m using the historical price-to-tangible book multiple (“P/TB”) to value INBK. The stock has traded at an average P/TB ratio of around 0.85 in the past, as shown below.
Multiplying the average P/TB multiple of 0.85 with the forecast tangible book value per share of $35.5 gives a target price of $30.3 for the end of next year. This price target implies only a 4.8% upside from the December 24 closing price. The following table shows the sensitivity of the target price to the P/TB ratio.
Apart from the small potential price upside, INBK is also offering a very low dividend yield of 0.8%, assuming the company maintains its quarterly dividend at the current level of $0.06 per share. INBK has maintained its dividend at the same level since 2013; therefore, I’m not expecting the company to increase its dividend now. The price upside and dividend yield give a total expected return of only 5.7% for next year. I’m adopting a neutral rating on INBK because its market price is already quite high and close to the year-ahead target price. I would consider investing in the company if its stock price dipped by at least 10%.
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.
Additional disclosure: Disclaimer: This article is not financial advice. Investors are expected to consider their investment objectives and constraints before investing in the stock(s) mentioned in the article.