BHB - Bar Harbor Bankshares: Rosy Earnings Outlook Attractive Valuation

2023-04-07 01:05:16 ET

Summary

• The margin will continue to expand this year due to rate hikes and the margin’s moderate rate sensitivity. Further, loan additions will boost the margin.
• New England’s economic metrics indicate healthy credit demand.
• BHB’s risk level appears satisfactory despite the unrealized losses which are as large as 20% of the equity value.
• The year-end target price suggests a high upside from the current market price. Further, BHB is offering a moderately-high dividend yield.

Earnings of Bar Harbor Bankshares ( BHB ) will most probably continue to grow strongly this year on the back of further margin expansion. New England’s economic strength will also play a role in earnings growth as it will support loan growth. Overall, I’m expecting Bar Harbor Bankshares to report earnings of $3.24 per share for 2023, up 12% year-over-year. Compared to my last report on the company, I haven’t changed my earnings estimate much. The year-end target price suggests a high upside from the current market price; therefore, I’m maintaining a buy rating on BHB stock.

Margin Expansion is a Big Earnings Catalyst for 2023

Bar Harbor Bankshares’ net interest margin continued to grow strongly in the fourth quarter of 2022 as asset re-pricing outweighed deposit re-pricing. This is quite an achievement as the deposit book is quicker to re-price than the loan portfolio. Variable-rate loans made up 42% of total loans, while variable-rate deposits (NOW, savings, and money market) made up 67% of total deposits at the end of 2022, according to details given in the 10-K Filing . The credit for the margin expansion then goes to good management who controlled costs and pushed up yields.

Another evidence of good management is that the deposit mix considerably improved last year. Even though the sharp up-rate cycle provided a greater incentive for depositors to shift their funds from non-paying accounts to higher-rate accounts, the proportion of costly time deposits in total deposits actually declined last year.

I’m expecting the margin to continue to expand this year because I’m expecting a further 25-50 basis points hike in the fed funds rate till the mid of 2023. Further, last year’s rate hikes will also boost the margin this year due to the maturity of fixed-rate loans. According to details given in the 10-K Filing, fixed-rate loans maturing this year amounted to $19.8 million, or 1% of total loans. The difference between rates on the outgoing fixed-rate loans and rates on new loans could be as high as the cumulative fed funds rate hikes of 475 basis points in this cycle so far.

I’m also expecting decent loan growth this year (discussed below), which will further boost the average asset yield and thereby lift the margin. The results of the management’s rate-sensitivity analysis given in the 10-K filing show that a 200-basis point hike in interest rates could increase the net interest income by 2.3% in the first year and 6.9% in the second year of the rate hike.

Considering the factors given above, I’m expecting the margin to grow by 20 basis points in 2023. In comparison, the margin rose by 97 basis points from period-end 2021 to period-end 2022.

New England’s Economic Strength to Sustain Loan Growth

Bar Harbor Bankshares’ loan growth slowed down to 1.8% in the fourth quarter of 2023, which led to full-year loan growth of 14.7%. A further slowdown is likely from the fourth quarter’s level because interest rates have increased since then. The higher borrowing costs are bound to hurt credit demand.

However, other economic factors currently appear in favor of loan growth; therefore, the growth is unlikely to dip too low. Bar Harbor operates in the region of New England, with branches in Maine, New Hampshire, and Vermont. House prices in the region have cooled down of late, which bodes well for housing affordability and consequently mortgage demand. Moreover, the unemployment in the region is enviably low, which indicates healthy business activity and consequently strong commercial loan demand. Further, a low unemployment rate means that BHB will have a lot of good potential retail customers, and it does not have to be too cautious or picky when it decides to lend.

Personal income in the region has also been growing at a satisfactory rate in the region since a dip in early 2022, according to Boston Fed .

Considering these factors, I’m expecting the loan portfolio to grow by 5% in 2023, which is below last year’s rate but higher than the historical CAGR of 3% for the last five years. Further, I’m expecting deposits to grow in line with loans. The following table shows my balance sheet estimates.

In my last report on Bar Harbor Bankshares, which was published in November 2022, I estimated earnings of $3.31 per share for 2023. I’ve barely changed my earnings estimate because the fourth quarter’s results were as expected, and my outlook hasn’t changed much since my last report.

Risk Level Appears Satisfactory Despite Large Unrealized Losses

Even though Bar Harbor’s available-for-sale (“AFS”) securities portfolio isn’t too large, the rising interest-rate environment has racked up huge unrealized mark-to-market losses on the portfolio. These unrealized losses totaled $79 million at the end of December 2022, which is around 20% of total equity at the end of the year or 1.8 times the net income reported for last year. I’m expecting all these losses to start reversing next year when the down-rate cycle starts. However, there is a very slim chance that a deposit run, or some other extraordinary stress event, could force the company to sell its securities portfolio, thereby turning the unrealized losses into realized losses.

Apart from the unrealized losses, Bar Harbor’s risk level is low due to the following.

1. Uninsured deposits were just 11% of total deposits at the end of December 2022, as mentioned in the 10-K filing.
2. BHB does not have material exposure to start-ups, cryptocurrencies, or digital tokens.
3. The total capital ratio stood at 13.50% at the end of December 2022, which is much higher than the minimum regulatory requirement of 8.00%.

Maintaining a Buy Rating

Considering the earnings outlook, I’m expecting the company to increase its dividend by $0.02 per share to $0.28 per share in the second quarter of 2023. The earnings and dividend estimates suggest a payout ratio of 34% for 2023, which is below the five-year average of 42%. Based on my dividend estimate, Bar Harbor is offering a forward dividend yield of 4.4%.

I’m using the historical price-to-tangible book (“P/TB”) and price-to-earnings (“P/E”) multiples to value Bar Harbor Bankshares. The stock has traded at an average P/TB ratio of 1.34x in the past, as shown below.

The stock has traded at an average P/E ratio of around 12.0x in the past, as shown below.

Equally weighting the target prices from the two valuation methods gives a combined target price of $32.4 , which implies a 29.5% upside from the current market price. Adding the forward dividend yield gives a total expected return of 33.9%.

In my last report written in November 2022, I adopted a buy rating with a December 2023 target price of $33.6. Since then, the stock price has plunged largely due to the increased risk level in the banking sector following the recent bank failures. As I discussed above, the company’s risk level appears manageable. Therefore, the market seems to have overreacted in Bar Harbor’s case. Considering my updated total expected return, I’m maintaining a buy rating on Bar Harbor Bankshares.

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