IBTX - Independent Bank Group: Growth Hampered Sustainability Unperturbed

2023-04-26 01:17:00 ET

Summary

• Independent Bank Group, Inc. started the year with mixed results.
• Its solid asset quality and excellent financial positioning are its strong foundations.
• Macroeconomic headwinds may persist, but improvements may materialize.
• Dividend payouts continue to increase with enticing yields.
• The stock price has decreased for over a year, making it cheap.

In a high-inflation environment, banks benefit from higher loan and security yields. But it also comes at a high price as deposits and borrowings become more expensive. The same scenario applies to Independent Bank Group, Inc. (IBTX). Margins have contracted as interest and non-interest expenses skyrocketed. Worse, it had to deal with the Stanford Ponzi Lawsuit, leading to a net loss.

On a lighter note, the company stays resilient with its solid asset quality and high liquidity. Its prudent management of loans, securities, and deposits remains one of its cornerstones. Also, its liquid assets are high and stable, which can cover its operating capacity, outstanding borrowings, and dividends. Indeed, the company remains sustainable.

Meanwhile, the stock price has been in a downtrend for over a year. The plunge became sharper this quarter. It was logical, given the macroeconomic uncertainties and the litigation it faced. Despite this, IBTX stock stays enticing, given the high upside potential.

Company Performance

The market landscape is still risky for banks like Independent Bank Group, Inc. Macroeconomic volatility is evident as interest rate increments continue. It must beware of a mild recession this quarter. Even so, the bank continues to withstand all these disruptions with its solid fundamentals. It faced more challenges at the start of the year, but it showed a high capacity to bounce back.

Its operating revenue reached $201.17 million in 1Q 2023, a 43% year-over-year growth. It was a massive improvement, given the threats posed by inflation and interest rate hikes. As a bank, its operating revenue comes in the form of interest income. Interest and fees on loans comprised 90% of the total interest income. It was reasonable since its loan portfolio accounted for over 70% of the total assets. The substantial increase in loan yields from 1.02% to 1.45% was also noticeable. Indeed, interest rate hikes worked to IBTX's advantage and drove loan yields. Meanwhile, its active loan repricing was instrumental in stabilizing loan volume. This move helped the company ensure consistent loan repayments. More importantly, IBTX maintained solid loan quality to avoid or at least minimize defaults and delinquencies. Its nonperforming loans were only 0.27% of the total loans in 1Q 2023 versus 0.59% in 1Q 2022 and 0.29% in 4Q 2022. Also, loan composition was crucial in the sustainability yields and payments. Nearly 20% of loans were C&I loans, which were more secure. Meanwhile, 80% were real estate loans, with the vast majority coming from the commercial segment. These loans may be riskier these days, given the current real estate market changes. But given the secure collateral, the bank can limit risks. We will discuss more of these in the following section.

Investment security and deposit yields comprise the remaining 10% of revenues. Interest income on investment securities was slightly lower than in 1Q 2021. Fortunately, the decrease was only 2%. We can also attribute it to the continued interest rate hikes, which could affect security yields. The consolation was that most of its securities are backed by the government and government-sponsored enterprises. In essence, their nature is more suitable in the current macroeconomic environment. They can hedge valuation losses better and may have better yields. It could only be challenging to sustain yields since interest rate hikes persisted. Meanwhile, its deposits in other banks paid off. Despite the lower balance last quarter, higher interest rates led to higher deposit yields. Overall, interest rate increments have a mixed impact. But it was more favorable in sustaining revenue growth.

However, inflation and interest rate hikes also came with higher expenses. They made the cost of deposits and borrowings more expensive. Deposits decreased, but borrowings rose by more than five times. In turn, interest expenses increased by more than seven times from 1Q 2022. The difference between interest income and interest expense contracted to $127.92 million versus $131.15 million. So, the impact of interest expense offset the increase in interest income. Moreover, it incurred litigation expenses of $102 million, leading to an operating loss -$49 million. Nevertheless, the company would have remained profitable if we would only consider its interest segment. And without litigation expenses, the non-interest segment would have been stable. The operating margin dropped to -24% versus 45% in 1Q 2022. If we exclude the impact of litigation expenses, the operating margin will increase to 26%, still lower than the previous quarters. We can also see the uninterrupted decrease in the operating margin in 2022, showing that inflation affected expenses more than revenues.

This year, the company may face the same macroeconomic headwinds. Its first-half performance may remain flat as interest rate hikes continue. Despite this, we may see improvements in the succeeding quarters since the company has already recognized litigation expenses in its income statement. And by this time, the company now has a better grasp of the economy as inflation relaxes. We will discuss it further in the following section.

How Independent Bank Group, Inc. May Remain Sound This Year

We already saw how Independent Bank Group, Inc. fared from 2022 to the first quarter of 2023. Indeed, inflation can be a double-edged sword for the banking industry. What matters is how banks manage their earning asset portfolio and liabilities. IBTX was also successful as it remained profitable if we disregard the impact of litigation. Yet, it must watch out for the risks still present that may affect its performance. It survived the litigation that may have a lasting impact on its reputation. It must be more cautious to maintain the trust of its clients and borrowers. Interest rates can also impose more risks as increments continue. These have yet to peak since the Fed remains conservative in stabilizing inflation. Consensus estimates are ranging from 5.25% to 5.5% . While it can mean higher loan yields, default risks may increase as well. Interest on deposits and borrowings may keep rising.

On the flip side, IBTX may see hope on the horizon as inflation continues to decrease. Today, it is only 5%, a massive difference from the 2022 peak of 9.1%. It is still higher than pre-pandemic levels, but it is the lowest rate in nearly two years. It may be sustained as The Fed sticks to its conservative approach to monetary policies. If the downtrend continues, its investment security yields may start to improve. Non-interest income and expenses may become more stable. Also, it can help slow down interest increments in the following meetings. Interest rates are still increasing, but we already saw them start to relax. In the most recent meeting, The Fed only raised rates by 25 bps, a massive decrease from the 75 bps in the previous four quarters. While their spillovers may not materialize in the first half, improvements may speed up in the second half. Likewise, mortgage rates may follow their direction. We understand the pessimistic view of many investors on banks with heavy loads of real estate loans. But the current changes may not lead to a massive crash despite the cooling sales. First, the soaring prices were driven by the near-zero rates and demand influx. Second, there were no speculative mania and unethical practices, unlike during the Great Recession. Third, commercial and residential property builders have remained conservative over the past decade. It led to property shortages, which intensified in the past three years. Fourth, the absence of speculative mania and the conservative approach of property builders avoided overselling of properties. Fifth, property shortages remained high, especially in the residential housing market. In fact, the US was short of 6.5 million houses in 1Q. To sum it up, macroeconomic indicators may become more stable at the end of the year.

But what makes IBTX secure is its stable operations founded on solid fundamentals. Its Balance Sheet shows its excellent financial positioning. For instance, its loans and deposits remain well-managed with increasing yields. The loan-to-deposit ratio jumped from 91% to 98%, but it has enough reserves to cover potential delinquencies. It may have to be careful, though, but it can set more favorable deposit rates to entice more clients. More importantly, its cash and bank deposits of $1.05 billion are already 57% higher than the balance in 1Q 2022. They can also cover outstanding borrowings and dividend payments. And although borrowings rose substantially, the combined value of cash and investment securities can cover borrowings in a single payment. They amount to $2.9 billion, or 16% of the total assets. The bank maintains adequate liquidity levels and shows its sustainability.

Stock Price Assessment

The stock price of Independent Bank Group, Inc. has been in a downtrend for more than a year. It has become steeper in the last two months and decreased further after the 1Q results release. At $38.92, the stock price is 44% lower than last year’s value. It is logical, though, given the lawsuit and relatively 1Q performance. Despite this, it can offer opportunities to buy its shares at a discount. The PTBV Ratio shows that the stock price is less than the intrinsic value of the company. It has a current TBVPS and PTBV Ratio of 31.42 and 1.21x. If we use the average of 1.7x, the target price will be $53.41.

Moreover, IBTX is an ideal dividend stock, given its consistent payments. Its yields are enticing at 3.71%, way higher than the S&P 600 and NASDAQ average of 1.68% and 1.57%. They are also well-covered with adequate cash reserves even after declaring another payout of $0.38 per share. To assess the stock price better, we will use the Dividend Discount Model.

Average Dividend Growth 0.2701

Estimated Dividends Per Share $1.52

Stock Price $38.92

Cost Of Capital Equity 0.3060544707

Derived Value $49.43

The derived value confirms that the stock price is undervalued. There may be a 27% upside in the next 12-18 months. So, investors may take this chance to purchase shares at a discount.

Bottomline

Independent Bank Group, Inc. remains a solid bank despite incurring net losses. It has already closed a dark chapter after paying legal settlements. The important thing to note is its adequate capacity to withstand more headwinds. Indeed, its performance has a solid foundation on its excellent financial positioning. It can cover its borrowings and sustain dividend payments. Market prospects may become more optimistic this year as inflation continues to relax. Even better, the stock price appears cheap relative to the fundamentals and dividends. It may be a perfect opportunity since it has high upside potential. The recommendation is that Independent Bank Group, Inc. is a buy.

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