TMP - Tompkins Financial: Earnings Likely To Trend Upwards On The Back Of Loan Growth

2023-11-23 23:13:20 ET

Summary

• I’m not worried about the large loss on the sale of securities in the third quarter because the proceeds have been invested in higher-yielding securities.
• Loan growth will likely slow down from the third quarter’s impressive level but remain above the historical average thanks to economic factors.
• The December 2024 target price suggests a small downside from the current market price.
• The dividend yield is quite attractive at around 4.5%.
• Unrealized losses on the available-for-sale securities portfolio increase TMP’s riskiness because there is a chance that the management will realize further losses.

Earnings of Tompkins Financial Corporation ( TMP ) will likely trend upwards in upcoming quarters thanks to subdued loan growth. Further, a slight margin expansion later next year will likely support earnings. Overall, I'm expecting the company to report earnings of $0.76 per share for 2023 including the loss on sale, and $4.08 per share for 2023 excluding the loss on sale of securities booked in the third quarter of the year. For 2024, I'm expecting the company to report earnings of $4.90 per share. The year-end target price suggests a small downside from the current market price. Based on the total expected return, I'm maintaining a hold rating on Tompkins Financial.

Loss on Securities Sale Not a Problem in the Longer Run

Tompkins Financial reported a loss in the third quarter of 2023 because it realized large losses of around $47.5 million on the sale of $429.6 million worth of investment securities. As interest rates had risen over the last year and a half, the market value of these securities had fallen resulting in large unrealized losses. By selling these securities, Tompkins Financial had converted the unrealized losses (showing up only on the total equity balance) into realized losses (showing up on the income statement).

The company is likely to make up for this realized loss soon because it invested the proceeds from the sale into higher-yielding securities. As mentioned in the earnings release , the securities sold had an average yield of 0.93%, while the securities bought carried an estimated yield of approximately 5.12%.

The company still has a large balance of unrealized loss on its available-for-sale securities portfolio. These losses amounted to $194.6 million at the end of September 2023, or 32% of the total equity balance. Although there is no indication in the earnings release or elsewhere that the management wants to sell more securities, the risk remains. The risk will stand until the unrealized losses reverse, which could partially happen in the latter half of next year.

Nevertheless, I'm not worried because while a sale will hurt quarterly earnings, in the longer run of around a year or so, the sale will turn out to be beneficial. Moreover, I'd like to point out that my tangible book value estimate, and consequently the target price, already incorporates the unrealized loss.

I'm assuming no further big sale of securities till the end of December 2024. Further, I'm expecting fee income to grow at a normal rate. As a result, I'm expecting the non-interest income to decline by 84% in 2023 (due to the loss on sale) and increase by 591% year-over-year in 2024.

Expecting Loan Growth to Slow Down

Loan growth in the last two quarters has far exceeded my expectations. The portfolio grew by 1.5% in each of the second and third quarters of this year, translating to an annualized growth rate of around 6%. In comparison, the five-year compounded annual growth is only 2.4%.

Macroeconomic factors are currently presenting a mixed outlook for loan growth in the near term. Tompkins Financial primarily serves businesses and individuals in New York and Pennsylvania. While New York's unemployment rate has ticked upward in recent months like the national average, Pennsylvania's unemployment rate has continued to improve.

As agricultural loans make up 5% of Tompkins' total loans, agricultural commodity prices are another appropriate indicator of credit demand. As shown below, corn prices have fallen quite sharply in recent months.

Considering these factors, I'm expecting the quarterly loan growth rate to slow down to 1.0% in the last quarter of 2023, and then further down to 0.9% in the first quarter of 2024. I'm expecting loan growth to stabilize at 0.9% for the remainder of 2024. My anticipated growth rates are above the historical average. The following table shows my balance sheet estimates.

Compared to my last report on the company, I have reduced my earnings estimate for 2023 because the non-interest income has been lower than my expectations so far this year even after adjusting for the loss on sales of securities.

Unrealized Losses are the Major Source of Risk

The unrealized losses on Tompkins' available-for-sale securities portfolio are the biggest risk factor, especially after the management realized some of these unrealized losses in the third quarter. A lot of investors consider only the price-to-earnings ratio when they value banks; therefore, their valuation of the company could take a hit if Tompkins converts more unrealized losses into realized losses. As of the end of September 2023, these unrealized losses amounted to $194.6 million, which is around 32% of the total equity balance.

Another source of risk is the large balance of uninsured deposits. As mentioned in the 10-Q filing, the uninsured deposits totaled $3.1 billion at the end of September, representing a hefty 47% of total deposits.

Maintaining a Hold Rating

Tompkins Financial is offering a dividend yield of 4.5% at the current quarterly dividend rate of $0.60 per share. The earnings and dividend estimates suggest a payout ratio of 49% for 2024, which is higher than the five-year average of 38% but still easily sustainable. Hence, I'm not expecting any change in the dividend payout.

I'm using the peer average price-to-tangible book ("P/TB") and price-to-earnings ("P/E") multiples to value Tompkins Financial. Peers are trading at an average P/TB ratio of 1.10 and an average P/E ratio of 9.26, as shown below.

Multiplying the average P/E multiple with the forecast earnings per share of $4.90 gives a target price of $45.4 for the end of 2024. This price target implies a 14.7% downside from the November 22 closing price. The following table shows the sensitivity of the target price to the P/E ratio.

Equally weighting the target prices from the two valuation methods gives a combined target price of $48.2 , which implies a 9.6% downside from the current market price. Adding the forward dividend yield gives a total expected return of negative 5.1%. Hence, I'm maintaining a hold rating on Tompkins Financial.

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