UNTY - Unity Bancorp: No Evidence Of A Bank Run On Deposits

2023-04-17 15:30:20 ET

Summary

• There is a massive concern of a run on deposits at regional banks.
• A larger concern for Unity Bancorp, Inc. which saw deposits increase is slowing loan growth and a decline in net interest margins.
• The bank recently raised its dividend.
• We expect the broader market to decline, and this could create an even better buying opportunity in shares.

Our coverage of the regional bank earnings Q1 season starts with Unity Bancorp, Inc. ( UNTY ). The company is headquartered in Clinton, New Jersey. Unity provides financial services to retail, corporate, and small business customers throughout New Jersey and the Lehigh Valley, Pennsylvania. As we all know, the landscape for regional banks changed dramatically in the last few months as banks began to collapse. All of the pressure is on for regionals as there has been a major concern over a flight of deposits out of banks, as well as the pressure on net interest margins from having to pay more to attract customer deposits. In addition, there is a risk of banks tightening their lending standards. In our opinion, some of these smaller regional banks could face pressure, while others will remain unscathed. As we begin to enter a recessionary period, we will be interested in buying shares of quality regional banks trading at a discount. For the most part, we had called for waiting for pullbacks in bank stocks back in January and February, but we did not think it would be because banks were collapsing. Right now, Unity is in fine shape, but some trends in key metrics are noteworthy.

The stock has actually pulled back quite a bit in the last few weeks and is more attractive on a valuation basis , and it has mixed operational metrics, along with a pretty low dividend yield of 2.1%. Overall, we think this stock would be interesting under $20, which we think when this market turns lower will be possible. This comes following the just-reported earnings.

In the quarter, Unity Bancorp's operational results were stronger than expected in Q1, with some areas showing strength and others with some weaknesses. Thanks to continued loan growth, Unity saw revenues continue to improve once again. Higher rates are having a benefit on the yields on loans, but higher rates on deposits are weighing. The bank's net interest margin was strong but is on the decline now.

Unity Bancorp's earnings power and margins

Performance was led once again led by loan growth, and deposits were also up. This shows that not all regional banks are getting crushed, though the overall sector is showing some risk. Now more than ever, there is a very competitive landscape for customer deposits. There were also better margins thanks to higher those higher rates, but deposits now are earning much more interest and this will weigh on margins going forward.

Unity reported net income of $10.3 million, or $0.96 per share, which was a nice increase of $0.11, or 13%, from last year, and was up $0.04 from the sequential fourth quarter. We believe that 2023 will continue to show strength year-over-year, but the sequential strength may flatten out if net interest margins are compressed.

For now, with higher rates, net interest margin is declining. However, loan quality and moderate levels of loan loss provisions have not weighed. Margins should remain strong but are on the decline. While there are higher rates on loans issued relative to what is paid to deposit holders, depositors are being paid much more for their deposits. Net interest margin was 4.19% and was down 28 basis points from the fourth quarter.

Loans and deposits grow in Q1

This regional bank is focused on traditional banking. It takes in deposits and lending them out at a higher rate, and collecting the difference. The company saw loan growth of 1.2% from Q4. Total loans grew to $2.13 billion, up from $2.10 billion to start the quarter, and were up 25% from a year ago. This is very solid growth, all things considered. The bank is also taking in more capital to lend, alleviating fears of a run on deposits. Deposits rose to $1.82 billion versus $1.78 billion to start the quarter, and up from $1.70 billion at the end of Q1 2022. We will continue to watch closely trends in loans and deposits for all regional banks.

Asset quality deteriorates

So there was growth in Unity Bancorp, Inc. loans and deposits, but this quarter we saw loan quality decline. As of March 31, 2023, nonperforming assets were $14.7 million gross. As of December 31, 2022, nonperforming assets were $9.1 million gross. This is a massive increase of 57% in nonperforming assets quarter-over-quarter. That is something to watch. And as of March 31, 2023, criticized, classified and nonaccrual assets were $35.4 million gross. Further, the ratio of nonperforming loans to total loans grew to 0.69, up from 0.43 in Q4 2022, and up from 0.55 a year ago.

In addition to quality metrics, we also examine certain return metrics which are critical. The return on average assets was 1.72%, identical from Q4 2022. The return on average equity was 17.14%, up from 16.82% sequentially. Finally, the efficiency ratio is a stellar 44.56% but did tick up from 43.24% last quarter.

Final thoughts

This was a pretty strong quarter overall for this small regional bank. We believe the performance of regional banks is going to be extremely mixed. Investors here can be reassured that there was not a run on deposits on the bank, and in fact, Unity Bancorp, Inc. increased its deposit base. The shorter-term concern is a slowing in loan growth, as well as pressures on net interest margins.

While the yield is nothing impressive, Unity Bancorp, Inc. pays a growing dividend. The valuation is relatively fair, but perhaps a touch stretched given the growth profile even after the pullback. We think this market is heading lower, and if Unity Bancorp, Inc. shares dip under $20, they would be a decent buy. For now, we rate Unity Bancorp, Inc. shares as a hold.

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