2023-04-15 02:02:39 ET
Summary
- External factors, including commodity prices and a strong regional job market, will drive loan growth.
- I’ve revised downwards the margin estimate for 2023 as I’ve pushed forward the expected time for a trend reversal.
- The risk level is high due to the large balance of unrealized losses on the AFS securities portfolio.
- The year-end target price suggests a moderate upside from the current market price. Further, ATLO is offering a high dividend yield of over 5%.
Earnings of Ames National Corporation ( ATLO ) will likely dip this year as higher operating expenses and a lower net interest margin will undermine the effect of loan growth. I’m expecting the company to report earnings of $1.91 per share for 2023, down 10% year-over-year. Compared to my last report on the company, I’ve reduced my earnings estimate because I’ve slashed my margin estimate. The year-end target price suggests a moderate upside from the current market price. Based on the total expected return and the elevated risk level, I’m maintaining a hold rating on Ames National Corporation.
Loan Growth Likely to be Close to the Historical Average
Ames National’s loan growth continued to accelerate during the last quarter of 2022, which beat my expectations. The loan portfolio surged by 4.3% during the quarter, taking the full-year growth to 7.2%. Loan growth for 2023 will depend on external factors, as discussed below.
Ames National has a sizable agricultural loan segment, whose demand depends on Iowa’s trade policies, weather, and commodity prices. As shown in the chart below, commodity prices are at a high level compared to the last decade. Agriculture and agricultural real estate loans altogether made up 22% of total loans at the end of 2022; therefore, satisfactory growth in this segment will have a material impact on total loan growth.
Further, the state’s strong labor market indicates that business activity is currently healthy, which bodes well for credit demand.
On the other hand, high borrowing costs will discourage credit offtake. Considering these external factors, I’m expecting the loan portfolio to grow by 4% in 2023, which is close to the three-year CAGR of 5%. Further, I’m expecting other balance sheet items to grow in line with loans. The following table shows my balance sheet estimates.
Financial Position | FY18 | FY19 | FY20 | FY21 | FY22 | FY23E |
Net Loans | 890 | 1,048 | 1,130 | 1,144 | 1,226 | 1,276 |
Growth of Net Loans | 15.4% | 17.7% | 7.8% | 1.3% | 7.2% | 4.1% |
Other Earning Assets | 489 | 595 | 768 | 921 | 813 | 846 |
Deposits | 1,221 | 1,493 | 1,716 | 1,878 | 1,898 | 1,975 |
Borrowings and Sub-Debt | 55 | 47 | 40 | 43 | 80 | 83 |
Common equity | 173 | 188 | 209 | 208 | 149 | 147 |
Book Value Per Share ($) | 18.6 | 20.3 | 22.9 | 22.8 | 16.5 | 16.2 |
Tangible BVPS ($) | 17.2 | 18.6 | 21.2 | 21.2 | 14.9 | 14.6 |
Source: SEC Filings, Earnings Releases, Author's Estimates(In USD million unless otherwise specified) |
Revising Downward the Margin Estimate
Ames National’s net interest margin negatively surprised me in the fourth quarter of 2022. It shrank by 18 basis points during the quarter as deposit costs surged while asset yields increased slightly. Only around 39% of the loan portfolio consists of variable-rate loans or fixed-rate loans that will mature within a year, according to details given in the 10-K filing . The average yield of the other 61% of the portfolio is unlikely to change; therefore, the total loan yield can be expected to remain somewhat sticky this year despite the expected 75-100 basis points hike in the fed funds rate in the first half of 2023.
The large securities portfolio, which makes up 39% of total earning assets, will also hold back the margin as most securities are based on fixed rates.
Ames National’s asset and deposit mixes have barely changed over the last year, which shows that the management does not focus on active asset-liability management for handling interest-rate risk. This strategy let the company lose out when rates were rising, but it will also prevent the company from suffering when rates start declining next year.
In my last report, I projected the margin to increase this year once the up-rate cycle ended and deposit re-pricing stopped outpacing asset re-pricing. Following the fourth quarter’s disappointing performance, I’ve now decided to push out the time of the trend reversal further into the future. I’m now expecting the margin to be somewhat stable this year and start inching up next year. On an average basis, the margin for 2023 will be lower than last year because of the dip in the last quarter of 2022.
Expecting Earnings to Dip by 10%
Earnings of Ames National will most probably dip this year because operating expenses will continue to grow on the back of inflation. However, revenue will not grow at par with operating expenses because the lower average margin will undermine the effect of loan growth. Overall, I’m expecting Ames National to report earnings of $1.91 per share for 2023, down 10% year-over-year. The following table shows my income statement estimates.
Income Statement | FY18 | FY19 | FY20 | FY21 | FY22 | FY23E |
Net interest income | 42 | 45 | 55 | 56 | 53 | 53 |
Provision for loan losses | 1 | 1 | 6 | (1) | (1) | 2 |
Non-interest income | 8 | 9 | 11 | 11 | 10 | 10 |
Non-interest expense | 28 | 32 | 37 | 37 | 39 | 39 |
Net income - Common Sh. | 17 | 17 | 19 | 24 | 19 | 17 |
EPS - Diluted ($) | 1.83 | 1.86 | 2.06 | 2.62 | 2.14 | 1.91 |
Source: SEC Filings, Earnings Releases, Author's Estimates(In USD million unless otherwise specified) |
In my last report, I projected earnings of $2.22 per share for 2023. I’ve reduced my earnings estimate because I’ve slashed my net interest margin estimate, as discussed above.
Moderately High Risk-Level Due to Large Unrealized Losses
The available-for-sale (“AFS”) investments portfolio had racked up unrealized losses of $83.6 million by the end of December 2022, which is a whopping 56% of total equity and more than four times the net income earned last year. Needless to say, if these unrealized losses turned to realized losses (through the sale of AFS securities) then the stock’s fair value will take a big hit. The market has already incorporated some of this risk in the stock’s valuation as the stock price has dipped by 15% since March 8, when the first bank, Silvergate Capital ( SI ), showed trouble and triggered widespread panic in the banking sector. However, I’m confident that most if not all the unrealized losses will reverse next year when interest rates start declining. There are currently no signs of a deposit run that could force Ames National to sell its securities portfolio.
Apart from the unrealized losses, the risk level appears manageable.
- Uninsured deposits make up 20% of total deposits, which is not too bad.
- The company does not operate in risky areas of cryptocurrencies and digital tokens. Further, it does not have material exposure to venture capital investments and start-ups.
- Ames National doesn’t disclose its exposure to office properties and their vacancy rate amid the emergence of the work-from-home and hybrid work culture. The company only discloses the total commercial real estate (“CRE”) balance. As of the end of 2022, CRE loans made up 43% of total loans; therefore, the exposure to loans backed by office properties cannot be more than 43%. In my opinion, this concentration isn’t a cause for concern.
Considering these factors, I believe Ames National's risk level is currently moderately high.
Maintaining a Hold Rating
Ames National is offering a dividend yield of 5.4% at the current quarterly dividend rate of $0.27 per share. The earnings and dividend estimates suggest a payout ratio of 57% for 2023, which is close to the five-year average of 50%. Therefore, the earnings outlook presents no threat of a dividend cut.
I’m using the historical price-to-tangible book (“P/TB”) and price-to-earnings (“P/E”) multiples to value Ames National. The stock has traded at an average P/TB ratio of 1.36x in the past, as shown below.
FY18 | FY19 | FY20 | FY21 | FY22 | Average | |
T. Book Value per Share ($) | 17.2 | 18.6 | 21.2 | 21.2 | 14.9 | |
Average Market Price ($) | 28.6 | 27.1 | 21.2 | 24.3 | 23.1 | |
Historical P/TB | 1.66x | 1.46x | 1.00x | 1.15x | 1.55x | 1.36x |
Source: Company Financials, Yahoo Finance, Author's Estimates |
Multiplying the average P/TB multiple with the forecast tangible book value per share of $14.6 gives a target price of $20.0 for the end of 2023. This price target implies a 1.0% downside from the April 14 closing price. The following table shows the sensitivity of the target price to the P/TB ratio.
P/TB Multiple | 1.16x | 1.26x | 1.36x | 1.46x | 1.56x |
TBVPS - Dec 2023 ($) | 14.6 | 14.6 | 14.6 | 14.6 | 14.6 |
Target Price ($) | 17.0 | 18.5 | 20.0 | 21.4 | 22.9 |
Market Price ($) | 20.2 | 20.2 | 20.2 | 20.2 | 20.2 |
Upside/(Downside) | (15.5)% | (8.3)% | (1.0)% | 6.2% | 13.5% |
Source: Author's Estimates |
The stock has traded at an average P/E ratio of around 12.1x in the past, as shown below.
FY18 | FY19 | FY20 | FY21 | FY22 | Average | |
Earnings per Share ($) | 1.83 | 1.86 | 2.06 | 2.62 | 2.14 | |
Average Market Price ($) | 28.6 | 27.1 | 21.2 | 24.3 | 23.1 | |
Historical P/E | 15.6x | 14.6x | 10.3x | 9.3x | 10.8x | 12.1x |
Source: Company Financials, Yahoo Finance, Author's Estimates |
Multiplying the average P/E multiple with the forecast earnings per share of $1.91 gives a target price of $23.2 for the end of 2023. This price target implies a 14.9% upside from the April 14 closing price. The following table shows the sensitivity of the target price to the P/E ratio.
P/E Multiple | 10.1x | 11.1x | 12.1x | 13.1x | 14.1x |
EPS 2023 ($) | 1.91 | 1.91 | 1.91 | 1.91 | 1.91 |
Target Price ($) | 19.4 | 21.3 | 23.2 | 25.1 | 27.0 |
Market Price ($) | 20.2 | 20.2 | 20.2 | 20.2 | 20.2 |
Upside/(Downside) | (4.1)% | 5.4% | 14.9% | 24.4% | 33.9% |
Source: Author's Estimates |
Equally weighting the target prices from the two valuation methods gives a combined target price of $21.6 , which implies a 6.9% upside from the current market price. Adding the forward dividend yield gives a total expected return of 12.3%. Based on the total expected return and the moderately high-risk level, I’m maintaining a hold rating on Ames National Corporation.
For further details see:
Ames National: Margin Outlook Counters The Positive Loan Growth Outlook