2023-03-15 08:30:00 ET
Summary
- The internet-only bank has a strong balance sheet with a robust equity position.
- The AFS portfolio is less than 10% of the assets, so the negative impact should be very manageable.
- Ideally, I would like to see a higher amount of liquid assets (cash & interest bearing deposits) but I think the risk is low.
- The loan portfolio appears to be pretty strong as well, with a very low NPL ratio.
Introduction
Regional banks are in the spotlights these days. Although I do think the fallout from the failure of Signature Bank ( SBNY ) and SVB Financial ( SIVB ) will remain limited, it is pretty normal to see a ripple effect go through the sector. A few months ago I wrote an article on First Internet Bancorp ( INBK ) and after seeing how the bank performed I decided to invest in the listed debt ( INBKZ ). A prudent choice, in hindsight, as the share price cratered by about 30-35% while the listed bonds remained relatively stable for the first few trading days before also losing 20% yesterday, Monday.
A look at the 2022 results
During the fourth quarter, First Internet saw its net interest income decrease. That wasn’t a surprise as for instance author Sheen Bay Research already warned for margin compression in her December article.
She was right. In the fourth quarter, the total interest income increased from just over $39M to just under $46M but the interest expenses increased at a much faster pace: those increased by 60% to $24M which resulted in a 10% lower net interest income which came in at $21.7M.
The net non-interest expenses were slightly better than anticipated ($12.7M versus $13.M) which results in a pre-tax and pre-provision income of $9M. As you can see in the income statement above the bank recorded a $2.1M provision for loan losses which ultimately resulted in a pre-tax income of $6.9M and a net income of just under $6.4M which translates into $0.68 per share. A decent result but obviously lower than the past few quarters. The full-year EPS came in at $3.73 but that result will likely not be repeated this year as the pressure on the net interest margin should continue.
The company pays a quarterly dividend of just $0.06 per share which means the vast majority of the earnings are retained on the balance sheet, and that has proven to be a big help to strengthen the balance sheet and the capital position of this internet-only bank.
The Securities Available For Sale (‘AFS portfolio’) appears manageable
The low dividend payout ratio actually resulted in an increase of the equity value on the balance sheet which increased from $361M at the end of Q3 to $365M at the end of 2022 and that is just $15M lower than the total amount of equity on the balance sheet as of the end of 2021.
The bank obviously also recorded losses on its AFS portfolio, but this loss remained relatively ‘limited’, also because the total size of the AFS portfolio isn’t that high relative to the asset basis. As you can see below, the AFS portfolio had a total size of $390M which is just 8.6% of the total asset base, so investors (and customers) should not expect a massive impact on the solvency of the bank even if the situation would get much worse (which I don’t think it will).
Liquidity also shouldn’t be a major issue: the bank has $255M available in cash and interest-bearing deposits while it should also be able to unwind the $390M AFS portfolio without too much of a haircut. Even in a scenario where a fire sale were to occur with a 10% haircut, INBK would still be able to almost immediately access $600M in cash, which is 17% of the deposits. So while I would ideally like to see the liquidity levels to be a bit higher given the current confidence crisis, I don’t think the AFS portfolio is going to cause a headache at First Internet Bank.
This doesn’t mean I’m going long the stock yet, but I have added a little bit to my position in First Internet Bancorp’s debt securities which are trading with ( INBKZ ) on the exchange. As explained in September this was my preferred way to gain exposure to First Internet Bancorp and so far, the debt security has outperformed the common shares. INBKZ is down as well, but I’m not too worried.
This is a fixed to floating (‘FtF’) debt security and although it's a subordinated security, it obviously still ranks senior to the common shares and is part of the regulatory Tier 2 capital.
The total size of the offering is just $37M which means it should be very easy for First Internet to simply repay these notes upon reaching the maturity date. At this moment, the notes have a 6% yield with the $1.50 in interest payments payable in four equal quarterly tranches of $0.375. From June 2024 on, the securities will move to a floating interest rate with a three-month LIBOR + 411 bp interest rate until the maturity date in 2029. The (small) issue is that INBK hasn’t announced yet what it will use to replace the LIBOR with but I would anticipate some sort of SOFR-based metric will be used. And with the SOFR at around 5%, it’s not hard to see a total coupon of 8-9% on this debt security based on the current circumstances.
INBK also has the right to call INBKZ in June 2024 and given the most recent share price of $19, the yield to call is approximately 30% which I think offers an excellent risk/reward ratio given the small size of this security and the likely yield to maturity of approximately 11-14% (depending on the details of the reset in 2024).
Investment thesis
The guarantee of the Fed, FDIC and Treasury Department to protect all deposits at both Silicon Valley Bank as well as Signature Bank should calm the markets and avoid additional bank runs as depositors should be reassured their cash is safe.
This doesn’t mean I’m going long on the common shares of First Internet Bancorp although they have become much more appealing at the current price as the stock is trading at just over 0.5 times TBV. But I did add a little bit to my existing long position in the bank’s fix-to-float debt securities.
For further details see:
First Internet Bancorp: Just An Innocent Victim In The Banking Crisis?