2023-03-11 03:39:16 ET
Summary
- Deposit re-pricing will outpace loan re-pricing until a little after the end of the up-rate cycle. Therefore, the margin will likely continue to contract in the first nine months.
- The state of the regional economy is currently mixed. Hence, I'm expecting loan growth to be subdued compared to previous years.
- The December 2023 target price suggests a high upside from the current market price. Further, FNCB is offering a very high dividend yield for a bank-holding company.
Earnings of FNCB Bancorp, Inc. ( FNCB ) will likely remain flattish this year. The margin will likely continue to decrease as deposit repricing will outpace loan repricing, which will drag earnings. On the other hand, subdued loan growth will support the bottom line. Overall, I'm expecting FNCB Bancorp to earnings of $1.05 per share for 2023, up by just 1% year-over-year. Compared to my last report on the company, I've slightly reduced my earnings estimate because I've reduced both my loan and margin estimates. The December 2023 target price suggests a high upside from the current market price. Further, FNCB is offering quite a high dividend yield. Based on the total expected return, I'm maintaining a buy rating on FNCB stock.
Margin Likely to Continue to Dip Through Most of this Year
FNCB Bancorp's net interest margin declined by 11 basis points in the fourth quarter as the growth in funding costs outweighed a rise in earning asset yields. The surge in funding costs was not only attributable to a rise in market interest rates but also to a growth in the volume of costly borrowings. In fact, borrowings more than doubled over the quarter. The management’s rate-sensitivity analysis given in the third quarter’s 10-Q filing showed that a 200-basis points hike in interest rates could reduce net interest income by 6.5% over twelve months.
I'm expecting the fed funds rate to rise by a further 50 basis points till the mid of 2023 before plateauing. Therefore, I'm expecting the margin to slip further in the first half of the year. For the second half of 2023, I'm expecting the margin to rise slightly partly because of new loans that will originate at higher rates. Further, FNCB Bancorp has a large securities portfolio (around 30% of earning assets) which will continue to reprice long after the end of the up-rate cycle as most investment securities are based on fixed rates.
Overall, I'm expecting the net interest margin to dip by six basis points in the first nine months of 2023 and then rise by five basis points in the last quarter of the year. Compared to my last report on FNCB Bancorp, which was issued back in August 2022, I've reduced my net interest margin estimate as the up-rate cycle has been more extreme than I previously anticipated.
Loan Growth in 2023 to be Lower than in Most Previous Years
The loan portfolio’s growth rate continued to decelerate in the fourth quarter of 2022. The portfolio grew by only 1.2% during the quarter, as opposed to 2.0% in the third quarter and 5.1% in the second quarter of the year. Loan growth will likely remain subdued in 2023 on the back of a mixed economic outlook. FNCB operates in northeastern Pennsylvania, namely Lackawanna, Luzerne, and Wayne counties. The state of Pennsylvania currently has one of the worst unemployment rates in the country, according to official sources .
Fortunately, the current economic activity trend is slightly better than the national average. As shown below, the trend line for Pennsylvania's economic activity is slightly steeper than that for the national average.
Considering these factors, I'm expecting the loan portfolio to grow by 6.1% in 2023. In my last report on FNCB Bancorp, I projected the loan balance to grow by 8.2% in 2023. I've reduced my growth estimate as my outlook is worse than before.
Meanwhile, 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 | 820 | 820 | 889 | 967 | 1,110 | 1,178 |
Growth of Net Loans | 9.0% | (0.1)% | 8.5% | 8.8% | 14.8% | 6.1% |
Other Earning Assets | 300 | 290 | 488 | 612 | 499 | 530 |
Deposits | 1,096 | 1,002 | 1,287 | 1,455 | 1,421 | 1,508 |
Borrowings and Sub-Debt | 34 | 57 | 10 | 30 | 182 | 194 |
Common equity | 97 | 134 | 156 | 162 | 119 | 132 |
Book Value Per Share ($) | 5.8 | 6.7 | 7.7 | 8.1 | 6.0 | 6.7 |
Tangible BVPS ($) | 5.8 | 6.7 | 7.7 | 8.1 | 6.0 | 6.7 |
Source: SEC Filings, Earnings Releases, Author's Estimates(In USD million unless otherwise specified) |
Expecting Flattish Earnings for 2023
The anticipated loan growth will support the bottom line while margin contraction in the first nine months will drag earnings this year. Meanwhile, I'm expecting the provisioning for expected loan losses to remain near a normal level. The reserves for loan losses seem high enough for FNCB to comfortably ride out a mild recession. Allowances made up 1.26% of total loans while non-performing loans made up just 0.25% of total loans at the end of December 2022. Therefore, I'm expecting the provisioning for 2023 to be near a normal level. I'm expecting the net provision expense to make up 0.17% of total loans this year, which is close to the average for the last five years.
Overall, I'm expecting FNCB Bancorp to report earnings of $1.05 per share for 2023, up by just 1% year-over-year. The following table shows my income statement estimates.
Income Statement | FY18 | FY19 | FY20 | FY21 | FY22 | FY23E |
Net interest income | 37 | 36 | 40 | 49 | 54 | 56 |
Provision for loan losses | 2.6 | 0.8 | 1.9 | 0.2 | 2.0 | 2.0 |
Non-interest income | 12 | 8 | 9 | 8 | 8 | 9 |
Non-interest expense | 29 | 30 | 29 | 31 | 35 | 38 |
Net income - Common Sh. | 13 | 11 | 15 | 21 | 20 | 21 |
EPS - Diluted ($) | 0.79 | 0.56 | 0.76 | 1.06 | 1.03 | 1.05 |
Source: SEC Filings, Earnings Releases, Author's Estimates(In USD million unless otherwise specified) |
In my last report on FNCB Bancorp, I estimated earnings of $1.15 per share for 2023. I've reduced my earnings estimate partly because I've decreased both my loan balance and margin estimates.
My estimates are based on certain macroeconomic assumptions that may not come to fruition. Therefore, actual earnings can differ materially from my estimates.
FNCB Appears Significantly Undervalued
FNCB Bancorp usually increases its dividend every year. Based on the earnings outlook, I’m expecting the company to increase its quarterly dividend by $0.025 per share in the third quarter, taking the dividend to $0.115 per quarter. My earnings and dividend estimates suggest a payout ratio of 39% for 2023, which is higher than the five-year average of 29%, but still easily sustainable. Based on my dividend estimate, FNCB Bancorp is offering a hefty forward dividend yield of 5.7%.
I’m using the historical price-to-tangible book (“P/TB”) and price-to-earnings (“P/E”) multiples to value FNCB Bancorp. The stock has traded at an average P/TB ratio of 1.08 in the past, as shown below.
FY19 | FY20 | FY21 | FY22 | Average | |
T. Book Value per Share ($) | 6.7 | 7.7 | 8.1 | 6.0 | |
Average Market Price ($) | 7.9 | 6.4 | 7.7 | 8.4 | |
Historical P/TB | 1.17x | 0.83x | 0.96x | 1.39x | 1.08x |
Source: Company Financials, Yahoo Finance, Author's Estimates |
Multiplying the average P/TB multiple with the forecast tangible book value per share of $6.7 gives a target price of $7.2 for the end of 2023. This price target implies a 0.3% upside from the March 9 closing price. The following table shows the sensitivity of the target price to the P/TB ratio.
P/TB Multiple | 0.88x | 0.98x | 1.08x | 1.18x | 1.28x |
TBVPS - Dec 2023 ($) | 6.7 | 6.7 | 6.7 | 6.7 | 6.7 |
Target Price ($) | 5.9 | 6.6 | 7.2 | 7.9 | 8.6 |
Market Price ($) | 7.2 | 7.2 | 7.2 | 7.2 | 7.2 |
Upside/(Downside) | (18.2)% | (9.0)% | 0.3% | 9.5% | 18.8% |
Source: Author's Estimates |
The stock has traded at an average P/E ratio of around 9.5x in the past, as shown below.
FY19 | FY20 | FY21 | FY22 | Average | |
Earnings per Share ($) | 0.56 | 0.76 | 1.06 | 1.03 | |
Average Market Price ($) | 7.9 | 6.4 | 7.7 | 8.4 | |
Historical P/E | 14.1x | 8.4x | 7.3x | 8.1x | 9.5x |
Source: Company Financials, Yahoo Finance, Author's Estimates |
Multiplying the average P/E multiple with the forecast earnings per share of $1.05 gives a target price of $9.9 for the end of 2023. This price target implies a 37.4% upside from the March 9 closing price. The following table shows the sensitivity of the target price to the P/E ratio.
P/E Multiple | 7.5x | 8.5x | 9.5x | 10.5x | 11.5x |
EPS 2023 ($) | 1.05 | 1.05 | 1.05 | 1.05 | 1.05 |
Target Price ($) | 7.8 | 8.8 | 9.9 | 10.9 | 12.0 |
Market Price ($) | 7.2 | 7.2 | 7.2 | 7.2 | 7.2 |
Upside/(Downside) | 8.4% | 22.9% | 37.4% | 52.0% | 66.5% |
Source: Author's Estimates |
Equally weighting the target prices from the two valuation methods gives a combined target price of $8.6 , which implies an 18.9% upside from the current market price. The large discount to the target price shows that the market has overreacted to the prospects of continued margin decline this year. Further, in my opinion, the current negative investor sentiment in the banking sector is overblown and the SVB Financial Group's ( SIVB ) failure does not affect FNCB. (Readers can see this article to understand one of the major reasons behind the overall negative sentiment in the banking industry over the last couple of days).
Adding the forward dividend yield to the price upside gives a total expected return of 23.4%. Hence, I’m maintaining a buy rating on FNCB Bancorp.
For further details see:
FNCB Bancorp: High Dividend Yield With A Flattish Earnings Outlook