After plunging in the first quarter of 2020, earnings of Northrim Bancorp, Inc. (NASDAQ:NRIM) will likely recover in the remainder of the year on the back of lower provisions expense. However, the earnings will likely remain below last year’s level because provisions will most probably remain above normal. NRIM has high exposure to COVID-19-sensitive industries, which will likely drive provision expense in the year ahead. Moreover, the drop in yields on earning assets will likely pressurize net income for the year. On the other hand, NRIM’s participation in the Paycheck Protection Program will limit the earnings decline. For the full year, I’m expecting earnings to dip by 30% year-over-year to $2.12 per share. The uncertainties related to the COVID-19 pandemic and NRIM’s significant exposure to it have increased the chances of an earnings surprise this year. The December 2020 target price suggests a high upside from the current market price. However, I’m adopting a neutral rating on NRIM due to the risks and uncertainties.
Substantial Exposure to Vulnerable Industries Poses Risks to Earnings
NRIM posted a provision expense of $2 million in the first quarter of 2020, up from $0.8 million in the corresponding period last year. NRIM’s provision expense will likely decline in the year ahead from the first quarter’s high but remain above last year’s level. The company has high exposure to vulnerable industries that will likely keep credit costs above normal in the last three quarters of this year. As mentioned in the first quarter’s earnings release, vulnerable industries made up a massive 30% of total loans as of March 31, 2020. The following table shows NRIM’s exposure to COVID-19-sensitive industries.
On the plus side, NRIM is based in Alaska, which is one of the states that have been least affected by COVID-19. According to news sources, Alaska currently has just 167 cases per 100,000 people compared to 2,054 for New York. Furthermore, the management mentioned in the earnings release that it did not receive any material loan accommodation requests until the end of the first quarter. However, the risk of a rise in loan modifications and troubled debt restructurings will likely remain until as long as the pandemic lasts. Considering these factors, I’m expecting NRIM to book a provision expense of $3.9 million in 2020 versus a net recovery of $1.2 million in 2019.
The actual provision expense can differ materially from its estimate due to the uncertainties surrounding the COVID-19 pandemic. Moreover, NRIM has more credit risk than peers because of its high exposure to COVID-19-sensitive industries.
Paycheck Protection Program to Limit Earnings Decline
As mentioned in the earnings release, NRIM funded $309 million of loans in the first half of April under the government’s stimulus program, called the Paycheck Protection Program or PPP. The funded amount is quite large relative to NRIM’s asset size and will increase total loans by around 29% in the second quarter. I’m expecting a majority of the PPP loans to get forgiven in the third quarter, at which time NRIM will book the unamortized fees. Assuming fees of 3.0% and funding cost of 0.25%, PPP will likely add $8.5 million to the net interest income in 2020.
Excluding the impact of PPP, the net interest income will likely decline in the last three quarters of the year. NRIM’s net interest margin, NIM, is quite rate-sensitive; therefore, the 150bps federal funds rate cut in March will likely squeeze NIM in the second quarter. As mentioned in the last 10-K filing, more earning assets than liabilities will mature or reprice in 2020, which will make the yield on earning assets less sticky than funding costs. The repricing gap for 2020 was $76 million as of December 31, 2020, as mentioned in the 10-K filing. Further, the management’s rate-sensitivity analysis showed that a 100bps decline in interest rates could reduce net interest income by 7.4% over 12 months. The following table from the 10-K filing shows the rate sensitivity.
Considering the factors mentioned above, I’m expecting NIM to decline by 28bps in the second quarter and by 58bps in 2020, excluding the impact of PPP. The following table shows my estimates for yield, cost, and NIM.
I’m expecting NRIM’s loan growth, apart from PPP, to slow down in the last three quarters of the year. The economic downturn and the uncertainties related to the COVID-19 pandemic will likely keep credit demand low. Consequently, I’m expecting loan growth to decelerate to 1.0% sequentially in each of the last three quarters from 3.6% in the first quarter of the year. The following table shows my estimates for loans and other balance sheet items. PPP loans are not visible in the estimates because I’m expecting them to get forgiven in the third quarter and the table shows year-end numbers.
Earnings Decline of 30% Likely
I’m expecting earnings to improve in the year ahead compared to the first quarter due to an expected decline in provision expense. However, I’m expecting future provision expense to remain above last year’s level; hence, earnings will likely decline on a year-over-year basis. Furthermore, a reduction in NIM will likely pressurize earnings. On the other hand, NRIM’s participation in PPP will likely limit the earnings decline. Overall, I’m expecting earnings to decline by 30% year-over-year to $2.12 per share in 2020. The following table shows my income statement estimates.
The probability of an earnings surprise is higher than usual this year because of the uncertainties related to the COVID-19 pandemic and its impact on credit quality. The risks to earnings are exacerbated by NRIM’s high exposure to COVID-19-sensitive industries. The high credit risk that NRIM is facing will likely restrain the stock price in the coming two to three months.
Risks to Negate High Price Upside Potential
NRIM has traded at an average price-to-book multiple, P/B, of 1.11 in the past, as shown in the table below.
Multiplying the average P/B ratio with the forecast book value per share of $31.1 gives a target price of $34.5 for December 2020. The price target implies an upside of 46.6% from NRIM’s July 2 closing price. The following table shows the sensitivity of the target price to the P/B multiple.
NRIM is also offering a dividend yield of 5.8%, assuming the company maintains its quarterly dividend at the current level of $0.34 per share.
As discussed above, NRIM is facing high credit risks due to the COVID-19 pandemic and the company’s high exposure to vulnerable industries. In my opinion, the risks will likely restrain the stock price in the coming months regardless of the attractive valuation and the dividend yield. As a result, I’m adopting a neutral rating on NRIM.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Disclaimer: This article is not financial advice. Investors are expected to consider their investment objectives and constraints before investing in the stock(s) mentioned in the article.
Source: Seeking Alpha