• Tue. Nov 22nd, 2022

Independent Bank: Delayed Benefit of Rising Rates to Boost Profits (NASDAQ:INDB)

ByMadeleine J. Pierce

Oct 5, 2022

Sean Pavon

Earnings of Independent Bank Corp. (NASDAQ:INDB) will most likely rise this year and next thanks to significant spread expansion in a rising rate environment. Weak loan growth will further support the bottom line. Overall, I expect Independent Bank Corp. will report earnings of $5.29 per share for 2022, up 53% year-over-year. Compared to my last report on the company, I have increased my earnings estimate partly because I have revised my margin estimate upwards. For 2023, I expect earnings to increase 10% to $5.81 per share. The year-end target price suggests a slight upside from the current market price. Accordingly, I am adopting a holding rating on Independent Bank Corp.

The benefits of rising rates appear with a lag

The Independent Bank’s deposit book is loaded with interest-bearing deposits that are quickly revalued, namely savings accounts, money market accounts, and interest-bearing checking accounts. These deposits represented 58.7% of total deposits at the end of June 2022. In comparison, the loan portfolio is slower to revalue. Only about 34% of the loan portfolio is linked to LIBOR, SOFR or prime rate, as mentioned in the last conference call.

Therefore, the rising interest rate environment will affect the net interest margin with a lag. The results of management’s interest rate sensitivity analysis show that a 200 basis point increase in interest rates can increase net interest income by 4.0% in the first year and 19 .2% the second year of the rate hike.

Sensitivity to interest rates

Filing 2Q 2022 10-Q

In addition, the margin can benefit from improvements in the asset mix. Independent Bank has successfully deployed much of its excess liquidity so far this year. Nonetheless, it still has quite high excess cash on its books. If Independent Bank succeeds in shifting this excess cash into higher yielding assets; it could then substantially improve its margin. The following graph shows the evolution of remunerated deposits with banks, which are a component of cash and cash equivalents.

Cash and cash equivalents

SEC Filings

Given these factors, I expect the net interest margin to increase by 20 basis points in the second half of 2022 and by 30 basis points in 2023. Compared to my last report on Independent Bank, I increased my margin estimate because the rate hike cycle is more extreme than I had previously anticipated.

Loan growth will remain subdued

Independent Bank’s loan growth was negligible in the first half of the year as the company exhausted some of the loans acquired by East Boston (note: Independent Bank acquired Meridian Bancorp and East Boston Savings Bank in November 2021 ). Loan growth will improve in the second half of this year as liquidation of acquired loans and repayments decline.

Nonetheless, loan growth will most likely remain at the lower end of the historical range. This is partly due to high interest rates which will discourage borrowing, especially for residential and home equity loans, which account for about 21% of total loans.

On the other hand, strong regional labor markets will likely support loan growth. Independent Bank Corp. operates primarily in Massachusetts, where the unemployment rate is near record highs, in line with the national average.

Chart
Data by Y-Charts

In addition, the state’s coincident economic activity index shows a satisfactory recovery from the pandemic.

Massachusetts Economic Activity Index

Federal Reserve Bank of Philadelphia

Given these factors, I expect the loan portfolio to grow by 1.0% each quarter through the end of 2023. During this time, most other balance sheet items will grow in line with loans. However, the book value of equity will come under pressure from unrealized capital losses on available-for-sale securities. As interest rates rise, the market value of fixed-rate available-for-sale securities declines, resulting in unrealized losses. These losses are charged directly to the equity account, bypassing the income statement. The book value of equity has already fallen by 5% in the first half. As the Federal Reserve is projecting a further hike in interest rates by 125 to 150 basis points through the end of 2023, unrealized losses will likely continue to grow.

The following table shows my balance sheet estimates.

EX18 FY19 FY20 FY21 FY22E FY23E
Financial situation
Net loans 6,842 8,806 9,279 13,440 13,803 14,364
Net loan growth 8.7% 28.7% 5.4% 44.8% 2.7% 4.1%
Securities 1,075 1,275 2,348 4,789 4,253 4,339
Deposits 7,427 9,147 10,993 16,917 16,974 17,663
Loans and sub-debts 259 303 181 152 139 140
Common Equity 1,073 1,708 1,703 3,018 2,806 2,924
Book value per share ($) 38.8 49.7 51.5 74.8 60.1 62.6
Tangible BVPS ($) 29.0 34.1 35.5 49.6 38.4 40.9
Source: SEC filings, author’s estimates ($ millions, unless otherwise noted)

Profits are expected to increase by 53% this year

Expected margin expansion will be the main driver of earnings through the end of 2023. In addition, mid-single-digit loan growth will also support earnings. Given that loan growth is likely to remain subdued, provisioning for expected loan losses will also remain low. However, high inflation will put some pressure on provisioning.

Overall, I expect Independent Bank Corp. reports earnings of $5.29 per share in 2022, up 53% year-over-year. For 2023, I expect earnings to increase 10% to $5.81 per share. The following table shows my income statement estimates.

EX18 FY19 FY20 FY21 FY22E FY23E
income statement
Net interest income 298 393 368 402 591 661
Allowance for loan losses 5 6 53 18 2 8
Non-interest income 89 115 111 106 110 108
Non-interest charges 226 284 274 333 377 404
Net income – Common Sh. 122 165 121 121 247 271
BPA – Diluted ($) 4.40 5.03 3.64 3.47 5.29 5.81
Source: SEC filings, author’s estimates ($ millions, unless otherwise noted)

In my last report on Independent Bank, I estimated earnings of $4.48 per share for 2022. I revised my earnings estimate upward in part because I increased my net interest margin estimate. . Additionally, I reduced my estimate of non-interest expense because the company has already realized greater cost savings from bank acquisitions than I had previously anticipated.

Actual earnings may differ materially from estimates due to the risks and uncertainties associated with inflation and, therefore, the timing and magnitude of interest rate increases. Also, a deeper or longer than expected recession may increase the expected loan loss provisioning beyond my estimates.

Adopt a holding note for now

Independent Bank has increased its dividend every year since 2001. Given the earnings outlook, I expect the company to increase its dividend from $0.04 per share to $0.55 per share in the first quarter of 2023. Earnings and dividend estimates suggest a payout ratio of 38% for 2023, which is close to the 2017-2019 average of 37%. Based on my dividend estimate, Independent Bank Corp. offers a forward dividend yield of 2.8%.

I use historical price/tangible (“P/TB”) and price/earnings (“P/E”) multiples to value Independent Bank. The stock has traded at an average P/TB ratio of 1.92 in the past, as shown below.

FY19 FY20 FY21 Medium
Tangible BVPS ($) 34.1 35.5 49.6
Average market price ($) 77.8 66.4 80.0
Historical PER 2.3x 1.9x 1.6x 1.9x
Source: Company Financials, Yahoo Finance, Author’s Estimates

Multiplying the average P/TB multiple by the expected tangible book value per share of $38.40 yields a target price of $73.80 for the end of 2022. This price target implies a decline of 6.2% compared to the closing price on October 4. The following table shows the sensitivity of the target price to the P/TB ratio.

Multiple P/TB 1.72x 1.82x 1.92x 2.02x 2.12x
TBVPS – Dec 2022 ($) 38.4 38.4 38.4 38.4 38.4
Target price ($) 66.1 70.0 73.8 77.6 81.5
Market price ($) 78.7 78.7 78.7 78.7 78.7
Up/(down) (16.0)% (11.1)% (6.2)% (1.3)% 3.5%
Source: Author’s estimates

The stock has traded at an average P/E ratio of around 18.9x in the past, as shown below.

FY19 FY20 FY21 Medium
Earnings per share ($) 5.03 3.64 3.47
Average market price ($) 77.8 66.4 80.0
Historical PER 15.5x 18.2x 23.1x 18.9x
Source: Company Financials, Yahoo Finance, Author’s Estimates

Multiplying the average P/E multiple with the expected earnings per share of $5.29 yields a price target of $100.20 for the end of 2022. This price target implies a 27.3% upside from at the closing price on October 4. The following table shows the sensitivity of the target price to the P/E ratio.

Multiple P/E 16.9x 17.9x 18.9x 19.9x 20.9x
EPS 2022 ($) 5.29 5.29 5.29 5.29 5.29
Target price ($) 89.6 94.9 100.2 105.4 110.7
Market price ($) 78.7 78.7 78.7 78.7 78.7
Up/(down) 13.8% 20.6% 27.3% 34.0% 40.7%
Source: Author’s estimates

Equal weighting of target prices from both valuation methods gives a combined result target price of $87.00, which implies an increase of 10.5% compared to the current market price. Adding the forward dividend yield gives an expected total return of 13.3%. This expected total return is not high enough for me. Therefore, I adopt a holding rating on Independent Bank Corp. I would consider investing in the stock if its price drops more than 5% from the current level.