Rising NPLs And Shrinking Profit Margins Spell Trouble For Future Profitability

Key Takeaways

• Rising nonperforming loans and the struggle with asset quality issues may lead to increased provisions for losses, impacting the bank's profitability.
  
• Modest loan growth projections and a decline in net interest margin highlight challenges in expanding revenue and sustaining profitable growth.
  
• RBB Bancorp's strategy focuses on enhancing revenue and earnings through loan growth, improving net interest margins, resolving nonperforming loans, and maintaining financial resilience.

Catalysts

Operates as the bank holding company for Royal Business Bank that provides various banking products and services to the Chinese-American, Korean-American, and other Asian-American communities.

• The increase in nonperforming loans (NPLs) in the second quarter, primarily due to three loans migrating to nonaccrual, indicates potential future credit quality issues that could impact net interest income and increase provisions for loan losses, affecting the bank's profitability.
  
• Modest loan growth reported with a projection of continued low to mid-single-digit growth amid a challenging lending environment may limit revenue expansion, impacting the bank's ability to significantly grow its net income in the near term.
  
• A decline in net interest margin (NIM) by 2 basis points, despite efforts to reduce reliance on wholesale funding, shows vulnerability in sustaining profitable growth rates in interest earnings, which is critical for the bank's net interest income.
  
• The bank's proactive reliance on wholesale funding reduction and deposit-funded loan growth strategy, while beneficial for cost management, could restrict its ability to scale operations quickly, potentially capping revenue growth in a competitive market environment.
  
• The operational focus on resolving troubled loans without material loss, coupled with a cautious outlook on NPL recoveries, suggests that asset quality issues could persist, potentially requiring additional provisions that affect net income and erode investor confidence.

Assumptions

• Analysts are assuming RBB Bancorp's revenue will decrease by -0.2% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 30.5% today to 20.6% in 3 years time.
• Analysts expect earnings to reach $24.2 million (and earnings per share of $1.44) by about September 2027, down from $35.8 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 15.7x on those 2027 earnings, up from 11.5x today. This future PE is greater than the current PE for the US Banks industry at 11.8x.
• Analysts expect the number of shares outstanding to decline by 6.27% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 6.15%, as per the Simply Wall St company report.

Risks

• Loan growth is expected to increase in future quarters due to an expanding loan pipeline and increased loan activity, which would likely contribute positively to revenue growth and earnings.
  
• A decline in interest expenses resulting from a reduction in reliance on wholesale funding could improve net interest margins, positively impacting profitability.
  
• The ability to resolve nonperforming loans without material loss, as indicated by the management's confidence in the underlying collateral of troubled loans, could mitigate potential negative impact on net income.
  
• Stability in total deposits and successful replacement of wholesale funding with retail deposits at stable rates may support funding stability and cost efficiency, contributing positively to net interest income.
  
• The company's strong capital levels above regulatory well-capitalized levels suggest financial resilience and operational flexibility, which could support continued growth and earnings stability.
  

Valuation

• The analysts have a consensus price target of $22.7 for RBB Bancorp based on their expectations of its future earnings growth, profit margins and other risk factors.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $117.1 million, earnings will come to $24.2 million, and it would be trading on a PE ratio of 15.7x, assuming you use a discount rate of 6.2%.
  
• Given the current share price of $23.19, the analyst's price target of $22.7 is 2.2% lower. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.