Growth In Loan Yields And Critical Capital Moves Brighten Outlook, Though Credit Risks And Rate Cuts Could Dampen Profitability

Key Takeaways

• Expansion in net interest margin shows a prospect for growth in net interest income due to favorable loan yields surpassing funding costs.
  
• Strategic capital management demonstrated by reallocating funds from the sale of assets and debt redemption could enhance net interest margin and overall earnings.
  
• Exposure to credit quality issues, single borrower concentration risk, and strategic moves in mortgages and CD rates could affect profitability and revenue stability.

Catalysts

A financial holding company, provides various consumer and commercial banking services in the United States.

• The expanded net interest margin (NIM) indicates potential for increased net interest income growth, particularly as loan yields outpaced funding costs for the first time since Q4 2022.
  
• Mid-single-digit loan growth anticipated by Q4 and into 2025, driven by loan origination capabilities, could result in significant revenue and earnings growth.
  
• Strong deposit performance, especially in low-cost deposit regions, coupled with competitive rates on time deposits, may improve liquidity and fund anticipated loan growth without significantly impacting the cost of funds.
  
• Introduction of well-structured and well-priced consumer loan categories in response to possible rate cuts could enhance consumer lending profitability and attract more customers.
  
• The use of $5.6 million from the sale of Visa B shares to offset the loss sale of low-yielding securities, alongside the redemption of $50 million in subordinated debt, suggests strategic capital management that could further improve net interest margin and earnings.

Assumptions

• Analysts are assuming First Commonwealth Financial's revenue will grow by 4.5% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 34.3% today to 29.2% in 3 years time.
• Analysts expect earnings to reach $154.3 million (and earnings per share of $1.56) by about October 2027, down from $158.7 million today.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 14.2x on those 2027 earnings, up from 10.9x today. This future PE is greater than the current PE for the US Banks industry at 11.9x.
• Analysts expect the number of shares outstanding to decline by 1.1% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 5.87%, as per the Simply Wall St company report.

Risks

• The increase in specific reserves for nonperforming loans (NPLs), particularly from the Centric loan portfolio, highlights potential credit quality issues that could impact net margins and earnings.
  
• The mention of a significant loan from the Centric portfolio requiring additional reserves suggests exposure to single borrower concentration risk, which could affect loan loss provisions and, ultimately, profitability.
  
• The anticipated quarterly downdraft in interchange income due to the Durbin impact, starting next quarter, could negatively influence noninterest income and impact overall revenue.
  
• The strategy of retaining a high percentage of newly originated mortgages and selling off a significant portion could impact the predictability and stability of fee income, affecting net revenue.
  
• The bank's reliance on competitive CD rates to grow deposits, particularly noting the potential pressure from interest rate cuts, could compress net interest margins if deposit costs do not decrease in tandem with loan yields, affecting overall profitability.

Valuation

• The analysts have a consensus price target of $18.83 for First Commonwealth Financial based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $22.0, and the most bearish reporting a price target of just $17.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $528.5 million, earnings will come to $154.3 million, and it would be trading on a PE ratio of 14.2x, assuming you use a discount rate of 5.9%.
• Given the current share price of $16.95, the analyst's price target of $18.83 is 10.0% higher.
• 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.