Seeking Alpha • Aug 29
FNCB Bancorp: High Dividend Yield, Flattish Earnings Outlook
Summary
Strength in Pennsylvania’s job market and satisfactory regional economic activity will likely support loan growth through the end of 2023.
The margin will suffer from the rising rate environment as the re-pricing of liabilities will overtake the re-pricing of assets.
The equity book value will also decline due to higher interest rates.
The December 2022 target price suggests a moderate upside from the current market price. Further, FNCB is offering a high dividend yield for a bank holding company.
Strong loan growth will likely be the chief driver for FNCB Bancorp’s (NASDAQ: FNCB) earnings in the next year and a half. On the other hand, the margin will likely dip this year as the re-pricing of deposits will outweigh the re-pricing of earning assets. Meanwhile, the provisioning for expected loan losses will likely remain at a normal level. Overall, I'm expecting FNCB Bancorp to report earnings of $1.06 per share in 2022, almost unchanged from last year. For 2023, I'm expecting the company to report earnings of $1.15 per share, up 9% year-over-year. The year-end target price suggests a moderate upside from the current market price. Further, FNCB is offering a high dividend yield. Based on the total expected return, I'm adopting a buy rating on FNCB Bancorp.
Pennsylvania's Economy is Pivotal for Loan Growth
Compared to previous years, FNCB Bancorp’s loan growth has been extraordinary so far this year. The portfolio has already grown by 11.2% in the first half (22% annualized), raising hopes of at least mid-teen growth for the full year. However, high interest rates are likely to dampen credit appetite, leading to a deceleration of the growth rate from the first half’s level.
On the other hand, strong job markets and reasonable economic activity in local markets will likely keep loan growth near the historical median. FNCB mainly operates in northeastern Pennsylvania, including Lackawanna, Luzerne, and Wayne counties. The state has a commendable job market, with an unemployment rate that is very low from a historical perspective.
Pennsylvania Unemployment Rate data by YCharts
Further, the coincident index indicates that economic activity in Pennsylvania is at a satisfactory level.
Philly Fed Pennsylvania Coincident Index data by YCharts
Overall, I'm expecting the loan portfolio to grow by 2% every quarter, or 8% annualized, through the end of 2023, which is close to the historical trend.
Margin to Suffer from Rising Interest Rates
FNCB's balance sheet is liability sensitive in the short term, which means the re-pricing of liabilities will outweigh the re-pricing of assets. The following factors contribute to liability sensitivity.
A large balance of adjustable-rate deposits. Non-maturing interest-bearing deposits made up a hefty 66% of total deposits at the end of June 2022, according to details given in the 10-Q filing. These deposits re-price frequently; therefore, they will pressurize the margin amid a rising rate environment.
A large balance of securities. The available-for-sale debt securities portfolio made up a sizable 31% of total earning assets at the end of June 2022. A majority of debt securities are based on fixed rates. Therefore, they will weigh down the average earning-asset yield as rates rise.
The results of the management’s interest-rate sensitivity analysis given in the 10-Q filing showed that a 200-basis points hike in interest rates could DECREASE the net interest income by 7.4% over months. Considering these factors, I'm expecting the margin to dip by 5 basis points in the second half of 2022 and then remain unchanged throughout 2023.
Normalized Provisioning Likely
The loan portfolio’s asset quality has improved tremendously over the last year. Nonperforming loans made up just 0.26% of total loans at the end of June 2022, down from 0.46% at the end of June 2021. As a result of the reduction in nonperforming loans, the allowance now appears at a comfortable level. Allowances were 1.23% of total loans at the end of June 2022. In my opinion, FNCB can easily ride out the upcoming headwinds without making any out-of-the-ordinary contributions to reserves. The upcoming headwinds include high inflation, rising interest rates, and the possibility of a recession.
Overall, I believe provisioning will likely remain at a normal level through the end of 2023. I'm expecting the net provision expense to make up around 0.17% of total loans (annualized) in every quarter till the end of next year, which is the same as the average from 2017 to 2019.
Expecting Flattish Earnings for 2022, Moderate Growth for 2023
The anticipated loan growth discussed above will likely be the chief driver of earnings for the next year and a half. On the other hand, the reduction in net interest margin will likely drag earnings. Meanwhile, provisioning for expected loan losses will likely remain at a normal rate. Overall, I'm expecting FNCB to report earnings of $1.06 per share for 2022, almost unchanged from last year. For 2023, I'm expecting earnings to grow by 9% to $1.15 per share. The following table shows my income statement estimates.
FY18 FY19 FY20 FY21 FY22E FY23E
Income Statement
Net interest income 37 36 40 49 54 59
Provision for loan losses 2.6 0.8 1.9 0.2 1.8 2.0
Non-interest income 12 8 9 8 7 7
Non-interest expense 29 30 29 31 34 36
Net income - Common Sh. 13 11 15 21 21 23
EPS - Diluted ($) 0.79 0.56 0.76 1.06 1.06 1.15
Source: SEC Filings, Earnings Releases, Author's Estimates
(In USD million unless otherwise specified)
Actual earnings may differ materially from estimates because of the risks and uncertainties related to inflation, and consequently the timing and magnitude of interest rate hikes. Further, a stronger or longer-than-anticipated recession can increase the provisioning for expected loan losses beyond my estimates.
Further Book Value Erosion Likely
FNCB has a large balance of available-for-sale securities, which made up 31% of total earning assets at the end of June 2022. As a result, the company has accumulated significant mark-to-market losses on this portfolio amid the rising-rate environment. These unrealized losses have bypassed the income statement and gone directly to the equity account, as per relevant accounting standards. Consequently, the equity book value (tangible) has plunged from $8.13 per share at the end of December 2021 to $6.38 per share at the end of June 2022, according to details given in the earnings release.
I'm expecting a 150-basis point hike in the Federal Funds rate in the second half of 2022 and no change in the first half of 2023 before some rate cuts in late 2023. Therefore, the equity book value will face further pressure this year. On the other hand, retained earnings will lift the book value per share. The following table shows my balance sheet estimates.