Seeking Alpha • Oct 05
Northrim BanCorp: Margin's High Rate-Sensitivity To Benefit Earnings
Summary
The net interest margin is highly rate-sensitive because a significant portion of the loan portfolio will reprice this year.
High oil prices and the Alaskan economy will likely sustain loan growth.
Earnings will take a hit from mortgage banking income normalization and above-average provisioning for expected loan losses.
The December 2022 target price suggests a high upside from the current market price. Further, NRIM is offering a high dividend yield for a bank holding company.
Earnings of Northrim BanCorp, Inc. (NRIM) will benefit from the up-rate cycle and the margin’s elevated sensitivity to interest rate changes. Further, subdued loan growth will support the bottom line. On the other hand, normalization of mortgage banking income and above-average provisioning will likely drag earnings. Overall, I'm expecting Northrim BanCorp to report earnings of $5.06 per share for 2022, down 16% year-over-year. Compared to my last report on Northrim BanCorp, I've increased my earnings estimate mostly because I've revised upwards my net interest margin estimate. For 2023, I'm expecting earnings to grow by 23% to $6.22 per share. The year-end target price suggests a high upside from the current market price. Therefore, I'm maintaining a buy rating on Northrim BanCorp.
Margin is Set to Surge Amid the Rising Rate Environment
Northrim BanCorp’s margin surged by 49 basis points in the second quarter of 2022 thanks to the high loan beta. At the same time, Northrim was successful in holding down its funding costs even as market interest rates surged.
The Federal Reserve has surprised me by increasing the Fed Funds rate by 300 basis points so far this year. The Federal Reserve expects to further increase its rate by 125 to 150 basis points by the end of 2023, according to its latest projections release. This monetary tightening will significantly boost Northrim's interest income. As of December 2021, loans totaling $967 million were going to reprice this year, including floating-rate loans and fixed-rate loans scheduled to mature in 2022, as mentioned in the last 10-K filing. These loans represented a massive 68% of total loans at the end of December. Northrim BanCorp mentioned in the latest 10-Q filing that the rate sensitivity has not changed materially since the issuance of the 10-K filing.
Unfortunately, a majority of the deposit book will also reprice this year. Interest-bearing demand, savings, and money market accounts made up 57% of total deposits at the end of June 2022. These interest-bearing deposits reprice frequently; therefore, they will hurt the margin soon after every rate hike.
Nevertheless, the management’s rate sensitivity analysis shows that the net interest margin is highly sensitive to rate changes. A 200-basis points hike in interest rates could boost the net interest income by 15.7% in the first year and 22.09% in the second year of the rate hike, as mentioned in the 10-K filing.
2021 10-K Filing
Considering these factors, I'm expecting the margin to increase by 60 basis points in the second half of 2022 and by a further 50 basis points in 2023. Compared to my last report on Northrim BanCorp, I've raised my margin estimate because my interest rate outlook is now more hawkish than before.
Loan Outlook Remains Positive Thanks to Oil Prices
After four consecutive quarters of decline, the loan book grew by 2.1% in the second quarter of 2022. Going forward, loan growth will depend on the Alaskan economy. Alaska’s job market is currently one of the worst in the country. Nevertheless, it has undergone a big improvement from a historical perspective, and the unemployment rate is at a record low.
Data by YCharts
The coincident economic activity index shows that economic activity in the state is on an unsure footing.
Federal Reserve Bank of Philadelphia
Nevertheless, I'm positive about Alaska’s economy mostly because of oil prices. Despite a recent downturn, they are still very high.
Data by YCharts
The crude oil future curve is currently in backwardation, with the November 2022 contract trading at $86.52, the November 2023 contract trading at $74.78, and the November 2024 contract trading at $69.05. Nevertheless, despite the negative trend, the curve suggests that the market expects oil prices to remain high even two years out from today.
Considering these factors, I'm expecting the loan portfolio to grow by 0.75% every quarter till the end of 2023. Meanwhile, I'm expecting other balance sheet items to grow mostly in line with loans. The following table shows my balance sheet estimates.
FY18 FY19 FY20 FY21 FY22E FY23E
Financial Position
Net Loans 965 1,024 1,423 1,402 1,415 1,458
Growth of Net Loans 3.4% 6.2% 38.9% (1.5)% 0.9% 3.0%
Other Earning Assets 365 429 506 1,157 977 997
Deposits 1,228 1,372 1,825 2,422 2,371 2,442
Borrowings and Sub-Debt 52 19 25 36 35 36
Common equity 206 207 222 238 227 251
Book Value Per Share ($) 29 30 35 38 39 43
Tang. Book Value Per Share ($) 27 28 32 36 36 40
Source: SEC Filings, Author's Estimates
(In USD million unless otherwise specified)
Provision Expenses to Drag Earnings this Year
After reporting large provision reversals last year, provisioning for expected loan losses was almost back to normal in the first half of 2022. Allowances were 158% of non-performing loans at the end of June 2022, as mentioned in the earnings release. Although this coverage is uncomfortably low, it's still an improvement over the last year. Northrim BanCorp habitually keeps a low level of loan loss reserve coverage. Therefore, I'm not too worried about provisioning pressures from heightened inflation during the second half of 2022.
In my opinion, loan additions will likely be the primary driver of provisioning in the coming quarters. Considering these factors, I'm expecting provisioning to be slightly above normal through the end of 2023. I'm expecting the net provision expense to make up 0.12% of total loans (annualized) in the second half of 2022 and 0.08% of total loans in 2023. In comparison, the net provision expense averaged 0.06% of total loans from 2017 to 2019.
Mortgage Income Normalization to Further Drag Earnings this Year
Mortgage banking is an important component of non-interest income for Northrim BanCorp. During the second quarter, mortgage banking income made up 76% of non-interest income. Therefore, the ongoing slump in mortgage refinancing activity will have a significant impact on Northrim BanCorp’s revenues. The Mortgage Bankers Association forecasts mortgage refinancing volume to plunge by 73% year-over-year in 2022.
Mortgage Bankers Association
Apart from the anticipated fall in mortgage banking income, the higher provision expenses will also drag earnings this year. On the other hand, significant margin expansion will lift earnings through the end of 2023. Further, earnings will receive support from subdued loan growth. Overall, I'm expecting Northrim BanCorp to report earnings of $5.06 per share for 2022, down 16% year-over-year. For 2023, I'm expecting earnings to grow by 23% to $6.22 per share. The following table shows my income statement estimates.
FY18 FY19 FY20 FY21 FY22E FY23E
Income Statement
Net interest income 61 64 71 81 92 104
Provision for loan losses (1) (1) 2 (4) 1 1
Non-interest income 32 37 63 52 35 35
Non-interest expense 70 77 89 89 89 91
Net income - Common Sh. 20 21 33 38 29 36
EPS - Diluted ($) 2.87 3.04 5.11 6.00 5.06 6.22
Source: SEC Filings, Author's Estimates
(In USD million unless otherwise specified)
In my last report on Northrim BanCorp, I estimated earnings of $4.63 per share for 2022. I've increased my earnings estimate mostly because I've revised upwards my margin estimate.