Mid Penn Bancorp To Suffer From Margin Squeeze

Oct. 06, 2019 11:29 AM ETMid Penn Bancorp, Inc. (MPB)1 Comment
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Sheen Bay Research
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Summary

  • Earnings are expected to decline due to a reduction in net interest margin and growth in non-interest expense.
  • Loan growth is also expected to slow due to the overall slowdown in the economy and the resultant dip in demand for credit products.
  • MPB is expected to pay $0.72 as dividend in 2020, implying a dividend yield of 2.89%.
  • Valuation analysis suggests slight price upside.

Earnings of Mid Penn Bancorp (NASDAQ:MPB), a bank holding company, are expected to decline in 2020 on the back of a shrinkage in net interest margin and growth in non-interest expense. Due to the earnings decline, it is expected that MPB will skip the special dividend next year, and pay $0.72 as regular dividend per share. This dividend expectation implies a yield of 2.89%.

Loan Growth to Slow

MPB's loan growth is expected to slow in 2020 due to the overall economic slowdown that will affect demand for loan products in the economy. MPB focuses on the commercial real estate segment, CRE, which made up more than 60% of total loans as at the end of June 2019. As the CRE segment responds more quickly to prospects of economic slowdown than the residential real estate or consumer loans segments, MPB faces greater risk than peers focusing on other segments. I expect MPB's loan growth to slow to 4.1% in 2020. The table below shows estimates for loans and other key balance sheet items.

Mid Penn Bancorp Balance Sheet ForecastEarnings to Suffer From Net Interest Margin Reduction

MPB has a high amount of debt that the company previously took to finance loans and its First Priority Bank acquisition. In fact, borrowings made up 15% of MPB's total interest expense in 2QFY19. Due to the debt, MPB's cost of funds is expected to remain high and downward sticky. The notes for acquisition of First Priority bank expire in 2025, are non-callable in the first five years and bear a high interest rate of 7.0%, according to disclosures in MPB's financial statements. Meanwhile, the notes issued in 2017 carry a high fixed rate of 5.25% for the first five years, i.e. till 2022, after which their rate becomes floating. These notes expire in 2028. Notes issued in 2015 carry a high fixed rate of 5.15% for the first five years, i.e. till December 2020. I expect the 50bps Fed rate cut, and the stickiness of borrowing cost, to result in funding cost declining by just 4bps in the second half of 2019 before stabilizing. I'm not expecting any further Fed rate cut.

I expect the 50bps Fed Funds rate cut in 2019 till date, and the competition in the CRE segment, to lead to a 25bps dip in yields in the remainder of 2019, followed by 3bps decline in each of the first two quarters of 2020. As a result of the lower funding cost and yield expectation, I expect net interest margin to decline by 15bps in 2020. The table below summarizes the yield, cost, and margin estimates.

Mid Penn Bancorp Net Interest Margin

Non-Interest Expense to Further Drag Earnings

The decline in net interest margin is likely to undermine the positive effect of loan growth, thereby leading to earnings decline in 2020.The downturn is expected to be exacerbated by a rise in MPB's non-interest expense driven by the company's expansion strategy. As a result of its expansionary efforts, the Mid Penn Bank has recently received regulatory approval to open a new full-service retail branch in Hazel Township, which will add to occupancy and salary expenses.

Due to the lower net interest income and higher non-interest expense, I expect MPB's earnings to decline by 16% year over year in 2020. The table below shows the income statement forecasts.

Mid Penn Bancorp Income Forecast

MPB Offering Dividend Yield of 2.89%

I expect quarterly dividends to be maintained at $0.18 throughout 2020 with no special dividend, which will take down DPS for full year 2020 to $0.72 from $0.79 in 2019. This expected payout implies a dividend yield of 2.89%.

My expectation that MPB will skip the special dividend is based on the prospects of earnings decline and MPB's Tier I ratio, which is close to the minimum regulatory requirement. The Tier I ratio was recorded at 9.8% on June 30, 2019, versus regulatory requirement of 8.5%.

I expect the quarterly dividend to be maintained at the current level of $0.18 as it suggests a payout ratio of 45.9% for 2020, which is a comfortable level.

Valuing at $26.9

I'm using the historical price to book multiple, P/B, to value MPB. The company has traded at an average P/B ratio of 1.04 since 2013. Instead of taking this simple average, it is better to take a trimmed average due to the outlier in FY17. Excluding the outlier gives an average of 0.95x, as shown in the table below.

Mid Penn Bank Historical Price to BookMultiplying the trimmed average P/B ratio with forecast book value per share of $28.3 gives a December 2020 target price of $26.9. This price target implies a 7.8% upside from MPB's October 2, 2019 closing market price. The table below shows sensitivity of the target price to P/B multiple.

Mid Penn Bank Valuation

Conclusion: Adopting Neutral Stance

I'm adopting a neutral stance on MPB because its price upside is not high enough. Investors should buy the stock only if its price drops to below $24.43, i.e. 10% below the target price. Given the current widespread panic in the stock market due to signs of economic slowdown, it is likely that MPB's price will reach the target entry point of $24.43 in the coming months.

This article was written by

Sheen Bay Research profile picture
2.57K Followers
Around 10 years of experience covering Banks and Macroeconomics. Passionate about discovering lucrative investments and generating alpha.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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