Hanmi Financial Corp.: Provisions Normalization To Drive Earnings Next Year

Nov. 04, 2019 1:17 PM ETHanmi Financial Corporation (HAFC)
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Summary

  • Provisions charge normalized in the third quarter after a spike in 2Q. This charge is expected to continue to remain low next year, which will boost earnings.
  • Loan growth is expected to be moderate. NIM is also expected to be mostly unchanged next year. This will lead to flat growth in net interest income.
  • Dividend is expected to be maintained at $0.24 per share in every quarter of 2020. This estimate implies a dividend yield of 4.99%.

Hanmi Financial Corporation's (NASDAQ:HAFC) provisions charge for loan losses is expected to return to normal in 2020, which will increase earnings next year compared to 2019. Other earnings components are expected to see flat growth year over year.

Provisions To Continue To Remain Low

HAFC's earnings received a hit in the second quarter from a $15.7 million allowance relating to a troubled $40 million loan relationship. The provisions charge returned to normal in the third quarter, showing that the spike in the second quarter was in fact non-recurring. Going forward, provisions charge for credit losses is expected to remain low because the spike was apparently a standalone event only and not a widespread problem.

The implementation of the new accounting standard for credit losses named the Current Expected Credit Losses, CECL, standard may increase the allowance balance for loan losses, which will negatively affect equity. Post the implementation of the standard, there is risk that higher provisions charge will become the new normal. For now, I am not assuming CECL to drive a significant rise in provisions charge, but I may have to revise my assumptions in the future as more details come to light.

Selective Disbursement To Result In Modest Loan Growth

As mentioned in the 3QFY19 conference call, HAFC's strategy is to protect net interest margin with a moderate growth in loans and leases. The management also mentioned that the Asian-American landscape HAFC operates in is currently very competitive. Due to HAFC's preference to maintain margins and not aggressively price its credit products, I'm expecting the company to experience only moderate loan growth in 2020. The table below shows my loan estimate of $4.5 billion, depicting 1% year-over-year growth.

Hanmi Financial Corporation Balance Sheet Forecast

Limited Downside Foreseen For Margins

Due to HAFC's focus on margin maintenance, it is likely that monetary easing will have only a subdued impact on the company's net interest margin, NIM. The loans maturing in the fourth quarter have average rates similar to current origination yields, which means average yields will undergo limited reduction. Moreover, HAFC's deposit mix has improved in the third quarter, which will further help buoy margins going forward.

On the other hand, due to high competition for deposits, HAFC had to resort to relatively expensive borrowing to fund its assets. According to the earnings release, the company borrowed at an average rate of 1.96% in the third quarter, which is lower than the average time deposit rate of 2.29% but higher than average rates on money market and saving deposits. The higher borrowing cost is expected to partly offset the benefit from better deposit mix. The table below shows my estimates for yield, cost, and margin.

Hanmi Financial Corporation Net Interest Income

Management Attempting To Control Non-Interest Expense

Certain items that pushed up expenses in the third quarter, like CECL implementation and resolution of the bad debt (mentioned in the paragraph on provisions charge above), are expected to taper off in the fourth quarter. The management expects the non-recurrence of those items to lead to around $1 million reduction in expenses.

The one-off expenses were not the only drivers of HAFC's non-interest expenses. These expenses surged disconcertingly in the third quarter due to growth in recurring items as well, including salaries and occupancy costs. HAFC's efficiency ratio reached a problematic level of 64% in the third quarter, compared to 59% in 2QFY19.

The growth in the recurring parts of non-interest expense signals that the expense head will continue to remain high. To address the issue of high expenses, the management launched a branch consolidation initiative wherein five branches, or about 10% of the branch network, were shut down. The management is also investing in technology and systems to achieve cost reductions.

Given the high salary and occupancy costs and the management's efforts towards achieving operating efficiency, I expect HAFC's non-interest expense to grow by 0.3% year over year in 2020. The expense estimate implies an efficiency ratio of 60.5% in 2020.

Earnings To Increase By 25%

Due to expectations of lower provisions charge, I'm anticipating HAFC's earnings to surge by 25% year over year in 2020, to $1.71 per share. Line items apart from provisions are expected to remain mostly unchanged year over year.

Hanmi Financial Corporation Income Forecast

HAFC Offering Attractive Dividend Yield Of 4.99%

I'm expecting HAFC to maintain its quarterly dividend at $0.24 per share in 2020, which will result in an estimated payout ratio of 56%. This ratio is higher than the payout HAFC has maintained in the past, but it is still at a manageable level; hence, I believe there is no need for a cut in dividend. Further, the company is currently well-capitalized with a Tier I risk-based capital ratio of 12.04% at the end of September.

The dividend estimate suggests a high forward dividend yield of 4.99%.

Double-Digit Price Upside Expected

I'm using the historical average price to book ratio, P/B to value HAFC. The company's expected return on equity, ROE, is much lower for the future than it has been in the past, hence it is more appropriate to take the historical average for this year only. The table below shows HAFC's ROE in the past and the ROE forecast.

Hanmi Financial Corporation Return on Equity

HAFC has traded at a P/B multiple of 1.15 in the first nine months of 2019. Multiplying this ratio with the forecast book value per share of $19.4 gives a target price of $22.3 for December 2020. This price target implies a 15.7% upside from HAFC's October 31, 2019 closing price.

Hanmi Financial Corporation Valuation Sensitivity

Conclusion: Maintaining Bullish Stance

Due to the double-digit potential for price upside, I'm maintaining a bullish stance on HAFC. Combining the price upside of 15.7% and dividend yield of 4.99% gives a total expected return of 20.7%. Based on this expected return my suggestion is to buy the stock.

This article was written by

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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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