Premier Financial: Earnings Outlook Appears Priced In

Summary

• A recovery in economic activity will likely drive the growth of commercial loans. However, the upcoming forgiveness of Paycheck Protection Program loans will hurt the loan balance.
• The existing reserves will likely cover most of the upcoming pandemic-driven credit losses. As a result, the provision expense will likely normalize this year.
• The December 2021 target price suggests a limited upside from the current market price. Additionally, Premier is offering a modest dividend yield.

Earnings of Premier Financial Corp. (NASDAQ: NASDAQ:PFC) will likely receive a boost from earning asset growth. The economic recovery will likely play a pivotal role in commercial loan growth. Further, the provision expense will likely decline because Premier Financial already has a sizable reserve for loan losses relative to the losses I expect for this year. Overall, I’m expecting the company to report earnings of $2.86 per share in 2021, up 3.7% from the core earnings of 2020. The year-end target price is quite close to the current market price; hence, I’m adopting a neutral rating on Premier Financial Corp.

Asset Mix Shift, PPP Forgiveness to Partly Offset Organic Growth in Loans

The vaccine rollout and resultant recovery in economic activity will likely drive commercial loans this year. On the other hand, the forgiveness of Paycheck Protection Program (“PPP”) loans will likely constrain loan growth. As mentioned in the fourth quarter’s investor presentation, Premier had $387 million of PPP loans outstanding at the end of December 2020, representing 7% of total loans. I’m expecting most of these loans to get forgiven in the first half of this year.

Further, the company has historically grown through merger and acquisition activity. Within the last five years, Premier has completed a merger of equals and an acquisition of a bank, as per details given on the company’s website. As there are no M&A announcements so far this year, I’m not incorporating any acquisitions in my loan growth estimates. Further, the management mentioned in the presentation that it planned to be prudent with respect to M&A.

The management mentioned in the fourth quarter’s conference call that it expected loans to grow by 3% to 4% excluding the impact of PPP. Considering the factors mentioned above and management’s guidance, I’m expecting net loans to increase by 1.7% by the end of 2021 from the end of 2020. This expected growth rate is much lower than the historical trend.

Meanwhile, I’m expecting deposit growth to outpace loan growth. As a result, Premier will have to either park the excess funds into cash equivalents or invest in securities. The management mentioned in the conference call that it expects the security portfolio to expand for 2021. As a result, I’m expecting earning assets other than loans to grow by 6% by the end of 2021 from the end of 2020. The following table shows my estimates for balance sheet items.

Loans usually carry higher yields than other earning assets. Due to the anticipated shift in asset mix toward lower-yielding assets, I’m expecting the net interest margin (“NIM”) to decline this year. The following quote from the conference call also shows that the management is willing to let the NIM slide.

…we're looking to focus and grow net interest income dollars, to the detriment of margin in the interim until loan growth really rebounds.”

Further, fixed-rate loans made up 42% of total loans at the end of December, as mentioned in the presentation. Unlike adjustable and variable rate loans, many of the fixed-rate loans have not yet incorporated the interest rate cuts of early 2020. Hence, the NIM will likely face downward pressure as fixed-rate loans mature. Overall, I’m expecting the average NIM in 2021 to be 33 basis points below the average for 2020.

Considering the outlook for loan growth and NIM decline, I’m expecting the net interest income to increase by 6% year-over-year.

Last Year’s Allowances to Keep Provision Expense Subdued in 2021

The provision expense will likely decline this year because Premier built up large reserves for loan losses at the start of the pandemic. Allowances for credit losses made up 1.5% of total loans at the end of December. In comparison, the management expects charge-offs in 2021 to be only 0.20% to 0.35% of total loans, as mentioned in the conference call. As a result, I’m expecting the existing allowances to easily cover upcoming credit losses this year. Further, loans requiring payment deferrals made up just 0.8% of total loans at the end of December, according to details given in the presentation. These deferrals will expire by April 2021, at which time a clearer picture of the asset quality will emerge.

Although the deferrals show that the credit risk is low, the exposure to the traveler accommodation segment may lead to a surprise surge in credit losses. As mentioned in the presentation, loans to the traveler accommodation industry made up 2.8% of total loans.

Considering the above-mentioned factors, I’m expecting the provision expense to decline to $6 million in 2021 from $44 million in 2020. The estimate for 2021 makes up 11 basis points of total loans, which is the same as the actual provision-expense-to-total loans for 2019.

Expecting Earnings of $2.86 per Share

The expected growth in net interest income and decline in provision expense will likely drive earnings this year. On the other hand, the mortgage banking income will likely decline this year, which will reduce non-interest income. Stable interest rates will likely diminish the benefit of refinancing for homeowners, which in turn will reduce overall mortgage banking revenue. Considering these factors, I’m expecting Premier Financial to report earnings of around $2.86 per share. The following table shows my income statement estimates.

Actual earnings may differ materially from estimates because of the risks and uncertainties related to the COVID-19 pandemic and the vaccine rollout.

Current Market Price is Quite Close to the December 2021 Target Price

Premier Financial is offering a dividend yield of 3.0%, assuming the company maintains its quarterly dividend at the current level of $0.24 per share. There is little threat of a dividend cut because the earnings and dividend estimates suggest a payout ratio of just 34% for 2021.

Apart from the modest dividend yield, Premier Financial is offering a limited price upside. I’m using the historical price-to-tangible book multiple (“P/TB”) to value Premier. The stock has traded at an average P/TB ratio of 1.64 in the past, as shown below.

Multiplying the average P/TB multiple with the forecast tangible book value per share of $19.5 gives a target price of $32.1 for the end of 2021. This price target implies a 1.7% upside from the March 1, 2021 closing price. The following table shows the sensitivity of the target price to the P/TB ratio.

In my previous report on Premier Financial, I had adopted a bullish rating on the stock. Since the publication of that report, the stock price has rallied significantly, leaving little upside to the year-end target price, as shown above. Based on the limited price upside, I’m downgrading the rating on Premier Financial to neutral.

Analyst’s 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.

Disclaimer: This article is not financial advice. Investors are expected to consider their investment objectives and constraints before investing in the stock(s) mentioned in the article.