First Commonwealth Financial: Management's Efforts Likely To Support Revenues
- The management is taking steps to boost loan growth, including the launching of the equipment finance segment and the hiring of new bankers.
- The existing allowance level appears excessively high. As a result, provisioning will likely be a tailwind for earnings in the coming quarters.
- The December 2022 target price suggests a remarkable upside from the current market price. Further, FCF is offering a decent dividend yield.
Loan growth will likely be the chief driver of earnings of First Commonwealth Financial Corporation (NYSE: NYSE:FCF) in the quarters ahead. The management's plans to set up an equipment finance segment and hire new revenue generators will likely boost loan growth. Further, muted provision expense will likely act as a tailwind in the coming quarters. Overall, I'm expecting the company to report earnings of $0.65 per share in the second half of 2021, taking full-year earnings to $1.37 per share. The December 2022 target price suggests a high upside from the current market price. As a result, I'm adopting a bullish rating on First Commonwealth Financial Corporation.
Efforts to Boost the Loan Portfolio Likely to Drive Revenues
After increasing modestly in the first half of 2021, First Commonwealth’s net interest income will likely continue to trend upwards in the coming quarters due to the following factors.
- Setting up of the equipment finance business. First Commonwealth has recently announced via a press release that it plans on investing in an equipment finance business. This will likely boost loans, even though equipment finance is not the best business to get into amid the current environment. Equipment finance, especially the financing of gym equipment, has suffered deeply during the pandemic. Nevertheless, the new venture bodes well for loan growth in the short to medium term as the effects of the pandemic wear off. The management appears realistic about gains from this new venture, as it mentioned that it expects the business to break even late in 2022.
- Continuation of loan growth momentum. The management mentioned in the second quarter’s conference call that loan growth was very strong at the end of the second quarter. Further, the management expects to maintain the loan growth trajectory for the remainder of the year. Loans, excluding Paycheck Protection Program (“PPP”) loans, grew by a remarkable 3% in the second quarter of 2021. This growth was despite the 20% reduction of branches in December 2020. Therefore, the branch reduction seems to have had barely any negative impact on loan origination.
- New hires. The Management plans to hire new resources in revenue production and credit positions, as mentioned in the conference call.
- Improvement in the economy. It goes without saying that the current economic trends, i.e. the decline in the country's unemployment rate and upward trajectory of GDP, will boost credit demand.
On the other hand, the upcoming forgiveness of PPP loans will constrain loan growth in the second half of 2021. According to details given in the second quarter’s 10-Q filing, PPP loans made up 4.3% of total loans at the end of June 2021. Considering the factors mentioned above, I'm expecting loans to increase by 1% in the second half of 2021 and 4% in 2022. Meanwhile, I'm expecting deposits and securities to remain mostly stable, in line with management's guidance given in the conference call. The following table shows my balance sheet estimates (securities make up most of the Other Earning Assets line item).
On the other hand, pressure on the net interest margin will likely constrain net interest income growth. The average portfolio yield will face downward pressure because of lower reinvestment rates. At the same time, the funding cost will likely remain downward sticky as it is already quite low. As mentioned in the second quarter’s investor presentation, the cost of funds was just 0.19% in the second quarter.
Considering the balance sheet and the net interest margin outlook, I'm expecting the net interest income in the second half of 2021 to be almost flat from the second quarter’s level. For 2022, I'm expecting the net interest income to increase by 1.1% year-over-year.
Excessive Allowances to Keep Further Provisioning Low
First Commonwealth reported a provision expense, net of reversals, of just $1 million in the first half of 2021. The management mentioned in the conference call that it expects credit to be a tailwind in the back half of the year. In my opinion, the management's expectation is realistic because the current loan loss reserve appears excessively high. As mentioned in the presentation, the reserve was 1.5% of total loans (ex-PPP) at the end of the last quarter. In comparison, loan deferrals, which are one of the biggest sources of credit risk, made up only 0.88% of total loans at the end of the last quarter. Additionally, actual net charge-offs were only 0.25% of average loans in the second quarter, as mentioned in the presentation.
Considering these factors, I'm expecting First Commonwealth to report a provision expense of only $4 million in the second half of 2021. For 2022, I'm expecting the provision expense to remain below normal. I'm expecting the provision-expense-to-total loan ratio to be around 0.09% in 2022, as opposed to an average of 0.23% from 2016 to 2019.
Expecting Full-Year Earnings of $1.37 per Share
The anticipated loan growth will likely be the chief driver of earnings in the coming quarters. Further, subdued provision expense will support the bottom line. On the other hand, pressure on the net interest margin will constrain earnings growth. Moreover, the non-interest expense will likely trend upwards from the second quarter's level due to the following factors.
- The management plans to return to a normal work and travel environment, as mentioned in the conference call.
- First Commonwealth plans on hiring new people in revenue producing and credit positions, as discussed above.
- The launching of the equipment finance segment will increase operating expenditure.
The non-interest expenses had dipped sharply in 4Q'20 and 1Q'21 because of the branch network reduction. Therefore, the non-interest expense will decline on a year-over-year basis despite the three factors listed above.
Considering the outlook on income and expense components, I'm expecting First Commonwealth to report earnings of $0.65 per share in the second half of 2021, taking full-year earnings to $1.37 per share, up 83% year-over-year. For 2022, I'm expecting the company to report earnings of $1.31 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, especially the Delta variant.
Next Year’s Target Price Indicates a Good Capital Appreciation Opportunity
First Commonwealth is offering a dividend yield of 3.3%, assuming the company maintains its quarterly dividend at the current level of $0.115 per share. The earnings and dividend estimates suggest a payout ratio of 35% for 2022, which is in line with the pre-pandemic (2019) level of 37%. Therefore, I’m not expecting any further increase in the dividend level through the end of 2022.
I’m using the historical price-to-tangible book (“P/TB”) and price-to-earnings (“P/E”) multiples to value First Commonwealth. The stock has traded at an average P/TB ratio of 1.7 in the past, as shown below.
Multiplying the average P/TB multiple with the forecast tangible book value per share of $9.5 gives a target price of $16.5 for the end of 2022. This price target implies a 17.7% upside from the October 1 closing price. The following table shows the sensitivity of the target price to the P/TB ratio.
The stock has traded at an average P/E ratio of around 13.0x in the past, as shown below.
Multiplying the average P/E multiple with the forecast earnings per share of $1.31 gives a target price of $17.1 for the end of 2021. This price target implies a 22.2% upside from the October 1 closing price. The following table shows the sensitivity of the target price to the P/E ratio.
Equally weighting the target prices from the two valuation methods gives a combined target price of $16.8, which implies a 19.9% upside from the current market price. Adding the forward dividend yield gives a total expected return of 23.2%. Hence, I’m adopting a bullish rating on First Commonwealth Financial Corporation.
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