First Savings Financial: Undervalued Due To An Earnings Dip Outlook
- Higher interest rates will likely discourage mortgage refinancing activity. Therefore, mortgage banking income will normalize in 2022.
- Economic growth in Indiana will likely drive a loan portfolio expansion. Further, the bulk of the Paycheck Protection Program loan forgiveness is already over.
- The September 2022 target price suggests a significant upside from the current market price. However, FSFG is offering a low and unattractive dividend yield.
Earnings of First Savings Financial Group, Inc. (NASDAQ: NASDAQ:FSFG) will likely dip next year due to the looming normalization of mortgage banking income. On the other hand, strong double-digit loan growth will likely support the bottom line. Overall, I'm expecting the company to report earnings of $2.75 per share in the fiscal year 2022, down 33% year-over-year. The market appears to have overreacted to the prospect of mortgage banking income normalization as the company is currently trading at a high discount to its year-ahead target price. Based on the total expected return, I'm adopting a bullish rating on First Savings Financial Group.
Mortgage Banking Income Likely to Decline Further Before Stabilizing
Mortgage banking income was the chief reason why First Savings’ earnings remained elevated in fiscal years 2020 and 2021 (note: the company’s fiscal year ends in September). The interest rate cuts in late 2019 and early 2020 drove mortgage refinancing activity, which boosted the non-interest income. First Savings’ mortgage banking income has been steadily running out of steam in the last few quarters. I'm expecting a further decline in mortgage banking income before it stabilizes. The recent increase in mortgage banking rates, as shown below, will discourage refinancing activity going forward.
Moreover, interest rates will likely increase further in 2022 because of the persistently high inflation. The country’s inflation rate has remained stubbornly high since April of 2021, according to official sources. The Federal Reserve last projected an interest rate hike of around 25 basis points in 2022. If inflation continues to remain so high, then the interest rate could rise by more than 25 basis points in 2022.
The following chart shows that Mortgage Bankers Association expects refinancing originations to plunge in 2022.
Considering these factors, I'm expecting the non-interest income to decline by 42% year-over-year in the fiscal year 2022.
Loan Growth Outlook Remains Rosy
First Savings’ loan portfolio declined by 1.3% in the fiscal-year 2021 partly due to the forgiveness of Paycheck Protection Program (“PPP”) loans. As most of the forgiveness is already behind us, I'm expecting its pressure on loan growth to lessen in the coming quarters. As mentioned in the earnings release, PPP loans declined to $56.7 million by the end of September 2021 from $180.6 million at the end of September 2020. Although a majority of the total PPP loans have already gotten forgiven, there's still a large PPP balance that remains outstanding. These PPP loans made up around 5.2% of total loans at the end of September 2021.
Further, economic growth in First Savings’ home state of Indiana would likely drive loan growth. The state’s economy is doing quite well with the current unemployment rate already better than the pre-pandemic national unemployment rate, as shown below.
The company's loan portfolio had normally grown at low double-digit ranges before the pandemic. Considering the factors mentioned above, I'm expecting loan growth to return to a low double-digit range in 2022. Meanwhile, deposit growth will likely grow in line with loans. The following table shows my balance sheet estimates.
Meanwhile, the net interest margin will likely remain unchanged in the coming quarters. The margin has gradually improved throughout fiscal-year 2021, as mentioned in the earnings release. This upward trend will most probably pause in 2022 because of the unusual position of the balance sheet. At the end of June 2021, the balance sheet positioning ensured that both an increase and a decrease in interest rates were likely to hurt net interest income over 12 months. The management's interest-rate sensitivity analysis shows that a flat interest rate benefited earnings the most. The following table from the third quarter’s 10-Q filing shows the management's interest-rate sensitivity analysis.
Based on the outlook of stable margin and strong loan growth, I'm expecting the net interest income to increase by 6% year-over-year in fiscal-year 2021.
Expecting FY22 Earnings of $2.75 per Share
Earnings will likely decline in the fiscal year 2022 because of the impending normalization of mortgage banking income. Further, the provision expense will likely be higher in 2022 after a year of net provision reversals. The company reported allowances of 1.31% of total loans at the end of September 2021, as mentioned in the earnings release. The non-performing loans were comparatively higher at 1.42% of total loans at the end of September 2021. The net charge-offs have been quite low as of late, but in my opinion, the risk from the non-performing loans carries more weight than the actual loan losses. Therefore, I'm expecting provisioning for fiscal-year 2022 to be a bit higher than the historical average. The provision expense averaged 0.18% of total loans from 2016 to 2019. I'm expecting the provision expense to make up 0.20% of total loans in 2022.
On the other hand, strong loan growth will likely support earnings. Overall, I'm expecting First Savings to report earnings of $2.75 per share in fiscal-year 2022, down 33% year-over-year. 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 timeline of an interest rate hike.
Good Opportunity for Capital Appreciation
First Savings is offering a dividend yield of 1.9% at the current quarterly dividend rate of $0.12 per share. The earnings and dividend estimates suggest a payout ratio of only 17.5% for FY22. Therefore, there is very little threat of a dividend cut despite the prospects of an earnings decline.
I’m using the historical price-to-tangible book (“P/TB”) and price-to-earnings (“P/E”) multiples to value First Savings Financial. The stock has tended towards a P/TB ratio of 1.25 in the past, as shown below.
Multiplying the P/TB multiple of 1.25 with the forecast tangible book value per share of $25.9 gives a target price of $32.4 for September 2022. This price target implies a 25.3% upside from the December 3 closing price. The following table shows the sensitivity of the target price to the P/TB ratio.
The stock has tended towards a P/E ratio of around 10.0x in the past, as shown below.
Multiplying the P/E multiple of 10.0x with the forecast earnings per share of $2.75 gives a target price of $27.5 for September 2022. This price target implies a 6.4% upside from the December 3 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 $29.9, which implies a 15.8% upside from the current market price. Adding the forward dividend yield gives a total expected return of 17.7%. Hence, I’m adopting a bullish rating on First Savings Financial.
The company’s earnings are likely to dip in fiscal-year 2022 mostly because of the impending normalization of mortgage banking income. The market appears to have overreacted to the prospects of an earnings decline as the stock is currently trading at a significant discount to the September 2022 target price. I believe First Savings Financial is offering a good capital appreciation opportunity at the current market price.
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