Meridian Corp.: More Growth Ahead

Summary

• Meridian returns excess capital to shareholders.
• The supernormal profit cycle is likely to normalize over time, but new home construction booming in the region implies higher mortgage origination in the mortgage income mix.
• Meridian is positioned for long-term growth in a booming area.

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Overview

Meridian Corporation (NASDAQ:MRBK) is Philly-based community bank that serves the tri-state area. The bank specializes in business and industrial lending, retail and commercial real estate lending. Besides earning spread-based income, the bank earns fee income via mortgage origination and wealth management products. Mortgage origination fees accounted for ~75% of fee income during the past few quarters.

In terms of the market dynamics, Philly has seen a fair number of bank-related deals lately, and the most recent one is the merger between WSFS (WSFS) and Bryn Mawr Trust. Given the market dislocation, Meridian has been able to attract bankers, depositors, and clients on an organic basis, as WSFS set new guidelines on lending terms and target customer profiles; those that did not fit into the "new WSFS" standard naturally get eliminated. As such, the management team expects to see double-digit loan growth within the tri-state region.

One additional item worth mentioning is that the mortgage origination fee has been a strong profit driver during the past six quarters. The management team indicates that continued strength would persist to Q1'2022. As such while the mortgage refinancing activities begin to subside as rates begin to tick up, the strength in the local economy and housing boom would provide sufficient backdrop to a slower decline versus a market that only relies on mortgage refinancing activities. That being said, we expect the mortgage financing activities to decline slower than what the investors have reflected in the stock price.

Review of Operations

From a profitability perspective, ROA and ROE have been trending positively prior to COVID 19. The efficiency ratio has been consistently improving, although the bank is not running as efficiently as other peers within the region.

The credit quality of the loan portfolio remains robust and the non-performing loan is typically trending at less than ~75 basis points. Loan loss provision is manageable.

The cost of financing has been unattractive. The unattractive cost of deposit can be explained by heightened competition within the market. JPMorgan Chase (JPM) has lately moved in the market and has been driving market penetration. The cost of deposit increased significantly in FY2019, but of late the cost of deposit has been more manageable given the Fed policy. Management expects the deposit rate to be manageable over the long haul and does not have the expectation to go back to FY19 levels in the near term.

CapIQ, 10K

Valuation

The market is valuing Meridian at 6.2x P/E and 1.4x P/TBV, which is indicating that the market is valuing the business on a book value basis and expect the supernormal profit to subside over time.

CapIQ, 10K

Risk/Reward

From a risk perspective, competition for market share can be intense within the region. The misstep of larger banks created opportunities for community banks. However, lately, JPMorgan Chase had made a major push into the Philadelphia market, which can be a potential threat to smaller banks such as Meridian. Yet, our expectation is that competition will normalize over time.

From a reward perspective, Meridian will continue to benefit from a booming economy in Philadelphia. Moreover, the top regional bank, WSFS, has acquired Bryn Mawr Trust as well as Beneficial Bank. Investors should expect continued consolidation in the market and in my opinion Meridian can be on the block as the next consolidation target.

Conclusion

Shares are attractively priced for Meridian. The organic onboarding of clients, bankers will continue to drive loan growth. NIM is expected to be stable with the cost of deposit trending at a historical low, benefiting from the low-rate environment. Non-interest income will likely retreat slightly in the next few years, but the resilience in the new home construction market and increasing momentum in wealth management fees will likely partially offset the run-off of the mortgage financing profit super cycle. Last, but not least, given the increasing activities in the mergers and acquisitions market, Meridian could be the next on the market given its size, reputation and client relationship. As such, we believe Meridian presents an attractive opportunity given the risk/reward dynamics.

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.