Below are my notes on INBK. The 10-second takeaway:
o Management’s investments in people, IT, and processes is taking hold
o Loans growing at a healthy clip
o Earnings are growing at a healthy clip as well, thanks to scale efficiencies.
o Efficiency ratio went down to 0.63 (lower is better)
o Long runway for growth, insiders have skin in the game
o Still looks cheap, trading at 1x book value and 17x TTM earnings.
o Potentially trading at less than 10x FY 15 earnings!
Earnings release here: http://www.firstinternetbancorp.com/Cache/1500070882.PDF?Y=&…
1) Deposit Growth
Total average deposits increased to $784M in Q1 2015 versus $698M in Q1 2014, i.e., about a 12.3% increase in the deposit base. There was some sequential increase versus Q4 2014 with deposits being $747M at Dec 31, 2014 (i.e., a 5% sequential increase in the deposit base).
Note that the above numbers are the average deposit amounts taken from the summary page (pg. 6 of the release). If we used the total deposit value at quarter end, we will land up with different numbers. E.g., looking at the total deposits numbers on pg. 7 we get Q1 2015 at $821M versus $759M at Q4 2014 and $728M at Q1 2014. However, the relative growth rate numbers are similar.
One point of concern might be the slow growth in deposits. After all, deposits are the life line of banks. No need to panic here. We need to look at deposit versus loans, and I just think management has been managing deposit growth so increase their spreads. I.e., while the loan portfolio has been growing they still had enough room to put out more loans, so introducing additional lag by carrying unnecessary deposits would be a drag on the results. This was a problem in prior quarters. See Point (2) below for more details.
2) Loan Portfolio
- Let’s look at the loans receivable line and see how INBK has been doing. Here we are looking at quarter ending numbers:
Q1 2015 $767.7M
Q4 2014 $732.4M
Q3 2014 $695.9M
Q1 2014 $532.2M
At Q4 2014, we had seen a pretty solid QoQ loan growth of 46%. That’s kept pace this quarter as well and we got QoQ loan growth of 44%. Overall, loan portfolio is growing nicely.
Loan to deposit ratio stood at 94%, and it has been hovering around mid-to-low 90%’s since Q3 2014. This ratio was in the mid 80’s in Q2 2014 and only 72% in Q1 2014. This tighter coupling between loan and deposit partially explains the improved efficiency of the bank. It might also help explain why the bank has not attempted to push on deposit growth. I am hypothesising that the bank has been managing the rate at which deposits grow to improve efficiency and they will probably push the throttle on deposit growth may be in the second half of the year as soon they will need to bring in deposits at a much higher rate to keep up with the torrid growth in loans. This will be something to watch. We will need to keep an eye on this and make sure the bank is able to attract cheap capital at the rate it needs them to sustain its growth.
Total commercial loans went up to $395M at 31 March 2015, up from $351M at Dec 31, 2014, and up $243M at Q1 2014. That’s a 62.5% increase in commercial loans.
Commercial lending now accounts for 51.5% of the loans, up from 48% of total loans in Q4 2014, and 46% in Q1 2014.
A majority of the commercial loans is in single tenant lease financing. These accounted for $227M in Q1 2015 versus $192M in Q4 2014, versus $106M in Q1 2014.
Commercial and Industrial loans ticked up to $84M, up from the $75M level in Q4 & Q3 2014.
Residential mortgage + home equity loans accounted for $270M versus $280M in Q4 2014. As a percentage of total loans this segment accounted for 35% of the loan book.
Trailers and recreational vehicle loans (which were sort of the bread and butter of the company in its initial days) now account for about 12% of the loan portfolio. The total value is sitting around the $90M level since Q1 2014. These accounted for 19% of the loan portfolio in Q1 2014.
Overall, INBK has steadily grown its loan portfolio and nicely diversified the portfolio b/w commercial and residential loans in the last year or two.
3) Non-interest income
- Non-interest income ticked up to $3.1M this quarter. It was $2.1M in Q4 2014 and $1.5M in Q1 2014. Clearly, mortgage banking revenue is on the mend.
I like recapping what the company has said in prior quarters as it gives us perspective on how the management team is executing:
In Q2 2014, the company said the following with respect to decline in non-interest income:
The Company experienced a $2.23 million year-over-year decline in income from mortgage banking activities. The Company made adjustments to reduce expenses in the second quarter in the mortgage operations to reflect the lower volumes. The Company continued to invest in this revenue channel, launching a construction lending program in Central Indiana in the second quarter.
Then, in Q3 2104, they said the following, which was reassuring:
Over the last 12 months, the Company has increased its sales and marketing efforts related to purchase mortgage business and has added sales personnel since the second quarter following a restructuring of its mortgage operations earlier in the year. Furthermore, it recently launched an Indianapolis-based origination effort to complement its nationwide online origination platform. As a result, origination activity has increased throughout the year with third quarter originations increasing 23.2% compared to the second quarter.
It seems the Q4 2014 story is similar to Q3 2014. This is what the company noted in the earnings release:
The increase of $0.2 million, or 8.0%, compared to the linked quarter was driven by an increase of $0.2 million, or 12.5%, in mortgage banking revenue. The increase in mortgage banking revenue was primarily a result of higher origination volumes as purchase originations were supplemented by increased refinance activity when interest rates dropped early in the fourth quarter.
Here’s the latest update from the earnings release:
Non-interest income for the first quarter was $3.1 million compared to $2.1 million for the fourth quarter 2014 and $1.5 million for the first quarter 2014. The increase of $1.0 million, or 50.0%, compared to the linked quarter was driven by an increase of $1.0 million, or 56.7%, in mortgage banking revenue resulting from an improvement in gain on sale margin and higher origination volumes.
4) Net Interest Income & Net interest margin (NIM)
Net interest income for Q1 2015 was $6.8M versus $6.4M in Q4 2014 versus $4.1M in Q1 2014. That’s a 66% QoQ net interest income increase.
With respect to the sequential increase in net interest income, the company noted the following:
The increase in total interest income was driven by a $37.4 million, or 5.3%, increase in average loans receivable and an increase in the yield earned on the loan portfolio as well as a $15.5 million, or 12.0%,
increase in the average balance of securities available for sale and an increase in the yield earned on the securities portfolio. Total interest income also benefited from the recapture of $0.1 million of interest related to a loan recovery during the quarter.
The Company’s net interest margin was 2.84%, up from 2.78% in Q4 2014, 2.68% in Q3 2014, 2.61% in Q2 2014, and 2.51% in Q1 2014.
The following explains the whys of the net interest margin expansion:
The yield on interest-earning assets increased 9 bps to 3.85%. Excluding the impact of the interest income associated with the loan recovery, the yield on interest-earning assets increased 3 bps to 3.79% compared to the prior quarter, driven by higher yields earned on commercial loans and investment securities, partially offset by lower yields on consumer loans and mortgage loans held for sale. The cost of interest-bearing liabilities during the quarter increased 3 bps to 1.12% driven primarily by the increase in the cost of funds related to Federal Home Loan Bank advances, offset by a slight decline in deposit funding costs.
5) Credit Quality
Credit quality continues to remain strong.
Nonperforming loans to total loans declining 1 bps to 0.03% from 0.04% for Q4 2014.
Nonperforming assets to total assets declined to 0.47%. The allowance for loan losses was $6.4M.
6) Efficiency Ratio
Net Interest income (‘000):
Non-interest income (‘000):
Non-interest expenses (‘000):
Cash efficiency ratios
03/15: 0.63 (Q1 15)
12/14: 0.69 (Q4 14)
09/14: 0.76 (Q3 14)
06/14: 0.79 (Q2 14)
03/14: 0.85 (Q1 14)
12/13: 0.86 (Q4 13)
We have been discussing INBK’s efficiency ratios quite a bit. Efficiency ratio is a measure of the bank’s overhead (think of this as fixed costs such as people, IT, building, etc) as a percentage of its total income. Of course, lower is better and we would expect efficiency ratios to be better for online banks versus brick and mortar ones. BOFI, INBK’s big brother, has industry leading efficiency ratios in the low 30%’s. What’s going on here with INBK?
Following Q3 2014 release, we had an interesting discussion regarding INBK still working like a refinance shop and that it wasn’t making any monies from it’s real business of making out loans. In one of the posts, I had said the following:
If we just look at the net interest income for the just reported quarter, then it would appear that the bank is mostly earning monies from non-interest income activities because the non-interest expense is just as large as the net interest income. But, if we look at the trend, then we will notice that non-interest expense (“operating expenses”) have been flat-lining at least over the past four quarters. In fact, non-interest expense has grown only by 4% b/w 06/13 and 09/14. In the same time period, however, net interest income (i.e., income from the loans) has grown by 34%. If this trend is to hold, then any additional loan book growth should drop directly into the bottom-line. Increase in non-interest income is just the icing on the cake.
The flat-lining of the expenses seems to be aligning nicely with what management has been doing. The bank raised money by selling shares, used these funds to go on a hiring spree to give a boast to its commercial lending activities. So, I think this strategy is working, and we are probably sitting at a crucial junction. If the loan book growth continues at the rate it is, then we should be seeing a very bright Q4.
Then, I had gone on to make the argument that the costs are likely to be flatlining and this should essentially have a trickle down effect on the earnings.
Related to my point above, if the expenses stay relatively flat as they have over the past four quarters, then the increases in the loan book would have trickle down effect on the bottomline, which in turn should bring the efficiency measure down. Is a 65% efficiency measure possible by the end of the year?
We now have seen Q4 2014 and Q1 2015 since that discussion. What’s really pleasing is the fact that costs are stabilising and the loan book is growing at a pretty solid rate. Of course, non-interest income growth has helped as well and now we are sitting at an efficiency ratio of 0.63. It’s really nice to see the thesis play out and I do believe that scale advantages will help pushing the efficiency ratio lower. We will likely see mid-50%’s this year, I think.
One important peg in the wheel is the cost of funds. CDs account for about half of the deposits and they cost more than regular savings and money market accounts. Money market accounts are about 35% of the deposits. The distribution of CDs and money market accounts have been more or less steady. I guess INBK could try to attract more money market type funds to lower its cost of funds. However, I see that ‘Other borrowed funds’ has ballooned to $110M at end of Q1 2015 from $91M at end of Q4 2014 and $25M at end of Q1 2014. I think (although I ‘m not 100% sure) this refers to funds borrowed from ‘Federal Home Loan Banks’ which are chartered to provide on-demand, low-cost funding to American financial institutions. Now, looking at pg. 9 of the release “Average Balance and Rates” it is clear that these ‘Other borrowed fund’ cost much more than CDs, currently at 1.7% versus 1.38% for CDs and 0.73% for money market accounts. This seems to be a natural place for optimisation and I ‘m a bit confused why they borrowed more from other sources. One possible hypothesis is that they had more opportunities for loans than they though they would have and they hadn’t planned their deposit side to adequately cover this, so they had to borrow. Anyways, this is something to watch and this is also something that can be optimised.
7) Earnings Growth and Book Value
Earnings per share:
03/15; $0.46 (shares out: 4,523,246) [Some dilution owing to issuance of RSUs]
12/14: $0.32 (shares out: 4,514,505)
09/14: 0.28 (shares out: 4,511,291)
06/14: $0.22 (shares out: 4.45M) —> Significant increase in earnings with respect to 03/14 quarter; driven by strong increases in interest income.
03/14: $0.13 (shares out: 4.45M)
12/13: $0.19 (shares out: 4.45M) → Note the dilution following the bank’s secondary offering.
09/13: $0.25 (shares out: 2.86M)
06/13: $0.59 (shares out: 2.82M)
P/E: 17.1 (using $21.86, closing price as of April 27, 2015)
I look at the total shareholder’s equity line which is $97.84M (This is the assets minus liability line on the financials.) Then, I look at the diluted share count, which is 4523246. With the share price at $21.86, I get market cap of $98.9M. I calculate P/B as (Market Cap divided by Shareholder’s Equity) and get 1. Since our last analysis, the market participants have realised that INBK was being priced at a big discount and the discount with respect to book value is gone. However, I would think a fast growing bank with a big runway for growth could easily command a bigger multiple. A 2X book value multiple might be very reasonable.
Valuation and Concluding Remarks
This was yet another good quarter. It shows that management’s investments in people, processes, and IT is paying off. Expenses have flatlined. If loan book growth continues, the bank is well positioned to keep growing. Management is taking a cautious approach to growth, carefully balancing assets and liabilities. It’s positioning the bank to adapt to interest rate increases. I think management might have to work a bit harder on reducing cost of funding but this would seem reasonably feasible. After all, management has been able to improve net interest margin yet again this quarter.
So where does this leave us going forward? Management doesn’t provide any guidance. However, we can look at recent performance and scale improvements and make some educated guesses. Let’s look at the sequential growth in earnings over the past few quarters:
Looking at the above, it would seem 15% might be a very reasonable expectation for sequential eps growth. With this assumption we will be sitting around $2.29 as EPS for FY 15; i.e., I ‘m modelling for about 78% YoY earnings growth which I think is entirely doable. Therefore, today’s price represents a potential forward PE (next 9 months) of 9.5. That’s super cheap, however, one looks at the company. The earnings growth is picking steam, efficiency is improving, and insiders are holding on to their shares. Couple that with the opportunity of online and mobile banking and I see a very long runway for this company.