Community Financial: Modest loan growth to keep income above pre-pandemic level (TCFC)

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Community Financial Corporation (NASDAQ: NASDAQ: TCFC) is one of the few banks initially affected by the rise in interest rates. The company’s liabilities are more sensitive to rate variations than current assets; therefore, the margin will likely be decline in the twelve months following a rate hike. In addition to the margin contraction, the normalization of provisions will likely weigh on earnings this year. On the other hand, loan growth will likely improve year over year due to favorable economic factors, which in turn will support the bottom line. Overall, I expect The Community Financial to report earnings of $4.29 per share in 2022, down 4% year over year. Despite the drop, incomes will likely remain much higher than the pre-pandemic level. The year-end target price suggests a decent upside from the current market price. Based on the expected total return, I’m adopting a buy rating on the Community Financial Corporation.

Better loan growth likely

After a 1.5% decline in the loan portfolio in the first nine months of 2021, loan growth accelerated in the last quarter of the year. The portfolio grew by 4.4% (annualized) in the last quarter. Part of the decline in lending early last year was attributable to the Paycheck Protection Program (“PPP”) loan forgiveness. Outstanding PPP loans increased from $110.3 million at the end of December 2020 to $27.3 million at the end of December 2021, as mentioned in Filing 10-K. As outstanding PPP loans were only 1.7% of total loans at the end of December 2021, the remaining forgiveness will put limited pressure on the size of the loan portfolio going forward.

In addition, economic conditions will support an acceleration in loan growth this year. The Community Financial Corporation operates primarily in Maryland with some presence in Virginia. Maryland has yet to fully recover from the pandemic, as the state’s unemployment rate was at a high of 5.0% in February 2022. Additionally, the latest available data reveals that the economy of the state only grew by 1.8% in the third quarter of 2021, below the national average of 2.3%, according to official sources.

Given these factors, I expect loan growth in 2022 to be better than last year, but still at the lower end of the historical loan growth range. I expect loan growth of 5.7% in 2022. Meanwhile, I expect other balance sheet items to grow mostly in line with loans. The following table shows my balance sheet estimates.

EX17 EX18 FY19 FY20 FY21 FY22E
Financial situation
Net loans 1,141 1,337 1,445 1,594 1,587 1,678
Net loan growth 5.7% 17.2% 8.1% 10.3% (0.5)% 5.7%
Other productive assets 170 230 220 271 535 566
Deposits 1,106 1,430 1,512 1,746 2,056 2,174
Loans and sub-debts 178 90 80 59 44 46
Common equity 110 154 181 198 208 229
Book value per share ($) 23.8 27.8 32.6 33.6 36.0 39.6
Tangible BVPS ($) 23.8 25.4 30.3 31.5 33.9 37.5

Source: SEC Filings, Author’s Estimates

(In millions of dollars, unless otherwise indicated)

Margin likely to contract this year

The Community Financial Corporation’s loan portfolio is relatively insensitive to interest rate variations. Indeed, commercial real estate loans, CRE, are the majority, i.e. 70.66% of total loans. These loans have an initial fixed rate term generally between three and ten years, as mentioned in the 10-K file. Therefore, most of the loan portfolio will not be affected by an increase in interest rates this year.

At the same time, liabilities are quite sensitive to rate variations. Transaction deposits, including savings, demand deposits and money market deposits, accounted for 62% of total deposits at the end of 2021. These transaction deposits will be revalued shortly after each rate hike.

In my view, the revaluation of liabilities will most likely outweigh the revaluation of assets. Management’s interest rate sensitivity analysis also shows that Community Financial’s balance sheet is sensitive to liabilities in a rising interest rate environment. A 200 basis point increase in interest rates can decrease net interest income by 1.54% year-over-year, based on management’s sensitivity analysis presented in File 10-K.

Interest Rate Sensitivity Community Financial Corporation

Filing 10-K 2021

Given these factors, I expect the margin to remain broadly flat in the first half and decline two basis points in the second half of 2022.

Normalization of provision expenses on cards

Due to the substantial improvement in asset quality in 2021, the Community Financial Corporation released part of its loan loss reserves last year. Non-performing loans fell from 1.21% of total loans at end-December 2020 to 0.48% of total loans at end-December 2021.

For 2022, I expect mid-single-digit loan growth to require additional provisioning for expected loan losses. Additionally, I do not expect any further significant write-offs of provisions as the level of the provision has now fallen to a relatively comfortable level relative to credit risk. Provisions represented 1.17% of total loans at the end of December 2021, while non-performing loans represented 0.48% of total loans at the end of December 2021, according to details given in the 10-K filing.

Overall, I expect provisions, net of reversals, to return to normal levels this year. I expect provision charges to be around 0.21% of total loans in 2022, which is the same as the average ratio of position charges to total loans over the past five years.

Earnings are expected to fall 4% year-over-year

Earnings will likely fall this year as loan growth cannot compensate for margin compression and provision normalization. In addition, non-interest expenses will likely increase due to inflationary pressures and efforts to grow the loan portfolio. Overall, I expect The Community Financial to report earnings of $4.29 per share in 2022, down 4% year over year. Despite the decline, profits this year will likely be much higher than the pre-pandemic level. The following table shows my income statement estimates.

EX17 EX18 FY19 FY20 FY21 FY22E
income statement
Net interest income 43 51 54 61 66 70
Allowance for loan losses 1 1 2 11 1 4
Non-interest income 4 4 6 8 8 9
Non-interest charges 30 38 36 38 39 42
Net income – Common Sh. 7 11 15 16 26 25
BPA – Diluted ($) 1.56 2.02 2.75 2.74 4.47 4.29

Source: SEC filings, earnings releases, author’s estimates

(In millions of dollars, unless otherwise indicated)

Actual earnings may differ materially from estimates due to risks and uncertainties related to the COVID-19 pandemic and the timing and magnitude of interest rate increases.

A decent expected total return warrants a buy rating

Community Financial Corporation offers a dividend yield of 1.7% at the current quarterly dividend rate of $0.175 per share. Earnings and dividend estimates suggest a payout ratio of 16% for 2022, which is close to the five-year average of 19%. Therefore, I do not expect another increase in the level of dividends this year.

I use historical price/book tangible (“P/TB”) and price-earnings (“P/E”) multiples to value The Community Financial. The stock has traded at an average P/TB ratio of 1.06 in the past, as shown below.

EX18 FY19 FY20 FY21 Average
T. Book value per share ($) 25.4 30.3 31.5 33.9
Average market price ($) 34.7 31.6 24.8 34.8
Historical P/TB 1.37x 1.04x 0.79x 1.03x 1.06x
Source: Company Financials, Yahoo Finance, Author’s Estimates

Multiplying the average P/TB multiple by the expected tangible book value per share of $37.5 yields a price target of $39.6 for the end of 2022. This price target implies a decline of 1.4% compared to the closing price on March 29. The following table shows the sensitivity of the target price to the P/TB ratio.

Multiple P/TB 0.86x 0.96x 1.06x 1.16x 1.26x
TBVPS – Dec 2022 ($) 37.5 37.5 37.5 37.5 37.5
Target price ($) 32.1 35.9 39.6 43.4 47.1
Market price ($) 40.2 40.2 40.2 40.2 40.2
Up/(down) (20.1)% (10.7)% (1.4)% 7.9% 17.3%
Source: Author’s estimates

The stock has traded at an average P/E ratio of around 11.4x in the past, as shown below.

EX18 FY19 FY20 FY21 Average
Earnings per share ($) 2.02 2.75 2.74 4.47
Average market price ($) 34.7 31.6 24.8 34.8
Historical PER 17.2x 11.5x 9.1x 7.8x 11.4x
Source: Company Financials, Yahoo Finance, Author’s Estimates

Multiplying the average P/E multiple by the expected earnings per share of $4.29 yields a price target of $48.8 for the end of 2022. This price target implies a 21.5% upside from at the closing price on March 29. The following table shows the sensitivity of the target price to the P/E ratio.

Multiple P/E 9.4x 10.4x 11.4x 12.4x 13.4x
EPS 2022 ($) 4.29 4.29 4.29 4.29 4.29
Target price ($) 40.2 44.5 48.8 53.1 57.4
Market price ($) 40.2 40.2 40.2 40.2 40.2
Up/(down) 0.1% 10.8% 21.5% 32.2% 42.8%
Source: Author’s estimates

An equal weighting of the target prices from the two valuation methods gives a target price of $44.2, implying a 10.0% upside from the current market price. Adding the forward dividend yield gives an expected total return of 11.8%. Therefore, I adopt a buy rating on the Community Financial Corporation.

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