Republic Bancorp: Potential future gains in core loan portfolio (NASDAQ: RBCAA)

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georgeclerc

Thesis

Republic Bancorp, Inc. (NASDAQ: RBCAA) is improving its core loan portfolio despite declining warehousing line revenue, and as rates continue to rise, we may see an increase in net income over the next 12 months. Furthermore, on on a P/B basis, RBCAA is undervalued relative to its peers, driving the stock up approximately 15-30% from current prices.

Introduction

RBCAA is a Louisville, Kentucky-based regional bank with 42 accolades offering traditional banking, warehouse loans, mortgage banking, and repayment and credit solutions. The company, despite being a bank and expected to benefit from higher interest rates, has seen a decline in share price performance over the past year, following the S&P bear market 500, which currently sits at around $45.

Share price

SECOND

(Source: Yahoo Finance)

This decline in share price does not reflect the company’s outperformance and positive future outlook.

Financial analysis

Based on the company’s recent quarterly reports (3 months ending September 2022), the company has benefited from higher interest rates compared to the previous year. For example, while the total loan portfolio grew from $4.3 billion to $4.2 billion, net interest income held steady.

loan book

SECOND

(Source: SEC)

Currently, the loan portfolio (as of September 2022) is well diversified, with the majority of exposure to commercial real estate and residential real estate, followed by warehouse loans and commercial/industrial loans. The majority of the loan portfolio should perform well as interest rates are on the rise. We can expect interest income to increase for home loans and commercial loans. However, warehouse loans, despite rising rates, could see lower revenue due to reduced demand.

Looking at recent performance, overall net interest income for the quarter, net interest income performed well, improving nearly 10% to $58 million.

Revenue

SECOND

(Source: SEC)

This was driven by a strong performance from the traditional banking segment, the core loan portfolio which does not include the warehouse unit or repayment/credit solutions. The segment increased net interest income by 34% excluding PPP loan related items and increased net interest margin to 3.62% for the traditional banking unit.

However, unfortunately some of these gains were offset by a poor performance in the warehouse portfolio, where there was a 52% decline due to lower outstanding balances due to reduced demand for mortgage refinance due to rising interest rates. While an increase in interest rates may improve earnings from this segment, unfortunately lower demand will offset this, so we can expect further poor performance from this segment in the near future as rates continue to increase and the demand for mortgages decreases. Fortunately, warehouse loans only make up about 10% of the total loan portfolio.

While most of the loan portfolio, coming from traditional banks, performed well and improved the net interest margin from 3.61% to over 4%, the bank’s net income actually decreased by just under -3%, from $20 million to $19.5 million.

Net revenue

SECOND

(Source: SEC)

This was driven by the poor performance of the non-interest income and expense segment. Non-interest revenue fell -20% and non-interest expense increased 4%, to $46 million, a large portion of total costs, accounting for nearly 80% of net revenue. interest during the quarter. This increase in expenditure was driven by inflationary pressures on general expenditure items, such as salaries and overheads. Overall, this led to a static diluted EPS figure, which remains at $0.99.

Future prospects

Now, being a bank, we can expect interest income to continue to rise as interest rates continue to rise, as seen in the 3 month LIBOR pictured below.

LIBOR

Trade economy

(Source: Trade Economics)

LIBOR is expected to rise above 5% next year, so we may see further improvement in net interest margin to potentially over 5% next year if things go well.

However, due to inflationary pressures, we may see non-interest expenses continue to rise as well, which may offset partial gains in interest income. However, given the strength of the portfolio, interest income should perform well and net income should improve from its current level.

Evaluation

If we consider a set of regional peer group banks as comparable, we can understand if the RBCAA is undervalued on a price-to-book valuation

P/B Ratings

Yahoo finance

(Source: Yahoo Finance)

We understand that most, if not all, of these banks will benefit from macro factors (ignoring micro-level factors) and earn interest income through higher rates (but expenses will also increase due to inflationary pressures )

Looking at the P/B comps, we can see that RBCAA is only slightly undervalued against its peers, giving +15-30% upside potential. Not a significant amount, but still something and an indication of slight undervaluation.

Risks

  • The most obvious risk would be not to raise interest rates any further, which would halt the growth of net interest income. There would be further damage if inflation were to continue to rise, such that costs would offset income improvements and cause net income to fall further, and the RBCAA would no longer be undervalued (or could drive them to be overvalued)
  • The second risk would be a significant increase in non-interest spending due to new inflationary pressures (such as wage inflation), which would partially or entirely offset gains in interest income. However, this is a low risk.
  • If competitors were to improve their margins and keep expenses low relative to the RBCAA (e.g. improving revenue per branch), then we might see their peers outperform the RBCAA because they would not be more undervalued.

Conclusion

Overall, RBCAA benefited from recent rate hikes in its core loan portfolio, but its warehouse lineup suffered and non-interest expenses increased, leading to lower overall net income. Despite this, interest income should continue to increase as interest rates continue to rise, which will eventually lead to improved net income and EPS, expected next year. Looking at the comparison on a P/B valuation, RBCAA is undervalued relative to its peers, therefore, pairing this with improved net income, RBCAA has the potential for a 15-30% upside versus at current prices.

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