Earnings of Territorial Bancorp Inc. (NASDAQ: TBNK) dipped to $0.48 per share in the first quarter of 2020, down 11% from the last quarter of 2019. A surge in provision expense was the major cause of the earnings decline. Earnings will likely remain low in the remainder of the year due to high provision expense and a slight decline in loan balances. Overall, I’m expecting earnings to decline by 18% year-over-year to $1.91 per share in 2020.
TBNK is currently trading at a substantial discount to its year-end target price as the market appears to be overplaying risks. In my opinion, TBNK is less risky than other banks because of its loan portfolio that is concentrated in one-to-four family residential mortgages. Based on the high upside and relatively low risks, I’m adopting a bullish rating on TBNK.
Based On Historical Trend, Provision Expense Likely To Remain Elevated In The Last Three Quarters
TBNK increased its provision expense to $217 thousand in the first quarter of 2020 from $5 thousand in the first quarter of 2019. The provision expense made up 0.014% of total loans in the first quarter, which does not appear sufficient for a pandemic from a historical perspective. TBNK’s provision expense to total loans ratio averaged 0.033% from 2014 to 2016; hence, the company will likely need to keep provisioning elevated in the last three quarters of the year.
Furthermore, although TBNK’s direct exposure to COVID-19-sensitive industries is negligible, the company has high indirect exposure because it is based in Hawaii. The economy of Hawaii relies heavily on tourism; therefore, the credit quality of TBNK’s residential-mortgage-heavy loan book depends on employment in the tourism industry. Moreover, TBNK allowed forbearance on 12.5% of its total loan portfolio by the mid of April, as mentioned in the first quarter’s 10-Q filing. The forbearance requests show that a material portion of the loan portfolio is facing debt-servicing problems. I’m expecting all these factors to drive provision expense in the last three quarters of the year. For the full year, I’m expecting TBNK to book provision expense of $567 million, up from $61 million in 2019.
On the plus side, the one-to-four family mortgage portfolio is well-secured as the ratio of the loan balance to the value of the property securing these loans averaged 46.3% at the end of the first quarter, as mentioned in the 10-Q filing. Due to the low loan to value ratio, TBNK has a low risk of losing the funds invested in the loans as home prices decline. The one-to-four family mortgage portfolio makes up 97% of total loans; therefore, TBNK is less risky than several of its peers.
Loan Mix To Keep Margin Stable
TBNK’s net interest margin, NIM, improved in the first quarter as average funding cost declined while the average yield remained stable following the 150bps federal funds rate cut. As mentioned in the 10-Q filing, TBNK has historically operated as a traditional thrift institution, which is why a majority of its assets consist of long-term and fixed-rate residential mortgage loans and mortgage-backed securities. As a result, TBNK’s interest-bearing liabilities mature or reprice more quickly than the interest-earning assets. The nature of TBNK’s assets and liabilities will likely keep NIM stable this year. Consequently, I’m expecting the NIM to decline by a single-basis point this year, as shown in the table below.
TBNK’s loan portfolio has declined for the past three consecutive quarters on a linked-quarter basis. I’m expecting low mortgage rates to halt the declining trend in the last three quarters of the year. However, the loan growth rate will likely remain very low due to the economic downturn. Considering these factors, I’m expecting TBNK to end the year with loan balances of $1.6 billion, up 0.3% from the end of the first quarter and down 1.2% from the end of 2019. The following table shows my estimates for loans and other balance sheet items.
Expecting Earnings To Decline by 18%
The elevated provision expense will likely keep earnings low in the last three quarters of the year. For the full year, the drop in loan balances in the first quarter will likely pressurize earnings. Overall, I’m expecting earnings to decline by 18% year-over-year to $1.91 per share in 2020. The following table shows my income statement estimates.
The uncertainties related to the COVID-19 pandemic pose risks to earnings. If the pandemic lasts longer than expected, then provision expense can exceed its estimate leading to a negative earnings surprise. Additionally, TBNK operates in Hawaii whose economy relies heavily on tourism. However, apart from the indirect exposure to the tourism industry, TBNK faces very low credit risk because its loan book is concentrated in a relatively safe loan segment, i.e. one-to-four family mortgage. Overall, I believe TBNK has lower risk than most banks.
Year-End Target Price Suggests A High Upside
TBNK has traded at an average price-to-book multiple, P/B, of 1.10 in the past, as shown below.
Multiplying the P/B ratio with the forecast book value per share of $26.9 gives a target price of $29.6 for December 2020. This price target implies a 37.5% upside from TBNK’s July 8 closing price. The table below gives the sensitivity of the target price to the P/B ratio.
Apart from the price upside, TBNK is also offering a dividend yield of 4.3%, assuming the company maintains its quarterly dividend at the current level of $0.23 per share. I’m not expecting a dividend cut because the earnings and dividend estimates suggest a payout ratio of 48%, which is sustainable. Based on the high price upside, modest dividend yield, and relatively low risk, I’m adopting a bullish rating on TBNK.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any 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.
Additional disclosure: Disclaimer: This article is not financial advice. Investors are expected to conduct their own due diligence, and consider their investment objectives and constraints before investing in the stock(s) mentioned in the article.