Earnings of Park National Corporation (PRK) increased to $1.80 per share in the second quarter, from $1.36 per share in the first quarter of 2020. The earnings improvement was mostly attributable to realized gains on debt securities and real estate. Earnings will likely decline in the last two quarters of the year from the second quarter’s level because of the normalization of non-interest income and higher provision expense. On the other hand, the accelerated amortization of fees from the Paycheck Protection Program will likely support earnings in the second half of the year. Overall, I’m expecting earnings to decline by 6% in the second half of the year from the first half. For the full year, I’m expecting PRK to report earnings of $6.16 per share, down 2% from last year. PRK’s stock price recently rallied upon its addition to the S&P 600 index, leaving only a limited upside to the June 2021 target price. Hence, I’m adopting a neutral rating on PRK.

Potential Pandemic-Driven Credit Events to Drive Provision Expense

PRK’s provision expense surged to $12 million in the second quarter, from $5 million in the first quarter of 2020. As mentioned in the August 2020 investor presentation, PRK delayed the implementation of the new accounting standard for credit losses, called the Current Expected Credit Losses (“CECL”). Therefore, the company utilized the old incurred loss model to determine the provisioning requirement in the first half of 2020. Due to the incurred loss model, I’m expecting PRK’s provision expense to remain elevated in the second half of the year as the company will need to provide for credit loss events as they arise. Further, PRK’s allowances for loan losses made up just 1.02% of total loans at the end of the last quarter, which appears insufficient for a pandemic in a historical context. PRK’s allowances-to-loans ratio averaged at a higher level of 1.18% from 2013 to 2015. Considering these factors, I’m expecting PRK to report a provision expense of $30 million in the second half of 2020, up from $17 million in the first half.

Credit Risks Appear Moderately High

PRK is facing moderately high credit risks because of the large number of loans requiring payment accommodations amid the COVID-19 pandemic. As of June 30, 2020, PRK had modified 10.4% of total loans to provide relief to customers, according to details given in the presentation. Most of the troubled industries will likely return to payment soon as their business activity has picked up following the easing of lockdown restrictions. However, the hotel and accommodations industry is likely to continue to suffer through at least the mid of 2021 as the demand for non-essential and recreational traveling will likely remain subdued until life returns to normal. The Director of the National Institute for Allergy and Infectious Diseases mentioned last month that life could return to normal by late 2021.

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Including hotels, COVID-19 sensitive industries made up 10.7% of total loans at the end of the last quarter. The following table gives details of the vulnerable industries.

Park National COVID Sensitive Industries

Upcoming Loan Maturities/Repricing to Counter Paycheck Protection Program Benefits

PRK’s net interest income will likely increase in the second half of the year from the second quarter due to the accelerated amortization of fees from the Paycheck Protection Program (“PPP”). As mentioned in the presentation, PRK funded $543 million of loans under PPP, resulting in a fee income of $20.2 million that the company will amortize over the life of the loans. As most of the loans will likely get forgiven before the year-end, I’m expecting PRK to accelerate the amortization of the fees in the second half of 2020.

Excluding the impact of accelerated booking of PPP fees, the net interest margin (“NIM”) will likely decline through 2021. The maturity of fixed-rate loans and origination of new loans at lower rates will likely pressurize the yield and, consequently, NIM. As mentioned in the presentation, fixed-rate loans made up 48% of the total loan portfolio. Further, the presentation mentioned that the expected weighted average repricing duration of the loan portfolio was 1.4 years as of June 30, 2020. Consequently, I’m expecting most of the loans to reprice downwards through 2021, leading to lower NIM.

The interest rate sensitivity analysis conducted by the management shows that the NIM’s sensitivity to interest rate changes is moderately high. As of June 30, 2020, a 100bps decline in interest rates could reduce net interest income by 5.3%. The following table from the presentation gives the results of the management’s analysis.

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Park National Net Interest Income Sensitivity

Considering the factors mentioned above, I’m expecting the NIM to decline by 3bps in each of the last two quarters of 2020, excluding the impact of accelerated PPP fees amortization. Further, I’m expecting the average NIM in 2021 to be 15bps lower than the average for 2020.

PPP forgiveness will likely reduce loans in the second half of the year. Further, PRK’s deposits will likely decrease in the second half after surging in the second quarter of 2020 on the back of proceeds from PPP. The utilization of the PPP proceeds will likely reduce deposits. Moreover, the easing of the pandemic-driven panic will encourage deposit customers to hold less liquidity. Overall, I’m expecting deposits to decline by 4% and loans to decline by 7% until the end of December 2020 from the end of June 2020. The following table shows my estimates for loans, deposits, and other balance sheet items.

Park National Balance Sheet Forecast

Expecting Earnings to Decline by 6% in the Second Half

The increase in provision expense and NIM contraction will likely pressurize earnings in the second half of 2020. Moreover, the normalization of non-interest income will constrain earnings. PRK’s non-interest income surged in the second quarter due to one-time gains on sales of real estate and debt securities. Overall, I’m expecting earnings to decline by 6% in the second half of 2020 compared to the first half. For the full year, I’m expecting PRK to report earnings of $6.16 per share, down 2% from last year. The following table shows my income statement estimates.Park National Income Forecast

Actual earnings may differ materially from the estimates because of the COVID-19 pandemic and PRK’s exposure to pandemic sensitive industries.

PRK Offering a Dividend Yield of 4.8%

PRK is offering a forward dividend yield of 4.8%, assuming the company maintains its quarterly dividend at the current level of $1.02 per share and the other annual dividend at $0.2 per share. There is very little threat of a dividend cut because the earnings and dividend estimates suggest a payout ratio of 67% for 2021, which is somewhat in line with PRK’s historical payout. Further, PRK’s capital position is quite comfortable as the company reported a common equity tier 1 ratio of 11.3% in the second quarter, which is fairly higher than the minimum regulatory requirement of 7%, as mentioned in the presentation.

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June 2021 Target Price Suggests a Limited Upside

I’m using the historical price-to-tangible-book ratio (P/TB) to value PRK. The stock traded at a P/TB multiple of 1.81 in 2019 and the first half of 2020. Multiplying this P/TB multiple with the June 2021 forecast tangible book value per share of $52.7 gives a target price of $95.4 for the mid of next year. As shown in the shaded column below, the target price implies only a 7% upside from PRK’s October 6 closing price. The table also shows the sensitivity of the target price to the P/TB ratio.

Park National Valuation Sensitivity

My last report on PRK showed a much higher price upside than the current upside. The depletion of the potential upside is partly attributable to the significant rally in PRK’s stock price since the publication of the last report. The addition of PRK to the S&P 600 Index triggered the sudden stock price appreciation. Due to the currently limited price upside, I’m adopting a neutral rating on PRK.

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 consider their investment objectives and constraints before investing in the stock(s) mentioned in the article.



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