Via SeekingAlpha.com

Earnings of Park National Corporation (NYSEMKT:PRK) dipped to $1.36 per share in the first quarter, down 6% from the last quarter of 2019. A decline in revenues and surge in provision expense were the major contributors to the earnings decline. Earnings for the remainder of the year will likely remain below last year’s level because PRK will adopt the new accounting standard for credit losses later in the year, which will increase provision expense. Additionally, PRK’s moderate exposure to COVID-19 sensitive industries will drive provision expense in the year ahead. Moreover, a slight decline in net interest margin will pressurize earnings. As a result, I’m expecting earnings to decline by 10% year-over-year to $5.68 per share in 2020. There is a chance that actual results will miss estimates because PRK’s provision expense is quite difficult to predict. The year-end target price suggests a high upside; nevertheless, I’m adopting a neutral rating on PRK due to the elevated level of risks and uncertainties.

CECL Adoption to Increase Provision Expense

PRK’s provision expense increased to $5.2 million in the first quarter of 2020 from $2.5 million in the corresponding period last year. The management used the incurred loss model to determine the provision for credit losses in the first quarter instead of the expected loss model under the new accounting standard, called CECL, as mentioned in the first quarter’s 10-Q filing. Further, the management used qualitative factors to incorporate the impact of the economic downturn on future asset quality. PRK will adopt CECL later in 2020, which will lead to an increase in provision expense because of the difference between expected losses under the two models. The management mentioned in the 10-Q filing that it expects the adoption of the new accounting standard to increase the allowance for credit losses.

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Furthermore, PRK’s exposure to COVID-19 sensitive industries will likely drive provision expense in the coming quarters. High-impact industries, including hotels, restaurants, recreation, and healthcare, made up 8.2% of total loans as of March 31, 2020, according to details given in the 10-Q filing. Further, PRK modified payments on around 14% of total commercial loans and 2.8% of consumer loans, which shows the extent of debt servicing problems among customers. Considering these factors, I’m expecting provision expense to increase to $20 million in 2020 from $6 million in 2019.

The probability of actual provision expense differing from the estimate is unusually high this year. Although future provision expense is difficult to predict for all banks, it’s even more difficult to predict for PRK because the company has not yet adopted CECL. Investors and analysts cannot know what economic factors will drive provisioning under CECL until PRK discloses its modeling assumptions following the adoption of the new accounting standard.

Adverse Change in Balance Sheet Positioning to Squeeze Margin

PRK’s balance sheet has changed over the first quarter such that the net interest margin, NIM, is now more sensitive to a decline in interest rates than it was at the end of last year. The management’s rate-sensitivity simulation model shows that NIM is now more vulnerable than it was at the end of 2019, according to details given in the 10-Q filing. On December 31, 2019, the earnings simulation model projected that net income would increase by 0.5% using a declining interest rate scenario over the next year. However, the model showed on March 31, 2020, that net income would decrease by 5.3% in a declining interest rate scenario. Considering the latest estimate of rate-sensitivity, I’m expecting NIM to decline by 9 basis points in 2020. The following table shows my estimates for yield, cost, and NIM.Park National Corporation Net INterest Margin

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The Paycheck Protection Program, PPP, will likely counter the impact of NIM decline on net interest income. As mentioned in the 10-Q filing, PRK has funded $547 million of loans under PPP through May 5, 2020. I’m expecting a majority of the PPP loans to get forgiven in the third quarter; therefore, the year-end number will not reflect the loan growth through PPP. Further, I’m expecting little growth apart from PPP because of the uncertain economic environment. Overall, I’m expecting loans to increase by 8.5% in the second quarter and to decline thereafter. Moreover, I’m expecting loans to grow by 1% until the end of the year from the end of 2019. The following table shows my estimates for loans and other balance sheet items.Park National Corporation Balance Sheet Forecast

Expecting Earnings Decline of 10%

The hike in provision expense and dip in NIM will likely pressurize earnings this year, while PPP will support earnings. Overall, I’m expecting earnings to decrease by 10% year-over-year to $5.68 per share in 2020. The following table shows my income statement estimates.Park National Corporation Income Forecast

The probability of actual earnings differing from the estimates is unusually high this year because the impact of COVID-19 on future provision expense is uncertain. Furthermore, the delay in the adoption of CECL has made forecasting provision expense even more difficult, as discussed above. Moreover, the fees that PRK will book this year under PPP is uncertain because the timing of the booking will depend on when the loans get forgiven. The high level of risks and uncertainties will likely keep the stock price subdued in the near-term of two to three months.

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High Upside Tarnished by Risks

I’m using the historical price-to-tangible-book ratio (P/TB) to value PRK. The stock traded at a P/TB multiple of 1.98 in 2019. Multiplying this P/TB multiple with the forecast tangible book value per share of $50.7 gives a target price of $100.3 for December 2020. As shown in the shaded column below, the target price implies a 42% upside from PRK’s June 19 closing price. The table also shows the sensitivity of the target price to the P/TB ratio.Park National Corporation Valuation Sensitivity

Apart from the price upside, PRK is also offering a decent dividend yield of 6.1%. The dividend yield estimate is based on the expectation that PRK will maintain its dividend at the current level of $1.02 per share. There is very little threat of a dividend cut because the earnings and dividend estimates suggest a payout ratio of 75%, which is manageable.

Despite the high price upside, I believe the stock price will remain range-bound in the near term of two to three months because of the elevated risk level. The riskiness of the stock will likely decrease as the uncertainties surrounding the COVID-19 pandemic get clearer and as PRK adopts the CECL model. For the near term, 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.