Eagle Bancorp Montana: Earnings Likely To Trend Downwards After Q2 Surge (NASDAQ:EBMT)

Earnings of Eagle Bancorp Montana, Inc. (NASDAQ:EBMT) rose to $0.84 per share in the second quarter from $0.57 per share in the first quarter of 2020, due to a surge in gains on sales of loans and securities. Earnings will likely trend downwards in the second half of the year due to a normalization of non-interest income. Further, the provision expense will likely remain elevated amid the Covid-19 pandemic. Moreover, the net interest margin will likely decline further as assets will reprice while funding cost remains sticky. Overall, I’m expecting earnings in the second half of the year to decline by 28% from the first half. For the full year, I’m expecting EBMT to report earnings of $2.43 per share, up 44% from last year. The June 2021 target price suggests a limited upside from the current market price; hence, I’m adopting a neutral rating on EBMT.

Loan Accommodations are the Primary Source of Credit Risk

EBMT’s provision expense doubled in the second quarter to $1.2 million from $0.7 million in the first quarter of 2020. The company will not adopt the new accounting standard for credit losses till 2023; hence, it is currently utilizing the old incurred loss model to determine the provisioning requirement, as mentioned in the second quarter’s 10-Q filing. Unlike banks that used the new expected-loss model, EBMT’s provisioning under the incurred loss model will remain elevated in the year ahead as the COVID-19 pandemic will drive up credit losses.

The credit risk mainly stems from a large number of modified loans in the total loan portfolio. According to details mentioned in the 10-Q filing, loan modifications made up 15% of total loans at the end of the last quarter. While I’m expecting most industries to return to payment soon, the hotel industry will likely remain a cause of concern. Hotels and travel will likely be the last industries to recover from the pandemic as people will likely avoid traveling until life returns to normal. In a recent interview, the director of the National Institute for Allergy and Infectious Diseases stated that life in the U.S. will likely normalize by late 2021, according to news reports. Hotels made up 3.4% of total loans at the end of the last quarter, as mentioned in the 10-Q filing.

Considering these factors, I’m expecting the provision expense to increase to $2.4 million in the second half of this year from $1.9 million in the first half. The table below shows details of loan modifications at the end of June 2020.

Margin to Take a Hit from Interest Rate Cuts Next Year

EBMT funded $44.85 million of loans under the Paycheck Protection Program, PPP, as mentioned in the 10-Q filing. Assuming fees of 3% and funding cost of 0.35%, PPP will likely add $1.2 million to net interest income over the life of the loans. I’m expecting a majority of the loans to get forgiven before the year-end; hence, I’m expecting EBMT to book most of the fees in the second half of this year.

Excluding the impact of the accelerated booking of PPP, the net interest margin, NIM, will likely trend downwards through 2021. The repricing down of assets, while funding cost remains sticky, will pressurize the NIM. The management’s interest-rate sensitivity analysis shows that the NIM becomes more sensitive to interest rate changes in the second year of the rate cuts. The following table from the 10-Q filing shows the results of the management’s analysis.

Eagle Bancorp Montana Interest Rate Sensitivity

Considering the factors mentioned above, I’m expecting the NIM to decline by 7bps in the third quarter and 2bps in the fourth quarter of 2020. Further, I’m expecting the average NIM in 2021 to be 22bps below the average for 2020.

The forgiveness of PPP loans will likely reduce the loan balance in the year ahead. As a result, I’m expecting EBMT to end 2020 with a loan balance of around $793 million, down 4.5% from the end of June, and up 2.9% from the end of last year. The following table shows my estimates for loans and other balance sheet items.

Eagle Bancorp Montana Balance Sheet Forecast

Expecting Earnings to Decline by 28% in the Second Half from the First Half

Elevated provision expense and NIM compression will likely pressurize earnings in the second half of the year. Additionally, the non-interest income will likely normalize in the year ahead after surging in the second quarter due to gains on sales of loans and available-for-sale securities. On the other hand, the accelerated booking of PPP fees will likely temporarily lift net interest income and support earnings in the year ahead. Overall, I’m expecting earnings in the second half of the year to be 28% lower than the first half’s earnings. For the full year, I’m expecting EBMT to report earnings of $2.43 per share, up 44% from last year. This estimate is higher than the previous estimate I gave in my last report on EBMT because of the surprisingly high non-interest income in the second quarter. Actual earnings in the year ahead may differ materially from my estimates because the provision expense is difficult to predict amid the pandemic. The following table shows my income statement estimates.

Eagle Bancorp Montana Income Forecast

Price Upside Not High Enough for Risks

I’m using the historical price-to-tangible-book, P/TB, multiple to value EBMT. The stock has traded at an average P/TB multiple of 1.05 in the past, as shown below.

Eagle Bancorp Montana Historical Price to Book

Multiplying the average P/TB ratio with the June 2021 forecast tangible book value per share of $18.8 gives a target price of $19.7 for the mid of next year. This price target is just 9.6% above the closing market price for September 18, 2020. The following table shows the sensitivity of the target price to the P/TB ratio.

Eagle Bancorp Montana Valuation Sensitivity

Apart from the limited price upside, EBMT is also offering a low dividend yield of 2.1%, assuming the company maintains its quarterly dividend at the current level of $0.0975 per share. There is little threat of a dividend cut because the earnings and dividend estimates suggest a payout ratio of only 20% for 2021, which is easily sustainable.

Based on the limited upside and low dividend yield, I’m adopting a neutral rating on EBMT. As discussed above, the company is facing a high level of credit risk because of the loans requiring accommodations. The stock’s market price is currently not attractive enough to compensate for the elevated risk level.

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.

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