OP Bancorp: Strong Loan Growth To Drive Earnings This Year (NASDAQ:OPBK)

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Earnings of OP Bancorp (NASDAQ:OPBK) will likely surge this year on the back of remarkable loan growth. Regional economic factors will likely boost loan portfolio size this year. Further, the rate-sensitive loan portfolio will ensure that earnings benefit from a rising interest-rate environment. On the other hand, slightly higher-than-average provision expenses will likely restrict earnings growth. Overall, I’m expecting OP Bancorp to report earnings of $2.28 per share for 2022, up 21% year-over-year. The year-end target price suggests a high upside from the current market price. Therefore, I’m adopting a buy rating on OP Bancorp.

Loan Growth to Decelerate but Remain Satisfactory

OP Bancorp’s loan portfolio grew by an astounding 8.8% during the first quarter of 2022, or 35% annualized. Such high loan growth is unsustainable; therefore, the growth rate will likely naturally decelerate for the second and third quarters of the year. Nevertheless, loan growth will remain at a decent level thanks to regional economic factors.

OP Bancorp’s loan portfolio is heavy on commercial and small business loans. Further, the portfolio is geographically concentrated in California. Therefore, the California Coincident Index of the Federal Reserve Bank of Philadelphia is a good indicator of economic activity, and consequently the credit demand for the near future. As shown below, the index’s upward trajectory is somewhat steep.

Chart
Data by YCharts

However, high interest rates are likely to take a toll on credit demand during the back half of the year. The Federal Reserve’s projections suggest that interest rates will peak in late 2022 or 2023 before trending downwards. As a result, it would make sense for commercial borrowers to delay their borrowing for capital expenditure by a few quarters. As a result, loan growth will likely slow down by the end of 2022 before picking up pace again next year.

Overall, I’m expecting the loan portfolio to increase by 18.9% by the end of 2022 from the end of 2021. Meanwhile, I’m expecting other balance sheet items to grow more or less in line with loans for the last three quarters of the year. The following table shows my balance sheet estimates.

FY18 FY19 FY20 FY21 FY22E
Financial Position
Net Loans 865 980 1,084 1,298 1,543
Growth of Net Loans 17.1% 13.2% 10.6% 19.7% 18.9%
Other Earning Assets 63 68 129 251 282
Deposits 905 1,021 1,200 1,534 1,827
Borrowings and Sub-Debt 10 13 10 11
Common equity 130 141 143 165 188
Tangible BVPS ($) 8.3 8.8 9.4 10.9 12.3

Source: SEC Filings, Author’s Estimates

(In USD million unless otherwise specified)

Loan and Deposit Mixes are Well-Positioned for Rate Hikes

OP Bancorp’s loan portfolio is quite rate-sensitive because variable-rate loans made up 41.1% of total loans at the end of March 2022, as mentioned in the earnings presentation. Further, $40 million of hybrid loans, representing 3% of total loans, will re-price within one year.

Additionally, the large balance of non-interest-bearing deposits will hold back the average deposit cost as rates rise. Non-interest-bearing deposits made up a whopping 50.7% of total deposits at the end of March 2022. Money-market and other deposits that will reprice quickly after every rate hike made up a much lower 27% of total deposits at the end of March 2022.

The management’s interest-rate sensitivity analysis given in the 10-Q filing shows that a 200-basis points increase in interest rates can boost the net interest income by 10.94% over twelve months.

OP Bancorp Interest Rate Sensitivity

1Q 2022 10-Q Filing

The above analysis assumes an immediate hike in interest rates. In reality, the rate hikes have been gradual this year. Therefore, the impact on net interest income will be less than 10.94%.

Considering these factors, I’m expecting the margin to increase by 14 basis points in the last three quarters of 2022 from 4.12% in the first quarter of the year.

Higher Interest Rates, Threats of a Recession to Keep Provisioning Slightly Above Normal

OP Bancorp’s nonperforming loans were well covered at the end of March 2022. Nonperforming loans made up 0.20% of total loans, while allowances made up 1.17% of total loans at the end of the first quarter, as mentioned in the presentation. Due to the significant cushion, I’m not too concerned that high interest rates and threats of a recession will push up provisioning costs by a large amount. In my opinion, provisioning will likely be only slightly above normal for the remainder of this year. The significant loan additions will likely further boost provisioning for expected loan losses.

Overall, I’m expecting OP Bancorp to report a net provision expense of 0.17% of total loans in 2022. In comparison, the net provision expense averaged 0.15% of total loans from 2017 to 2019.

Expecting Earnings to Grow by 21%

The significant loan additions in 2022 will likely be the biggest driver of earnings growth. Further, the anticipated margin expansion will lift the bottom line. On the other hand, slightly above normal provision expense will likely constrain earnings growth. Overall, I’m expecting OP Bancorp to report earnings of $2.28 per share for 2022, up 21% year-over-year. The following table shows my income statement estimates.

FY18 FY19 FY20 FY21 FY22E
Income Statement
Net interest income 41 44 45 61 75
Provision for loan losses 1 1 6 1 3
Non-interest income 9 11 11 16 17
Non-interest expense 30 33 32 36 40
Net income – Common Sh. 14 16 13 29 35
EPS – Diluted ($) 0.89 1.03 0.85 1.88 2.28

Source: SEC Filings, Earnings Releases, Author’s Estimates

(In USD million unless otherwise specified)

Actual earnings may differ materially from estimates because of the risks and uncertainties related to inflation, and consequently the timing and magnitude of interest rate hikes. Further, the threat of a recession can increase the provisioning for expected loan losses beyond my expectation. The new Omicron subvariant also bears monitoring.

Adopting a Buy Rating

OP Bancorp is offering a dividend yield of 3.8% at the current quarterly dividend rate of $0.10 per share. The earnings and dividend estimates suggest a payout ratio of 17.6% for 2022, which is close to the three-year average of 23.0%. Therefore, I’m not expecting an increase in the dividend level.

I’m using the historical price-to-tangible book (“P/TB”) and price-to-earnings (“P/E”) multiples to value OP Bancorp. The stock has traded at an average P/TB ratio of 0.94 in the past, as shown below.

FY19 FY20 FY21 Average
T. Book Value per Share ($) 8.8 9.4 10.9
Average Market Price ($) 9.5 7.2 10.5
Historical P/TB 1.08x 0.77x 0.96x 0.94x
Source: Company Financials, Yahoo Finance, Author’s Estimates

Multiplying the average P/TB multiple with the forecast tangible book value per share of $12.3 gives a target price of $11.6 for the end of 2022. This price target implies a 9.7% upside from the July 15 closing price. The following table shows the sensitivity of the target price to the P/TB ratio.

P/TB Multiple 0.74x 0.84x 0.94x 1.04x 1.14x
TBVPS – Dec 2022 ($) 12.3 12.3 12.3 12.3 12.3
Target Price ($) 9.1 10.3 11.6 12.8 14.0
Market Price ($) 10.6 10.6 10.6 10.6 10.6
Upside/(Downside) (13.7)% (2.0)% 9.7% 21.4% 33.1%
Source: Author’s Estimates

The stock has traded at an average P/E ratio of around 7.8x in the past, as shown below.

FY19 FY20 FY21 Average
Earnings per Share ($) 1.03 0.85 1.88
Average Market Price ($) 9.5 7.2 10.5
Historical P/E 9.3x 8.5x 5.6x 7.8x
Source: Company Financials, Yahoo Finance, Author’s Estimates

Multiplying the average P/E multiple with the forecast earnings per share of $2.28 gives a target price of $17.8 for the end of 2022. This price target implies a 68.4% upside from the July 15 closing price. The following table shows the sensitivity of the target price to the P/E ratio.

P/E Multiple 5.8x 6.8x 7.8x 8.8x 9.8x
EPS 2022 ($) 2.28 2.28 2.28 2.28 2.28
Target Price ($) 13.2 15.5 17.8 20.0 22.3
Market Price ($) 10.6 10.6 10.6 10.6 10.6
Upside/(Downside) 25.2% 46.8% 68.4% 90.0% 111.6%
Source: Author’s Estimates

Equally weighting the target prices from the two valuation methods gives a combined target price of $14.7, which implies a 39.1% upside from the current market price. Adding the forward dividend yield gives a total expected return of 42.9%. Hence, I’m adopting a buy rating on OP Bancorp.

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