Sierra Bancorp: Cheap But Risky (NASDAQ:BSRR)

Earnings of Sierra Bancorp (NASDAQ:BSRR) rose in the second quarter to $0.54 per share from $0.51 per share in the first quarter of 2020. The earnings improvement was attributable to loan growth and a one-time gain related to housing tax credits. Earnings will likely remain stable in the second half of the year because the accelerated booking of Paycheck Protection Program fees will likely offset a hike in provision expense. Overall, I’m expecting BSRR’s earnings in the second half of the year to be almost unchanged from the first half of the year. For the full year, I’m expecting BSRR to report earnings of $2.11 per share, down 9% from last year. The June 2021 target price suggests a high upside from the current market price. Nevertheless, I’m adopting a neutral rating on BSRR due to its elevated risk level ahead of the company’s adoption of the new accounting standard for credit losses.

High Amount of Loan Modifications Reflects the Elevated Level of Credit Risks

BSRR allowed payment deferrals on loans worth $386.2 million, representing 17.5% of total loans, according to details given in the July 2020 investor presentation. The large portion of loans requiring payment deferrals shows that BSRR is facing high credit risks. The hospitality segment is particularly problematic as BSRR had to allow modifications on around $145 million of loans within the segment, representing 37.5% of total modifications. Further, BSRR’s total exposure to the hospitality industry was $222.5 million, representing 10% of total loans, as mentioned in the second quarter’s 10-Q filing. While other sectors may return to payment soon, the hospitality segment will likely continue to face debt-servicing problems through the early part of 2021, as most people will continue to avoid traveling. The following table from the presentation shows the contributions of different industries to BSRR’s total loan modifications.

As mentioned in the 10-Q filing, BSRR delayed the adoption of the new accounting standard for credit losses, called the Current Expected Credit Losses, or CECL, to later this year. BSRR’s upcoming adoption of CECL will likely add to the company’s risks. The switch from the current incurred loss model to the new expected loss model can lead to surprises in provision expense in the year ahead. Further, the management mentioned in the 10-Q filing that if economic conditions do not improve, then the provision for loan losses could be at the same or higher level as that booked in the first half of 2020. Considering the above factors and BSRR’s current loan loss provisions, I’m expecting the company to report a provision expense of $4.4 million in the second half of 2020, up from $4.0 million in the first half.

Paycheck Protection Program to Temporarily Lift Net Interest Income

The accelerated booking of fees from the Paycheck Protection Program, PPP, will likely offset the pressure on earnings from a hike in provision expense. BSRR funded $116.2 million in loans under PPP, as mentioned in the presentation. These loans carry an average fee of 4%, which will lead to estimated fees of $4.6 million that BSRR will book 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 BSRR to accelerate the booking of the fees in the fourth quarter.

Excluding the impact of accelerated booking of PPP fees, the net interest margin, NIM, will likely trend downwards in the year ahead because assets with fixed rates will mature and new loans will originate at lower rates. Moreover, there is very little room for further funding cost decline because the cost was already just 0.2% in the second quarter. Further, the sensitivity analysis conducted by the management shows that BSRR’s net interest margin is quite sensitive to rate changes. According to the results of the analysis, a 100bps decline in interest rates can reduce net interest income by 6.3%. The following table from the 10-Q filing shows that net interest income is sensitive to interest rate movement.Sierra Bancorp Interest Rate Sensitivity

The PPP forgiveness will likely reduce the loan balance in the year ahead. Excluding the impact of PPP, I’m expecting loans to grow at a low rate as uncertainties related to the pandemic will undermine the attractiveness of low interest rates. As a result, I’m expecting BSRR to end the year with a loan balance of $2.1 billion, down 4% from the end of June, but up 20% from the end of last year. The following table shows my estimates for loans and other balance sheet items.

Sierra Bancorp Balance Sheet Forecast

Earnings Likely to Remain Stable in the Year Ahead

The accelerated booking of fees under PPP will likely drive earnings in the year ahead while a hike in provision expense will limit earnings. Moreover, non-interest income will likely normalize after surging in the second quarter. BSRR booked gains of $0.7 million related to low-income housing tax credits in the second quarter, which pushed up non-interest income. Overall, I’m expecting earnings in the second half of the year to be almost unchanged from the first half’s earnings. For the full year, I’m expecting BSRR to report earnings of $2.11 per share, down 9% from last year. The following table shows my income statement estimates.

Sierra Bancorp Income Forecast

Actual earnings may differ materially from estimates because the pandemic can result in a surprise in provision expense. Moreover, the upcoming adoption of CECL can potentially lead to negative surprises.

Risks Likely to Limit the Stock Price Appreciation this Year

I’m using the historical price-to-tangible-book value multiple, P/TB, to value BSRR. The stock has traded at an average P/TB multiple of 1.09 in the first half of 2020. Multiplying the June 2021 forecast tangible book value per share of $20.3 with the average P/TB multiple gives a target price of $22.2. This target price implies an upside of 26% from BSRR’s September 11 closing price. The following table shows the sensitivity of the target price to the P/TB multiple.

Sierra Bancorp Valuation Sensitivity

Apart from the price upside, BSRR is also offering a decent dividend yield of 4.6%, assuming the company maintains its quarterly dividend at the current level of $0.20 per share. The earnings and dividend estimates suggest a payout ratio of 46% for 2021, which is sustainable; therefore, there is little threat of a dividend cut.

Despite the attractive valuation, I’m not expecting the stock price to rise much in the year ahead. As discussed above, BSRR is facing a high level of credit risk due to exposure to several industries, including hospitality. Additionally, the company will adopt CECL later this year that could lead to surprises. Due to these near-term risks, I’m adopting a neutral rating on BSRR for the remainder of 2020.

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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