littleny/iStock via Getty Images
littleny/iStock via Getty Images
Earnings of Financial Institutions, Inc. (NASDAQ:FISI ) will most probably plunge this year on the back of higher provisioning. On the other hand, moderate loan growth will likely support the bottom line. Meanwhile, the margin will likely face pressure from the rising rate environment. Overall, I'm expecting Financial Institutions, Inc. to report earnings of $3.65 per share for 2022, down 24% year-over-year. For 2023, I'm expecting earnings to remain almost unchanged at $3.64 per share. The year-end target price suggests a high upside from the current market price. Nevertheless, I'm adopting a hold rating on Financial Institutions, Inc. because of the existing unfavorable operating environment.
Financial Institutions' loan portfolio grew by 2.2% in the first half of 2022, or 4% annualized, which is not bad considering the company's history. The management mentioned in the conference call that it expects mid-to-high-single-digit growth for 2022, with commercial and consumer indirect categories driving this growth. In my opinion, this target is a bit ambitious and the company's actual loan growth for the year will probably be at the lower end of the management's guidance. This is because high borrowing costs are bound to reduce the credit demand, especially for consumer indirect loans and residential loans which make up 45% of total loans.
On the other hand, strong regional job markets will sustain loan growth. Financial Institutions, Inc. mostly operates in Western and Central New York State, with some presence in Maryland as well. As shown below, New York's unemployment rate (excluding New York City) is currently very low, which bodes well for credit demand, especially for consumer indirect loans and residential loans.
Considering these factors, I'm expecting the loan portfolio to grow by 1% every quarter till the end of 2023.
According to the projections released this week, the Federal Reserve expects a further 125-150 basis points hike in the fed funds rate till the end of 2023 from the current level of 3.25%. Financial Institutions' borrowing costs will reprice quicker than assets in the short term; therefore, the margin will suffer for most of the monetary tightening cycle.
Interest-bearing demand, savings, and money market deposits made up 56.5% of total deposits at the end of June 2022. These deposits will reprice immediately after rate hikes. On the other hand, the large balance of securities will weigh down the average earning-asset yield as most securities have fixed rates. Securities made up a quarter of total earning assets at the end of June 2022.
The results of the management's interest rate sensitivity analysis given in the 10-Q filing show that a 200-basis points hike in interest rate can DECREASE the interest income by 1.46% over twelve months.
On the other hand, the anticipated loan growth discussed above will help lift the margin. Overall, I'm expecting the net interest margin to remain mostly unchanged through the end of 2023 from 3.19% in the second quarter of the year.
The anticipated loan growth will likely be one of the biggest drivers of earnings in the next year and a half. Further, Financial Institutions, Inc. is currently focusing on its Banking as a Service ("BaaS") initiative for growth. Through BaaS, the company will partner with fintech companies and non-bank financials to offer banking products and services to their end customers. Financial Institutions, Inc. will earn fees from the model; therefore, the company's non-interest income will likely grow at a high rate through 2023.
Meanwhile, the provisioning for expected loan losses will likely remain near the historical mean. Allowances were at a high level at the end of June 2022 relative to non-performing loans. Allowances were 648% of non-performing loans at the end of June 2022, as mentioned in the 10-Q filing, as opposed to 699% of non-performing loans at the same point in time last year. Therefore, I'm expecting provisioning requirements from the existing portfolio to be low and new loans to be the chief driver of provisioning. Overall, I'm expecting provisioning to remain at a normal level through the end of 2023. I'm expecting the net provision expense to make up 0.32% of total loans (annualized) in every quarter till the end of 2023, which is the same as the average for the last five years.
Overall, I'm expecting Financial Institutions, Inc. to report earnings of $3.65 per share for 2022, down 24% year-over-year. For 2023, I'm expecting earnings to remain flattish at around $3.64 per share. The following table shows my income statement estimates.
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, a stronger or longer-than-anticipated recession can increase the provisioning for expected loan losses beyond my estimates.
Financial Institutions, Inc. has a very large available-for-sale securities portfolio, which will cause problems in a rising rate environment. AFS securities made up 21% of total earning assets at the end of June 2022. As interest rates increase, the market value of the securities will fall leading to unrealized losses. These losses will flow directly into the equity account, leaving the income statement intact, as per relevant accounting standards.
Due to a large buildup of unrealized losses, the book value has already dropped from $28.1 per share at the end of March 2022 to $26.6 per share at the end of June 2022, as mentioned in the earnings release. The book value will face further pressure as the monetary tightening cycle is far from over. As mentioned above, the Federal Reserve expects around 125-150 basis points hike by the end of 2023.
The following table shows my balance sheet estimates.
Source: SEC Filings, Author's Estimates
(In USD million unless otherwise specified)
Considering the earnings outlook, I'm expecting the company to increase its dividend by just $0.01 per share to $0.30 per share in the first quarter of 2023. The earnings and dividend estimates suggest a payout ratio of 33% for 2023, which is close to the five-year average of 36%. Based on my dividend estimate, Financial Institutions, Inc. is offering a forward dividend yield of 4.8%.
I'm using the historical price-to-tangible book ("P/TB") and price-to-earnings ("P/E") multiples to value Financial Institutions. The stock has traded at an average P/TB ratio of 1.25 in the past, as shown below.
Multiplying the average P/TB multiple with the forecast tangible book value per share of $19.6 gives a target price of $24.6 for the end of 2022. This price target implies a 1.6% downside from the September 22 closing price. The following table shows the sensitivity of the target price to the P/TB ratio.
The stock has traded at an average P/E ratio of around 9.5x in the past, as shown below.
Multiplying the average P/E multiple with the forecast earnings per share of $3.65 gives a target price of $34.6 for the end of 2022. This price target implies a 38.7% upside from the September 22 closing price. The following table shows the sensitivity of the target price to the P/E ratio.
Equally weighting the target prices from the two valuation methods gives a combined target price of $29.6, which implies an 18.5% upside from the current market price. Adding the forward dividend yield gives a total expected return of 23.2%.
Financial Institutions, Inc. is currently trading at a large discount to its fair value, with good reason. Despite the large price upside, I wouldn't want to invest in the stock as we are only halfway through the monetary tightening cycle. I will revisit this stock later this year or next year. For now, I'm adopting a hold rating on Financial Institutions, Inc.
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