Hanmi Financial: Downgrading To Hold But Raising The Earnings Estimate

seekingalpha2024-11-21

California’s economy, the national economy, and declining interest rates indicate that loan growth can continue at the third quarter level.There is some opportunity to reinvest outgoing low-yielding ...

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Further, reinvestment opportunities will boost the net interest margin, which will, in turn, support the bottom line. Overall, I'm expecting earnings to dip by 23% year-over-year in 2024 to $2.01 per share and then grow by 11% to $2.23 per share in 2025. Compared to my last report on the company, I haven't changed my earnings estimate for 2024, but I've raised my estimate for 2025 because I have increased my margin estimate. The December 2025 target price is close to the current market price. Further, HAFC is offering a moderate dividend yield. Based on my updated total expected return, I'm downgrading Hanmi Financial to a hold rating. Loan Growth to Remain Near the Third Quarter’s Level Hanmi Financial’s loan growth bounced back in the third quarter after declining for the first two quarters of this year. The loan book grew by 1.3% during the quarter, which was mostly in line with the expectations given in my last report on the company. Hanmi Financial, through its subsidiary Hanmi Bank, serves multi-ethnic communities in urban markets. Loans to US subsidiaries of Korean companies made up 15% of total loans at the end of September, as mentioned in the latest earnings presentation. Further, the company is focused on Californian markets, but it also has a presence in New York, New Jersey, Virginia, Chicago, IL, Dallas, TX, and Houston, TX.   3Q 2024 Earnings PresentationAs shown below, California’s unemployment rate has worsened this year, but it’s still not too bad considering the history. Further, the state’s coincident index shows that economic activity is satisfactory. Data by YChartsDue to the diversity of the rest of Hanmi Financial’s markets, it’s appropriate to gauge credit demand using the national average. As shown below, despite an uptrend this year, the nation’s unemployment rate is still quite low compared to some pre-pandemic years. Moreover, professional forecasters expect the unemployment rate to rise only slightly next year. Data by YChartsFurther, interest rate cuts will whet the appetite for credit. Following the cumulative 75 basis points Fed funds rate cuts in September and November, I’m expecting the Fed to cut rates by a further 75–100 basis points by the end of next year. I have not incorporated the new US administration’s planned tariffs in my rate outlook because economies change slowly, and it’s unlikely that the full effect of tariffs will become visible on inflation within a year. Businesses and importers tend to keep inventory, so it will take several months for the effect of tariffs to get passed on to end consumers. Moreover, there is not enough clarity on the rate of tariffs. Considering the factors mentioned above, I’m expecting the loan portfolio to grow by 1% every quarter through 2025. Further, I’m expecting deposits to grow in tandem with loans. The following table shows my balance sheet estimates.         Financial Position FY19 FY20 FY21 FY22 FY23 FY24E FY25E   Net Loans 4,549 4,790 5,079 5,896 6,113 6,250 6,504   Growth of Net Loans (0.4)% 5.3% 6.0% 16.1% 3.7% 2.2% 4.1%   Other Earning Assets 657 762 924 862 878 970 1,000   Deposits 4,699 5,275 5,786 6,168 6,281 6,467 6,730   Borrowings and Sub-Debt 208 269 353 479 455 434 447   Common Equity 563 577 643 638 702 765 883   Book Value Per Share ($) 18.3 19.1 21.1 21.0 23.1 25.5 29.4   Tangible BVPS ($) 17.9 18.7 20.7 20.6 22.8 25.1 29.0   Click to enlarge Source: SEC Filings, Analyst's Estimates (In USD million unless otherwise specified). Margin Outlook is Positive Thanks to Reinvestment Opportunities After declining for six consecutive quarters, the net interest margin finally bounced back in the third quarter of 2024. The margin grew by 5 basis points in the quarter, which was better than my expectations. Management mentioned on the conference call that it expects a further 10–20 basis points expansion in the margin. Management’s target seems achievable because the loan portfolio’s average yield is much below the yields on new loan production. The company reported an average loan yield of 6.0% for the third quarter, while the yields on new loans were around 190 basis points higher at around 7.92%, as mentioned in the presentation. This means that even after the 75 basis points Fed funds rate cuts in September and November, there will be room to reinvest outgoing loans at a higher yield. However, management’s rate-sensitivity analysis provides a different conclusion. The results of management’s rate-sensitivity simulation model given in the 10-Q filing show that a 100-basis point rate cut could reduce the net interest income by 1.45% over twelve months.   3Q 2024 10-Q FilingThe above results of the simulation model are theoretical, and I’m going to take them with a pinch of salt. This is because of the opportunities to significantly raise rates through reinvestment of outgoing loans. Overall, I’m expecting the margin to grow by 5 basis points in the last quarter of 2024 and then another 5 basis points in the first half of 2025, before declining by 5 basis points in the latter part of next year. Compared to my last report on the company, I’ve raised my margin estimates as my short-term outlook is more positive than before because of the reinvestment opportunities now apparent. Moreover, the third quarter performance beat my expectations. Expecting Earnings to Grow to $2.23 Per Share Given my outlook on the net interest margin and balance sheet line items, I’m expecting the net interest income to grow at a healthy rate in upcoming quarters. Furthermore, I’m making the following assumptions to forecast the remaining income statement line items.  I’m assuming the provision expense for loan losses will remain constant at the average for the first nine months of 2024. I’m assuming the non-interest income will remain rangebound near the third quarter level. I’m assuming the efficiency ratio will remain near the third quarter level of 60%.  Overall, I’m expecting the company to report earnings of $2.01 per share for 2024, down 23% year-over-year. I haven’t changed my estimate much from my previous estimate of $2.00 per share given in my last report on the company. For 2025, I’m expecting earnings to grow by 11% to $2.23 per share. In my last report, I projected earnings of $2.01 per share for next year. I’ve raised my earnings estimate because I’ve increased my net interest margin estimate. The following table shows my income statement estimates.         Income Statement FY19 FY20 FY21 FY22 FY23 FY24E FY25E   Net interest income 176 181 195 238 221 201 214   Provision for loan losses 30 45 (24) 1 4 5 5   Non-interest income 28 43 40 34 34 33 34   Non-interest expense 126 119 124 130 137 143 148   Net income - Common Sh. 33 42 98 101 80 60 67   EPS - Diluted ($) 1.06 1.39 3.22 3.32 2.62 2.01 2.23   Click to enlarge Source: SEC Filings, Earnings Releases, Analyst's Estimates (In USD million unless otherwise specified) Risks are Unremarkable As discussed below, Hanmi Financial’s riskiness is satisfactory.   Good Loan Book Quality: The loan portfolio’s credit quality is quite good with non-accrual loans making up just 0.24% of total loans at the end of September. Office property loans made up 9% of total loans at the end of September, as mentioned in the presentation. However, so far, the office portfolio hasn’t started turning problematic.  Satisfactory Securities Portfolio: Unrealized losses on the Available-for-Sale securities portfolio amounted to $79 million at the end of September, which is as big as 11% of the equity book value. This level is easily manageable, especially as we’ve entered a rate downcycle. Rate cuts will lift the market value of AFS securities, thereby reversing the unrealized losses.  Admirable Capital Position: The company reported a total capital-to-risk-weighted assets ratio of 15.04%, which is much higher than the minimum regulatory requirement of 10.50%, as mentioned in the presentation.  Interest Rate Risk Seems Satisfactory: Due to the uncertainty related to the upcoming tariffs, it’s difficult to project inflation and consequently interest rates. Therefore, the interest rate risk is elevated for the entire banking industry. Fortunately for Hanmi, its earnings are not particularly sensitive to interest rate changes. As mentioned above, I’m expecting the margin to expand because of the reinvestment of low-yield loans, not because of rate cuts.  Downgrading to Hold Hanmi Financial is offering a dividend yield of 3.9% at the current quarterly dividend rate of $0.25 per share. The earnings and dividend estimates suggest a payout ratio of 45% for 2025, which is close to the five-year average of 42%. Therefore, I’m not expecting an increase in the dividend level despite my positive earnings outlook. I’m using the historical price-to-tangible book (“P/TB”) and price-to-earnings (“P/E”) multiples to value Hanmi Financial. The stock has traded at an average P/TB ratio of 0.952x and an average P/E ratio of around 9.421x in the past, as shown below. Data by YChartsMultiplying the average P/TB multiple with the forecast tangible book value per share of $29.00 gives a target price of $27.60 for the end of 2025. This price target implies an 8.7% upside from the November 19 closing price. The following table shows the sensitivity of the target price to the P/TB ratio.         P/TB Multiple 0.75x 0.85x 0.95x 1.05x 1.15x   TBVPS - Dec 2025 ($) 29.0 29.0 29.0 29.0 29.0   Target Price 21.8 24.7 27.6 30.5 33.4   Market Price 25.4 25.4 25.4 25.4 25.4   Upside/(Downside) (14.1)% (2.7)% 8.7% 20.1% 31.6%   Click to enlarge Source: Analyst’s Estimates Multiplying the average P/E multiple with the forecast earnings per share of $2.23 gives a target price of $21.00 for the end of 2025. This price target implies a 17.2% downside from the November 19 closing price. The following table shows the sensitivity of the target price to the P/E ratio.       P/E Multiple 7.4x 8.4x 9.4x 10.4x 11.4x   EPS 2025 ($) 2.23 2.23 2.23 2.23 2.23   Target Price ($) 16.6 18.8 21.0 23.3 25.5   Market Price ($) 25.4 25.4 25.4 25.4 25.4   Upside/(Downside) (34.8)% (26.0)% (17.2)% (8.4)% 0.4%   Click to enlarge Source: Analyst’s Estimates Equally weighting the target prices from the two valuation methods gives a combined target price of $24.30, which implies a 4.2% downside from the current market price. Adding the forward dividend yield gives a total expected return of negative 0.3%.  In my last report on Hanmi Financial, which was published in September, I adopted a buy rating because my valuation analysis suggested a sizable price upside and attractive dividend yield at that time. Since then, the stock price has rallied by a massive 30%. 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