2023 is not one of the best years for First Internet Bancorp (NASDAQ:INBK), in fact to date the stock has lost about 28%. The rapid rise in interest rates and the banking crisis in early 2023 have jeopardized the soundness of this bank.
In any case, there has been a strong recovery since the May 2023 bottom, and shareholders are wondering how much longer this can continue.
Based on management’s comments on Q3 2023 it would seem that the worst is behind us, but the data suggest that we should curb enthusiasm. The chances of a new rally are there since the stock has a lot of catching up to do, but we cannot rule out a bearish scenario since the problems of past quarters remain.
Loan portfolio and growth prospects
The loan portfolio reached $3.73 billion, an increase of 2.40% over the previous quarter. The average yield on loans originated this quarter was 8.92%, up 50 basis points from the previous quarter. So, First Internet was able to increase the loan portfolio even though the general demand for credit is decreasing due to high interest rates.
What’s more, the quality of loans/assets remains high and even improving from the previous quarter.
According to management’s estimates, we can expect that in Q4 2023 this growth can continue at the same pace or slightly increase. In other words, First Internet will keep meeting the demand for credit and is not concerned about an LTD ratio that is too high: it is currently at 91.50%. In addition, for the whole of 2024, management expects loan growth around 10% approximately.
However, it is not only loans that will grow, but also their yield. In fact, the latter is expected to increase between 20-25 basis points in Q4 2023, and then continue its growth in 2024 when about 30% of the loan portfolio will mature. The opportunity to roll over future maturing loans at current market rates is potentially the main growth driver for First Internet if demand remains as it has been in recent quarters.
So, I just think with some of the production perhaps being a little bit more weighted in the back end of the third quarter, it sets us up really good for the fourth quarter in terms of loan yield improvement. I guess looking over the course of the next, let’s just call it the next 18 months, in terms of our variable rate loans are about 20% of our loan portfolio today. And then when you take into account what’s going to mature and also pay down in our fixed loan portfolio, I mean, we’re probably looking at almost $1.1 billion or so, about 30% of the loan book that’s going to turn over between now and the end of 2024.
Deposits and profitability
From the main driver of growth, we now turn to the main driver of deterioration.
Total deposits amounted to $4.10 billion, up 5.90% from the previous quarter. The main problem here is not the amount of deposits per se, but the cost of deposits. In fact, non-interest-bearing deposits have an almost insignificant weight, while brokered deposits and certificates deposits have a huge weight.
Compared to two quarters ago, the weight of the latter has increased from 50% to 56% and may increase further. The consequences have been as rapid as they have been negative, in fact the cost of total interest-bearing deposits has risen from 3.24% to 4.09%. The trend does not seem to be slowing down; in fact, in the last quarter there was a not inconsiderable worsening of 34 basis points. Instead, the yield on loans has improved by only 9 basis points from last quarter and is not keeping pace with the rising cost of deposits.
The differential between the two rates is narrowing month by month, and as a result the net interest margin can only get worse. As of today it has reached 1.49%, significantly lower than 3.11%, which is the average NIM of banks with a similar size (assets between $1 and $4.90 billion).
The situation is not the best, but management remains positive nonetheless. In fact, according to CFO Ken Lovik’s statements, the net interest margin probably bottomed out in July-August, so Q3 2023 represents the tipping point beyond which it can only rise again. Moreover, it would appear that this ascent has already begun, in fact on a monthly basis the NIM improved as early as September. The reason for this inflection point is mainly due to the CD re-pricing gap narrowing, so in Q4 2023 there should be no considerable increase in the cost of deposits.
As we continue to optimize the loan book and pick up more yield there, I think with regards to deposit costs, especially with the CD re-pricing gap narrowing and frankly a lot of our deposits really tied to direct moves in Fed funds. I mean, we do not forecast deposit costs really increasing all that significantly in the fourth quarter. And again, notwithstanding forces outside our control, we expect net interest income, net interest margin to be up in the fourth quarter.
CEO David Becker, conference call Q3 2023.
In any case, even if management’s expectations turn out to be correct, the net interest margin would still remain much lower than peers. In addition, for Q4 2023 to be the turning point, it is necessary for the Fed Funds Rate to remain stable and the demand for credit not to fade despite loans having double-digit interest rates in some cases. I personally remain quite doubtful in this regard.
Capital ratios and buyback
The capital ratios are all above the minimum required threshold, which is good. However, if we looked at the adjusted data, i.e. those in which AOCI is included, we can see that the capital ratios are quite close to the minimum limit. In short, it is not an ideal situation. But there is more.
Given the situation one would think that management is doing everything possible to preserve as many resources as possible in order to improve CET 1 and TCE, instead it is the exact opposite: in Q3 2023 97,834 shares were purchased at an average price of $18.29 per share. Indeed, since First Internet was trading at a Price/Book Value below 40% it turned out to be an efficient buyback in terms of pricing, but I remain perplexed about the necessity of this transaction in such a challenging period. CFO Kevin Lovik is fully aware of the situation but does not rule out other buybacks in the future, albeit smaller ones.
One of the things that we’re focused on, and we know the outside world pays a lot of attention to it the TCE. We fell under seven. Our goal is to get us back above seven at the current time at the price. We really can’t be out of the market on share repurchase, but we’re diligently paying attention to that 7%. If by chance the Fed does nothing and the long-term rates come back and AOCI drops down yes, we’ll stay in actively purchasing. I think we’ll do something. I doubt that we’re going to expand much over what we did last quarter, particularly, hopefully the share price continues to climb as well as our numbers are getting better.
Basically, while many regional banks have suspended buybacks because the macroeconomic environment is unstable, First Interest gives its shareholders another remuneration in addition to the dividend. I would like to make it clear that I am not criticizing this choice, it simply appears at odds with the sentiment of the moment.
Overall, if management’s expectations are correct, the bottom has already been reached and from now on First Internet’s recovery will begin, supported also by buybacks. In the coming months we will see whether or not the rising cost of deposits will slow down: that is the key.