courtneyk
Due to its reliance on mortgage banking income, Meridian Corporation’s (NASDAQ:MRBK) earnings are closely related to the interest-rate cycle. Now that we’re on the verge of a down-rate cycle, chances are very high that the company’s earnings will improve. I’m expecting the company to report earnings of $1.32 per share for 2024, up 14% year-over-year. The year-end target price suggests a high upside from the current market price. Additionally, Meridian is offering a high dividend yield of over 5%. Based on the total expected return, I’m upgrading Meridian Corporation to a buy rating.
Mortgage Income is About to Turn Around
As expected, Meridian Corporation’s mortgage banking income remained subdued in 2023, as shown below.
SEC Filings
As mortgage refinance activity is closely related to borrowing costs, the demand for mortgage refinancing tapered off when interest rates started rising in early 2022. As a result, refinancing volume remained at a negligible level throughout 2023.
The Fed projects the Fed Funds rate to dip by around 100 basis points in 2024 and a further 50-75 basis points in 2025. As a result, there’s a very good chance that mortgage refinance activity will pick up later this year. Additionally, lower rates may encourage first-time home buyers, which will push up mortgage purchase volume.
The Mortgage Bankers Association projects mortgage refinance volume to jump up by 50% in 2024 and 36% in 2025. Further, MBA expects mortgage purchase volume to grow by 16% in 2024 and 10% in 2025.
Mortgage Bankers Association
As a result, I’m expecting the mortgage banking income to grow by double-digits in 2024. Further, I’m expecting other fee income to grow at a normal rate. Overall, I’m expecting non-interest income (including mortgage banking income) to increase by 11.9% this year compared to last year.
Change in the Interest Rate Cycle to Boost the Net Interest Income
Meridian Corporation’s net interest margin dipped by 63 basis points in 2023 as funding costs surged. The company has a variable-rate-account-heavy deposit mix which makes the funding cost highly sensitive to interest-rate changes. As a result, I’m expecting the funding cost to sharply reverse its trend this year as interest rates start to decline.
The falling interest rate environment will also boost loan demand, especially the demand for residential mortgages. (Note: Meridian Corporation originates mortgages for the purpose of selling as well as holding. The gains from sales of mortgages are reported in non-interest income and have been discussed in the section above. This section is about the loans MRBK holds, whose income flows into the net interest income line item of the income statement.)
Apart from falling rates, relatively strong economic activity will also support loan growth. Meridian Corporation operates in Pennsylvania, New Jersey, Delaware, Maryland, and Florida. The low unemployment rates in these states compared to their respective histories indicate that business activity is currently more robust than before in MRBK’s markets.
Overall, I’m expecting the net interest margin to increase by 16 basis points in 2024 from the last quarter of 2023. Further, I’m expecting the loan portfolio to grow by 8.2% this year. Based on these two estimates, I’m expecting the net interest income to grow by 7.6% year-over-year in 2024.
I’m expecting deposits to grow in line with loans. The following table shows my balance sheet estimates.
| Financial Position | FY19 | FY20 | FY21 | FY22 | FY23 | FY24E |
| Net Loans | 955 | 1,266 | 1,368 | 1,725 | 1,874 | 2,028 |
| Growth of Net Loans | 15.1% | 32.6% | 8.0% | 26.1% | 8.6% | 8.2% |
| Other Earning Assets | 123 | 360 | 249 | 224 | 255 | 261 |
| Deposits | 851 | 1,241 | 1,446 | 1,712 | 1,823 | 1,974 |
| Borrowings and Sub-Debt | 168 | 313 | 82 | 162 | 225 | 226 |
| Common equity | 121 | 142 | 165 | 153 | 158 | 151 |
| Book Value Per Share ($)* | 18.7 | 22.9 | 26.6 | 12.6 | 13.9 | 13.3 |
| Tangible BVPS ($)* | 18.0 | 22.2 | 26.0 | 12.2 | 13.5 | 13.0 |
| Source: SEC Filings, Author’s Estimates(In USD million unless otherwise specified)* Data before 2022 is as reported and not adjusted for the stock split | ||||||
Expecting Earnings to Turn Around
After two years of declines, I’m expecting earnings to turn around this year thanks to the upcoming interest rate cuts. Both non-interest income and net interest income will likely lift earnings this year. On the other hand, an inflation-driven growth of non-interest expenses will likely restrain earnings growth. Meanwhile, I’m expecting provisions expense for expected loan losses to track loan growth.
Overall, I’m expecting Meridian Corporation to report earnings of $1.32 per share for 2024, up 14% year-over-year. The following table shows my income statement estimates.
| Income Statement | FY19 | FY20 | FY21 | FY22 | FY23 | FY24E |
| Net interest income | 36 | 49 | 63 | 70 | 69 | 74 |
| Provision for loan losses | 1 | 8 | 1 | 2 | 7 | 7 |
| Non-interest income | 33 | 87 | 88 | 42 | 32 | 36 |
| Non-interest expense | 55 | 93 | 104 | 81 | 77 | 83 |
| Net income – Common Sh. | 10 | 26 | 36 | 22 | 13 | 15 |
| EPS – Diluted ($)* | 1.63 | 4.27 | 5.73 | 1.79 | 1.16 | 1.32 |
| Source: SEC Filings, Earnings Releases, Author’s Estimates(In USD million unless otherwise specified)* Data before 2022 is as reported and not adjusted for the stock split | ||||||
Interest Rates are the Major Source of Risk
Meridian Corporation’s earnings are highly dependent on the interest-rate trend; hence, interest-rate risk is the biggest risk factor for the company. Otherwise, the company’s risk level is low, as discussed below.
- Unrealized losses on the Available-for-Sale securities portfolio totaled just $10.96 million at the end of December 2023, which is around only 7% of the total equity book value.
- Uninsured deposits made up 21% of the total deposit book, as mentioned in the latest earnings presentation. These uninsured deposits aren’t worrisome because they’re not large enough for FDIC’s special assessment payment, as mentioned in the 10-K filing. (FDIC issued a final rule in November 2023 to recover the loss to the Deposit Insurance Fund following the closure of Silicon Valley Bank and Signature Bank. Under this final rule, banks with large uninsured deposits will have to pay a special rate into the Deposit Insurance Fund.)
- Office space loans amounted to $58.9 million at the end of December 2023, representing just 3% of total loans.
Dividend Yield is North of 5%
Unlike the years 2021 and 2022, Meridian Corporation skipped its annual special dividend in 2023, which is partly the reason why the company’s stock price has been depressed. However, even without the special dividend, Meridian’s dividend level is very attractive. The company is offering a dividend yield of 5.4% at the current quarterly dividend rate of $0.125 per share. The earnings and dividend estimates suggest a payout ratio of 37.7% for 2024, which is in line with the last three-year average of 40%. Therefore, the quarterly dividend appears secure.
Upgrading to Buy
I’m using the historical price-to-tangible book (“P/TB”) and price-to-earnings (“P/E”) multiples to value Meridian Corporation. The stock has traded at an average P/TB ratio of 1.04 and an average P/E ratio of 9.35 in the past, as shown below.
Multiplying the average P/TB multiple with the forecast tangible book value per share of $13.0 gives a target price of $13.5 for the end of 2024. This price target implies a 46.8% upside from the April 5 closing price. The following table shows the sensitivity of the target price to the P/TB ratio.
| P/TB Multiple | 0.84x | 0.94x | 1.04x | 1.14x | 1.24x |
| TBVPS – Dec 2024 ($) | 13.0 | 13.0 | 13.0 | 13.0 | 13.0 |
| Target Price ($) | 10.9 | 12.2 | 13.5 | 14.8 | 16.1 |
| Market Price ($) | 9.2 | 9.2 | 9.2 | 9.2 | 9.2 |
| Upside/(Downside) | 18.6% | 32.7% | 46.8% | 60.8% | 74.9% |
| Source: Author’s Estimates |
Multiplying the average P/E multiple with the forecast earnings per share of $1.32 gives a target price of $12.4 for the end of 2024. This price target implies a 34.6% upside from the April 5 closing price. The following table shows the sensitivity of the target price to the P/E ratio.
| P/E Multiple | 7.3x | 8.3x | 9.35x | 10.3x | 11.3x |
| EPS – 2024 ($) | 1.32 | 1.32 | 1.32 | 1.32 | 1.32 |
| Target Price ($) | 9.7 | 11.1 | 12.4 | 13.7 | 15.0 |
| Market Price ($) | 9.2 | 9.2 | 9.2 | 9.2 | 9.2 |
| Upside/(Downside) | 5.8% | 20.2% | 34.6% | 49.0% | 63.4% |
| Source: Author’s Estimates |
Equally weighting the target prices from the two valuation methods gives a combined target price of $12.9, which implies a 40.7% upside from the current market price. Adding the forward dividend yield gives a total expected return of 46.1%.
In my last report, I adopted a hold rating with a December 2023 target price of $13.1. Since then, the stock price has plunged. Based on the updated total expected return, I’m upgrading Meridian Corporation to a buy rating.
