Must-know: Analyzing First Internet Bancorp’s valuation and risks
Equity research: Is First Internet Bancorp a good investment? (Part 6 of 6)
Mis-pricing and valuation
Rising interest rates in the second half of 2013 significantly cut the volume of home re-fi’s and consequently INBK’s non-interest income. Falling earnings in the short term put pressure on the stock and created the current opportunity to buy INBK at only a small premium to tangible book value (TBV = $19.38 versus current price of $23.00). We expect the stock to appreciate as management executes on its expansion plan. Regarding their future growth, management commented in their 10K:
“We believe that we are well positioned to continue to take advantage of the consumer-driven shift from branch banking to direct banking. We believe Internet banking is now the preferred banking channel by consumers. According to a 2011 Banker’s Association survey, the number of bank customers who prefer to do their banking online increased from 21% to 62% between 2007 and 2011, while those who prefer branch banking declined from 39% to 20% over the same period.”
When evaluating INBK from a book value perspective, investors need to consider the quality of the company’s loan book. Most of INBK’s mortgage loans are sold into the secondary market. In 2012, it was 97% of them. INBK primarily retains only those loans with adjustable rates and higher credit quality. This limits long-term exposure from interest rate risk and gives us a greater confidence in their loan portfolio. Moreover, INBK has a good track-record of properly reserving for credit losses.
In 2012, the weighted average credit score of their mortgage customers was 775 at time of origination. The company’s volume of loans and assets continues to increase, but due to the precautions taken by the management team, the percentage of non-performing assets and loans has actually decreased. The precautionary steps taken by management combined with the reported financial growth signal great potential growth overall.
As previously mentioned, Mr. Becker believes INBK will be able to reach $1 billion in assets by 2015. We did some calculations to measure the impact of this. Here is what we gathered:
We used BOFI’s 2008 number for the 2015 efficiency ratio because this is the year that BOFI broke through the $1 billion in assets barrier. This number seems achievable in light of INBK’s own history too, as its five-year average efficiency ratio is 59.38% Also, instead of using INBK’s 2012 non-interest income number, we used its 2011 number to approximate an environment that wasn’t so heavily weighted towards re-financings (like 2012) which are unlikely to recur in a rising interest rate environment. In order to make these promising numbers come to life, INBK will have to achieve a compound annual loan growth rate of about 12% between 2013 and 2015. We believe this is realistic, especially considering the way the management team discussed the possibility of an acquisition similar to that of Landmark in 2007.
Risks
As an Internet bank, INBK puts a significant amount of reliance in the company’s communication and information systems. Any disruption in these systems can create security risks and poor customer service. Poor customer service can also escalate a possible reputational risk, which could lead to poor customer retention and minimized expansion.
Part of the bank’s strategy is potential M&A activity. We are encouraged by past successes, but M&A activity always carries with it the potential for value destruction. Investors should watch this carefully.
On the managerial side, Mr. Becker’s growing number of commitments could interfere and become a risk. In our conversation with him, he assured us that INBK was his number one priority, but we know that there is always a possibility of him being distracted by a new entrepreneurial venture. First Internet Bancorp has a number of business risks that could affect investors. As a bank, the company is subject to a significant amount of government regulation, which places restrictions on the operations of the company. However, we trust that the management team of the company will work around these restrictions to continue to operate efficiently.
Of course, there are several other business risks and risks related to the company. For a detailed, five-page analysis of potential risks, we encourage you to consult the First Internet Bancorp 10K.
The Market Realist Take
In 2013, revenue from mortgage banking declined 19% from 2012, as refinancing slowed in the third and fourth quarters and impacted non-interest income for the year. Non-interest expenses increased as the company invested in proven talent, premises, and marketing expenses to support growth.
In terms of significant risks, INBK’s commercial loan portfolio exposes it to higher credit risks than residential real estate and consumer loans, including risks relating to success of the underlying business and conditions in the market or the economy and concentration in its commercial loan portfolio.
Moreover, INBK’s business highly depends on technology. The financial services industry continually sees a rapid technological change, and INBK faces constant evolution of customer demand for technology-driven financial and banking products and services. Many of INBK’s competitors have substantially greater resources to invest in technological improvement and product development, marketing, and implementation. Any failure to successfully keep pace with and fund technological innovation in the markets in which the company competes could have a material adverse effect on its business, financial condition, and results of operations.
INBK competes with commercial banks, savings institutions, mortgage brokerage firms, credit unions, finance companies, mutual funds, insurance companies, and brokerage and investment banking firms operating locally. Some of its competitors have greater name recognition, and market presence offers certain extra services. Plus, larger competitors may be able to price loans and deposits more aggressively than INBK, which could affect its ability to increase market share and remain profitable on a long-term basis. Moreover, the residential mortgage business is highly competitive, and among other factors is highly susceptible to changes in market interest rates, consumer confidence levels, employment statistics, and the capacity and willingness of secondary market purchasers to acquire and hold or securitize loans.
To learn more about investing in the banking industry, see Einhorn’s Greenlight Capital increases its position in ING U.S.
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