Thursday, September 29 2022

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After a phenomenal year, earnings at Hanmi Financial Corporation (NASDAQ: HAFC) will likely fall this year due to an increase in net provision charges. On the other hand, economic factors will likely increase the loan portfolio, which in turn will support the bottom line. Additionally, the presence of liquid assets on Hanmi’s books and a favorable deposit mix will increase the margin in a rising interest rate environment. Overall, I expect Hanmi Financial to report earnings of $2.63 per share in 2022, down 18% year-over-year. Despite the drop, incomes will likely remain much higher than the pre-pandemic level. The year-end target price suggests a significant upside from the current market price. Therefore, I adopt a buy rating on Hanmi Financial.

Broad-based economic growth to support loan portfolio expansion

Hanmi Financial Corporation’s loan portfolio has grown by mid-single digit percentages in most previous years. The company can easily achieve similar loan growth this year due to the economic recovery. Hanmi Financial’s operations are large and geographically diverse, spanning multi-ethnic markets from California to New York. Therefore, national economic parameters are a good indicator of future loan demand. The GDP growth rate was quite robust in the last quarter, while the unemployment rate was close to the pre-pandemic level in January. The nationwide economic recovery will likely boost loan growth this year.

Additionally, Hanmi Financial has made significant investments in talent and technology, including its digital platform. These investments should contribute to loan growth in the coming quarters. Additionally, there are only a small number of Paycheck Protection Program (“PPP”) loans left to cancel. According to the details given in the earnings release, outstanding PPP loans stood at $3.0 million at the end of December 2021, representing only 0.1% of total loans. Therefore, their forgiveness this year will barely move the needle.

Given these factors, I expect the loan portfolio to grow by 6% by the end of December 2022 compared to the end of 2021. During this time, deposits will likely increase at the same rate as loans. The following table shows my balance sheet estimates.

EX17 EX18 FY19 FY20 FY21 FY22E
Financial situation
Net loans 4,273 4,569 4,549 4,790 5,079 5,391
Net loan growth 12.1% 6.9% (0.4)% 5.3% 6.0% 6.1%
Other productive assets 602 601 657 762 924 981
Deposits 4,349 4,747 4,699 5,275 5,786 6,141
Loans and sub-debts 267 173 208 269 353 374
Common equity 562 553 563 577 643 697
Book value per share ($) 17.4 17.2 18.3 19.1 21.1 22.9
Tangible BVPS ($) 17.1 16.9 17.9 18.7 20.7 22.5
Source: SEC filings, author’s estimates ($ millions, unless otherwise noted)

Balance sheet positioning to increase margin

As deposit growth outpaced loan growth last year, Hanmi Financial found itself with a substantial cash position on its books. The company deployed some excess cash and cash equivalents in the fourth quarter of 2021, but the cash balance was still quite excessive at the end of the year. It is better to have liquid assets on the books rather than assets locked in at fixed rates before an interest rate hike. Hanmi Financial can shift that excess cash into higher-yielding securities and loans once the Federal Reserve raises the federal funds rate target. However, since most financial institutions are sitting on excess liquidity, the impact of a rate hike could be delayed. There will be increased competition in the market to deploy excess liquidity, which could create price pressure.

Another factor that will help margin in a rising interest rate environment is a large amount of non-interest bearing deposits. Hanmi Financial has successfully increased its non-interest bearing deposits to 44.5% of total deposits by the end of 2021 from 36.0% at the end of 2020. The high proportion of non-interest bearing deposits will maintain the average cost of deposits stable when interest rates rise. .

However, the loan portfolio is not as well positioned as the composition of deposits. Approximately 72% of the loan portfolio consists of commercial real estate loans, which are generally based on fixed rates. Therefore, the revaluation of the portfolio is likely to be long and slow. Management’s interest rate sensitivity analysis presented in the third quarter 10-Q filing also shows a similar result. According to this analysis, a 100 basis point increase in interest rates can increase net interest income by 6.54% in the first year and 9.68% in the second year of the rate increase.

Given these factors, I expect the margin to remain virtually unchanged in the first half of 2022, compared to 2.96% in the last quarter of 2021. For the second half, I expect the margin to increase by eight basis points. .

Provision expenses to keep them below normal

Hanmi Financial canceled much of its previous provisioning last year. New reversals of provisions cannot be ruled out because the reserves for credit losses appear to be excessive in relation to the credit risk of the portfolio. Provisions represented 1.41% of total loans, while non-performing loans represented only 0.26% of total loans at the end of December 2021, as mentioned in the earnings press release. Management also mentioned on the conference call that it expects additional recoveries, but expects future recoveries to be less in magnitude.

Given these factors, I expect the provision charge, net of reversals, in 2022 to be higher compared to 2021, but lower than the pre-pandemic average. I expect the provisioning charge to be around 0.18% of total loans in 2022, compared to an average of 0.25% of total loans from 2017 to 2019.

Expect income to remain above pre-pandemic level

The higher net provision charge will likely weigh on earnings year over year. Nonetheless, earnings for 2022 are likely to be much higher than the pre-pandemic level due to strong top line growth. The economic recovery will likely boost loan growth, which in turn will boost revenue this year. In addition, the rigidity of the cost of deposits and a large balance of liquid assets will benefit turnover in a rising interest rate environment. Overall, I expect the company to report earnings of $2.63 per share in 2022, down 18% year over year. The following table shows my income statement estimates.

EX17 EX18 FY19 FY20 FY21 FY22E
income statement
Net interest income 177 181 176 181 195 211
Allowance for loan losses 1 4 30 45 (24) ten
Non-interest income 33 25 28 43 40 41
Non-interest charges 114 118 126 119 124 133
Net income – Common Sh. 55 58 33 42 98 80
BPA – Diluted ($) 1.69 1.81 1.06 1.39 3.22 2.63
Source: SEC filings, author’s estimates ($ millions, unless otherwise noted)

Actual earnings may differ materially from estimates due to the risks and uncertainties associated with the COVID-19 pandemic and the timing of an interest rate hike.

An attractive expected total return calls for a buy rating

Hanmi Financial cut its quarterly dividend from $0.24 per share to $0.08 per share in 2020. Since then, the company has gradually increased the quarterly dividend to $0.22 per share. Current dividend levels and earnings estimates suggest a payout ratio of 34% for 2022, which is below the five-year average of 49%. Due to the below-average implied payout ratio, it is possible that Hanmi Financial will revert to a dividend of $0.24 per share this year. However, to be on the safe side, I assume no change in the level of the dividend for 2022. The quarterly dividend of $0.22 per share implies a dividend yield of 3.3%, using the closing price of 18 February.

I use historical price/book tangible (“P/TB”) and price/earnings (“P/E”) multiples to value Hanmi Financial. The stock has traded at an average P/TB ratio of 1.21 in the past, as shown below.

EX17 EX18 FY19 FY20 FY21 Average
T. Book value per share ($) 17.1 16.9 17.9 18.7 20.7
Average market price ($) 30.1 27.1 20.7 11.2 19.4
Historical P/TB 1.76x 1.61x 1.16x 0.60x 0.94x 1.21x
Source: Company Financials, Yahoo Finance, Author’s Estimates

Multiplying the average P/TB multiple by the expected tangible book value per share of $22.5 yields a target price of $27.3 for the end of 2022. This price target implies an upside of 1.8% compared to the closing price on February 18. The following table shows the sensitivity of the target price to the P/TB ratio.

Multiple P/TB 1.01x 1.11x 1.21x 1.31x 1.41x
TBVPS – Dec 2022 ($) 22.5 22.5 22.5 22.5 22.5
Target price 22.8 25.0 27.3 29.5 31.8
Market price 26.8 26.8 26.8 26.8 26.8
Up/(down) (15.0)% (6.6)% 1.8% 10.2% 18.6%
Source: Author’s estimates

The stock has traded at an average P/E ratio of around 13.3x in the past, as shown below.

EX17 EX18 FY19 FY20 FY21 Average
Earnings per share ($) 1.69 1.81 1.06 1.39 3.22
Average market price ($) 30.1 27.1 20.7 11.2 19.4
Historical PER 17.7x 15.0x 19.5x 8.1x 6.0x 13.3x
Source: Company Financials, Yahoo Finance, Author’s Estimates

Multiplying the average P/E multiple by the expected earnings per share of $2.63 yields a price target of $34.9 for the end of 2022. This price target implies a 30.2% upside from at the closing price on February 18. The following table shows the sensitivity of the target price to the P/E ratio.

Multiple P/E 11.3x 12.3x 13.3x 14.3x 15.3x
EPS 2022 ($) 2.63 2.63 2.63 2.63 2.63
Target price ($) 29.7 32.3 34.9 37.5 40.2
Market price ($) 26.8 26.8 26.8 26.8 26.8
Up/(down) 10.6% 20.4% 30.2% 40.1% 49.9%
Source: Author’s estimates

Equal weighting of target prices from both valuation methods gives a combined result target price of $31.1, implying a 16.0% upside from the current market price. Adding the forward dividend yield gives an expected total return of 19.3%. Therefore, I adopt a buy rating on Hanmi Financial.

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