NBT Bancorp (NASDAQ:NBTB) reported earnings of $0.23 per share in the first quarter, down 64% from the last quarter of 2019. The earnings decline was mostly attributable to a surge in provision expense amid the COVID-19 pandemic. NBTB’s high exposure to consumer auto loans will likely drive provision expense in the year ahead because of the hike in unemployment. Moreover, a modest reduction in the net interest margin will pressurize earnings. On the other hand, the Paycheck Protection Program and the acquisition of Alliance Benefit Group will limit the earnings decline. Overall, I’m expecting earnings to decline by 28% year over year in 2020 to $1.99 per share. There is a chance of a negative earnings surprise in the remainder of the year because of the uncertain economic environment. The year-end target price suggests a high upside from the current market price; nevertheless, I’m adopting a neutral rating on NBTB due to the risks and uncertainties.
Consumer Auto Loans Pose Credit Risk
NBTB’s provision expense surged to $29.6 million in the first quarter from $6 million in the last quarter of 2019. As mentioned in the 10-Q filing, the model that the management used to determine loan loss provisioning incorporated a negative GDP environment in the second quarter. Additionally, the model incorporated a rebound in GDP in the second half of the year. The recent surge in COVID-19 cases has increased the likelihood of another dip in economic activity in the near future. Therefore, I believe that the assumption of an economic rebound in the second half of the year is too optimistic. As a result, I’m expecting NBTB to increase its provisioning in the second quarter.
NBTB has high exposure to consumer auto loans, which will likely face some issues in the coming quarters due to the heightened unemployment. As mentioned in the first quarter’s 10-Q filing, consumer auto loans made up 16% of total loans as of March 31, 2020. Further, NBTB accepted payment deferral requests on 11.6% of total loans up till the mid of April, as mentioned in the first quarter’s earnings release. The high proportion of payment deferrals early in the pandemic shows the debt servicing problems within the total loan portfolio. Considering these factors, I’m expecting NBTB to book provision expense of $57.6 million in 2020, up from $25.4 million in 2019.
Margin to Decline Due to Interest Rate Cuts, New Subordinated Debt
The 150bps federal funds rate cuts in March will likely have a modest impact on the net interest margin, NIM. Due to the nature of the loan portfolio, the interest rate change will only have a limited impact on NIM. Further, the management’s simulation model shows that NIM is not very sensitive to interest rate changes. The results of the simulation show that as of March 31, 2020, a 100bps interest rate cut could reduce net interest income by just 0.54% over 12 months. The following table from the 10-Q filing shows the results of the simulation.
NBTB has recently priced a new subordinated debt issue of $100 million at 5.0%, according to a press release. The new issue will increase the average funding cost because the rate of the issue is much higher than the average cost. However, the issue will make up just 1.1% of total funds; therefore, it will have an estimated impact of only around 5bps on the average funding cost. Considering these factors, I’m expecting NIM to decline by 8bps in the second quarter. Further, I’m expecting the average NIM for 2020 to be 16bps below the average for 2019. The following table shows my estimates for yield, cost, and NIM.
NBTB’s participation in the Paycheck Protection Program, PPP, will partially offset the impact of NIM decline on net interest income. As mentioned in the earnings release, NBTB funded $385 million worth of loans in PPP’s first round and intended to participate in the second round. Consequently, I’m expecting loans to increase by 6% in the second quarter from the end of the first quarter. PPP loans will likely get forgiven in a few months; hence, I’m expecting NBTB’s loans to decline in the third quarter, at which time the company will also book unamortized fees. I’m expecting the year-end loans to stand at $7.2 billion, up 2.4% from the end of 2019. The following table shows my estimates for balance sheet items.
Expecting EPS of $1.99 in 2020
The elevated provision expense and a modest decline in NIM will likely pressurize earnings this year. On the other hand, participation in PPP will offer some support to the bottom line. Additionally, the acquisition of Alliance Benefit Group in April will boost non-interest income in the year ahead. As mentioned in the earnings release, Alliance provides retirement plans to over 40,000 plan participants and has accumulated assets of $3.5 billion. The acquisition will also increase non-interest expenses because 70 team members from Alliance will join NBTB. Overall, I’m expecting earnings to decrease by 28% year over year to $1.99 in 2020. The following table shows my income statement estimates.
The probability of actual earnings differing from estimates is unusually high this year because of the uncertainties surrounding the COVID-19 pandemic. If the pandemic lasts longer than expected, then the provision expense can surpass its estimate. NBTB’s high exposure to consumer auto loans has increased the overall riskiness. In my opinion, the risks will overshadow the attractive valuation in the next few months.
High Price Upside Versus High Level of Risk
I’m valuing NBTB using its historical average price-to-tangible-book ratio, P/TB, of 2.05. The following table shows historical P/TB ratios.
Multiplying the P/TB multiple with the forecast tangible book value per share of $19.7 gives a target price of $40.3 for December 2020. The price target suggests an upside of 40% from the June 26 closing price. The table below displays the sensitivity of the target price to the P/TB ratio.
Apart from the price upside, NBTB also offers a dividend yield of 3.8%. The dividend yield estimate is based on the expectation that NBTB will maintain its quarterly dividend at the current level of $0.27 per share, leading to a payout ratio of 68%.
As discussed above, NBTB currently carries a high level of risk due to the uncertain economic environment amid the COVID-19 pandemic. The risks will likely overshadow the attractive valuation, thus, keeping the stock price subdued. Consequently, I’m adopting a neutral rating on NBTB.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Disclaimer: This article is not financial advice. Investors are expected to consider their investment objectives and constraints before investing in the stock(s) mentioned in the article.