Markets

First Internet Bancorp: An Undervalued Growing Small-Cap Bank

By Randall Herion :

Introduction

First Internet Bank ( INBK ) is a fast-growing Indiana-based true internet bank with no brick-and-mortar branches, and commercial loan production offices in Tempe, AZ, and Indianapolis, IN. They offer deposits, loans and mortgages nationwide and have deposit and loan customers in all 50 states. They have a rapidly expanding, and diverse, loan portfolio and a solid mortgage banking division. The attraction of this investment to me is that the risk of permanent loss of capital is negligible, and with conservative estimates of growth and no multiple expansion, INBK should gain 30% in the next six months, 60-85% over the next 18 months, and 250-430% over the next five years (the high end of the five-year estimate does allow for multiple expansion). In the analysis, I have kept my estimates on the conservative end; however, if management can meet their near-term forward growth guidance of 25-30%, and continue it, which is substantially above my estimates, the results would be even more phenomenal. The precedent would beBofI Holding, Inc. ( BOFI ), a very similar business model, which has grown for 10+ years at the rates INBK management has achieved and is forecasting.

When I began following the company in 2010, the stock traded OTC (as FIBP). In February 2013, it was listed on the NASDAQ as INBK. INBK is followed poorly, both in quantity and quality, by analysts. INBK has only two analysts following the stock and, over the last 4 quarters, INBK has beat their earnings estimates by an average of 33%, i.e., analysts' TTM EPS estimates totaled $1.18 and the actual TTM EPS was $1.56. The analysts' forward-looking estimates until recently were ridiculously low, and are still low even after recent revisions.

Business Developments and Recent Financial Results

A number of factors have converged to create a positive situation for INBK. First, INBK raised capital at approximately book value in Q4 2013 (more on this later), and put this capital to use to grow organically and are just now receiving the fruits of that (read easy comps at the present). Second, through the course of 2014, the bank built a commercial lending team that has and is fueling rapid loan growth in this area. Third, INBK is not covered well by analysts (only two) and they underestimate the earnings power currently and going forward.

EPS Results Q1'14 Q2'14 Q3'14 Q4'14 Q1'15 Q2'15 Q3'15
Actual $0.13 $0.22 $0.28 $0.33 $0.46 $0.50 $0.51
Anal Est N/A N/A $0.19 $0.27 $0.32 $0.40 $0.46
Forward EPS Q4'15 FY15 FY16
My Estimate $0.59 $2.07 $2.50-2.90
Analyst Est $0.19 $1.97* $2.28**

*Raised estimates two times in the last four months for FY15 from $1.68 to $1.97.

**Raised estimates three months ago for FY16 from $2.00 to $2.28.

The CEO, at the 2014 annual meeting and again at the 2015 annual meeting, said they are expecting YoY asset growth in the 25-30% range through 2015 and 2016. Given their past growth, size, online business model, national customer base, and increasing customer preference for online banking services, this growth forecast is realistic and could accelerate with the market valuation now 1.5 times book value, i.e. future capital raises would be accretive to book value. See table below.

2010 2011 2012 2013 2014 2015*
Assets (thousands) $503,915 $585,440 $636,367 $802,342 $970,503 $1,208,000
Assets YOY Growth 16% 9% 26% 21% 24%
Net Interest Inc (thousands) $14,511 $14,323 $15,842 $17,448 $22,287 $30,535
Net Interest Inc YOY Growth -1% 11% 10% 28% 37%
Prov for Loan Loss (thousands) $927 $2,440 $2,852 $324 $349 $1,700
Mortgage Inc (thousands) $3,098 $3,690 $10,647 $8,682 $5,609 $9,405
Mortgage Inc YOY Growth 19% 189% -18% -35% 68%
Net Income (thousands) $4,955 $3,186 $5,606 $4,593 $4,324 $9,318
Net Income YOY Growth -36% 76% -18% -6% 115%

* 2015 are estimates for the total year based on actual first nine months, and estimated fourth quarter. Mortgage income for the first nine months was $7,195,000.

** Net Interest Income is before provision for loan loss.

The volatility in the net income is a result of the refinance boom that happened in 2012 and 2013 that contributed mightily to the bottom line, and loan loss provision variance. We expect both of these to become less volatile as the financial crisis becomes further removed and we move to more normal circumstances.

The mortgage department has continued to grow in relation to the combined purchase and refinance mortgage banking index. Albeit that they are a very small player in the mortgage market, they are gaining market share as a result of an award winning national origination platform and excellent customer service. In December 2013, they received the title of Online Mortgage Originator of the Year in the 2013 Mortgage Technology Awards. The award recognizes a lender's use of web-based technologies to generate borrower leads and convert them into closed loans. They converted 71% of the mortgage applications its borrowers started online into completed application submissions.

With the commercial lending team hitting its stride, and given the mortgage team growth, if the housing market would come back it would be a bonanza for the bank. The EPS of $0.50 in Q2 2015 has $660,000 less mortgage income than is in the EPS of $0.46 in Q1 2015, i.e. if mortgage income would have been equal Q2 2015 EPS would have been $0.60. The lack of reliance on the mortgage income for earnings, less in their control, and increasing reliance on loan income for earnings, more in their control, is a huge development for the bank. As net interest income continues to become the more dominant income producer, and mortgage income becomes less significant to the income statement, the earnings growth and results should be smoother and less lumpy than the past results. As said above, the 2012 and 2013 results were a result of the massive refinancing wave, and believe 2014 and 2015 to be a return to the normal albeit subdued mortgage environment. The FY16 estimates I put out also assume mortgage banking lending remains subdued. An increase in the housing/mortgage environment would be icing on the cake.

Management and Capital Issues

The bank has a deep and conservative management and an experienced board of directors from banking, investment banking and other industries. Both management and the board have several members that have been with INBK from the beginning in 1999. They have grown it almost entirely organically to over a $1 billion, a threshold they passed in 2015. The only nonorganic growth was the purchase of a retail mortgage lending operation, Landmark Financial, in 2007. They did not take TARP and only lost money in one year, $2.1 million in 2009. I traveled to their annual meeting in May of 2013 and met the CEO, CFO and several board members and came to better understand the depth of management and the business. What I saw was a no-frills, business-minded organization. Obviously management is strong, growing the business in 15 years from nothing to $1 billion, in a profitable manner, and navigating through the crisis of 2008 and 2009 with minimal effect.

In Q4 of 2013, management raised approximately $30 million through an oversubscribed offering of approximately 1.5 million shares at $20/share, tangible book value per share was a little over $21. The bank although still "well" capitalized was approaching the 8% TCE/TA ratio that smaller banks prefer to stay above. The offering was slightly non-accretive, however in order to grow further management needed capital and used it to grow organically. It is obvious now it was an good decision by management, but at the time as a then-interested participant we were uncertain as to the intent of management on the use of the raised funds (i.e. were they using the funds to grow organically OR were they issuing shares at slightly below book to make acquisitions at above book), however we believe this is the primary reason the INBK is undervalued today. We believe the market agreed with our uncertainty and didn't like the offering of shares at below book prices by the action of the stock from the second half of 2013 on. Management had to take one step back to take two steps forward. INBK has now absorbed and utilized the raised capital and it is contributing to the earnings and efficiency of the bank. Efficiency has dropped from 74.89% for 2013 to 63.01% for the first half of 2015, and that trend will continue downward.

With the rapid growth of the bank, there will be offerings in the future to fund growth, however they are now trading at 1.5 P/TB so any further share offerings will be accretive to book value and viewed with less skepticism by the market. With INBK now trading above book value, provided this remains, the capital issues to fund further growth are removed and management should be motivated to grow, organically and by acquisition if the right situation arose.

Asset Quality

Their asset quality is simply exceptional. NPLs/Total Assets have come down from 1.23% and have remained under 0.10% since 2014. Loan-loss reserves to total loans is 0.88%, and loan loss reserves to NPLs is 3,724%. The loan portfolio is geographically diverse and loan composition is 55% commercial, 32% residential real estate, and 13% consumer. The commercial loans have grown from 28% of the portfolio at year end 2012 to 55%.

This bank, because of its all-online-banking model, attracts more creditworthy customers with higher incomes, which would cause the consumer and residential real estates to be of better asset quality. The commercial real estate loans have an average LTV of 56%, these loans make up 75% of the commercial loans.

Business Model Advantages

Not only is the all internet and no branches bank a low-cost model, it is in line with the trend of consumer preferences, and attracts a wealthier, younger and more creditworthy customer. The low-cost model, enables the bank to offer lower fees on transactional deposit accounts, attract deposits with better rates, and to be more competitive on loan rates.

People's banking preferences are switching to online and mobile, according to INBK's Q2 Investor Presentation. An ABA survey showed customer bank usage by channel is 27-40 times a month for mobile and online, and 6-12 times per year by phone or branch visit. The Q2 presentation also showed penetration of online/mobile banking increased sequentially and substantially the more people earn. In a research report by Accenture in 2014, 27% of all Americans would consider switching to a branchless bank, 39% of 18-34 year olds, and 29% of 35-55 year olds. Attracting this younger and wealthier demographic ensures long-term relationships with good customers, and the banking relationship follows if they relocate, instead of the customer having to change to a national chain, or local bank with branches where they are. When traditional banks with branches try to lower their cost structure by closing branches they suffer from the perception they are cutting services leading to disgruntled customers, another advantage to the all internet model.

Financial Statements (Last 3 years and pro formas going forward)

Below are the actual financials from 2012 through 2014, and pro forma statements for 2015 through 2020. For 2015 I made assumptions based on where I thought the year would end, assumptions on the pro forma's 2016 and beyond were, yield on loans 10 bps above expected 2015 and deposit expense 14 bps above expected 2015, asset growth of 16% and loan growth of 21% annually, mortgage income growth of 7% annually, and salaries and benefit rise of 20% annually. The pro forma growth projections are well below the 2012 - 2015 rates, asset growth averaged 24.9% and loan growth averaged 36.6%.

Income Statement
Pro Forma Pro Forma Pro Forma Pro Forma Pro Forma Pro Forma
Operating Data: 12/2012 12/2013 12/2014 12/2015 12/2016 12/2017 12/2018 12/2019 12/2020
Securities inc $4,814 $4,693 $3,094 $4,036 $4,000 $4,000 $4,000 $4,000 $4,000
Loan inc $19,560 $20,843 $27,875 $36,659 $46,096 $56,141 $68,238 $82,762 $99,194
Other Int Inc $0 $0 $246 $358 $160 $160 $160 $160 $160
Total Int Inc $24,374 $25,536 $31,215 $41,053 $50,256 $60,301 $72,398 $86,922 $103,354
Deposit interest expense $7,172 $6,861 $7,653 $8,750 $12,023 $14,428 $17,313 $20,776 $24,671
Other interest expense $1,360 $1,227 $1,275 $1,768 $1,902 $2,200 $2,700 $3,200 $3,700
Total interest expense $8,532 $8,088 $8,928 $10,518 $13,925 $16,628 $20,013 $23,976 $28,371
Net interest income $15,842 $17,448 $22,287 $30,535 $36,331 $43,673 $52,384 $62,947 $74,983
Provision for loan losses $2,852 $324 $349 $1,700 $2,300 $2,800 $3,400 $4,100 $4,900
Net int Inc after prov $12,990 $17,124 $21,938 $28,835 $34,031 $40,873 $48,984 $58,847 $70,083
Service charges and fees $685 $687 $707 $771 $707 $1,000 $1,000 $1,000 $1,000
Gain on loans sold $10,647 $8,682 $5,609 $9,405 $10,000 $10,700 $11,449 $12,250 $13,108
Other -than-temporary loss ($252) ($49) $538 $0 $0 $0 $0 $0 $0
Loss on asset disposals ($45) ($209) ($78) ($104) ($47) $0 $0 $0 $0
Other non-interest income $388 $406 $398 $409 $408 $0 $0 $0 $0
Noninterest income $11,423 $9,517 $7,174 $10,481 $11,068 $11,700 $12,449 $13,250 $14,108
Salaries and employee ben $8,529 $10,458 $12,348 $14,261 $15,500 $18,600 $22,320 $26,784 $32,141
Marketing and advertising $1,362 $1,870 $1,455 $1,880 $1,700 $2,000 $2,000 $2,000 $2,000
Consulting and professional $1,422 $2,267 $1,902 $2,250 $2,450 $2,600 $2,800 $3,000 $3,200
Data processing $897 $916 $995 $979 $1,011 $1,150 $1,150 $1,150 $1,150
Loan expenses $1,097 $800 $626 $750 $750 $1,000 $1,000 $1,000 $1,000
Premises and equipment $1,711 $1,923 $2,937 $2,684 $2,937 $3,200 $3,200 $3,200 $3,200
Deposit insurance premiums $455 $451 $591 $638 $750 $850 $950 $1,050 $1,150
Other non-interest expense $1,140 $1,797 $1,808 $1,770 $1,808 $2,000 $2,000 $2,000 $2,000
Noninterest expense $16,613 $20,482 $22,662 $25,021 $26,906 $31,400 $35,420 $40,184 $45,841
Income before taxes $7,800 $6,159 $6,450 $14,295 $18,193 $21,173 $26,013 $31,913 $38,350
Tax provision $2,194 $1,566 $2,126 $4,977 $6,368 $7,411 $9,105 $11,170 $13,423
Net income $5,606 $4,593 $4,324 $9,318 $11,826 $13,763 $16,909 $20,743 $24,928
Shares outstanding 2,869,365 3,050,001 4,507,995 4,507,995 4,507,995 4,507,995 4,507,995 4,507,995 4,507,995
EPS $1.95 $1.51 $0.96 $2.07 $2.62 $3.05 $3.75 $4.60 $5.53
Tax Rate 28.13% 25.43% 32.96% 34.82% 35.00% 35.00% 35.00% 35.00% 35.00%
Loan Income/Loans 5.5% 4.2% 3.8% 4.0% 4.3% 4.3% 4.3% 4.3% 4.3%
Deposit Expense/Deposits 1.39% 1.05% 1.04% 0.95% 1.10% 1.10% 1.10% 1.10% 1.10%
Balance Sheet
Pro Forma Pro Forma Pro Forma Pro Forma Pro Forma Pro Forma
12/2012 12/2013 12/2014 12/2015 12/2016 12/2017 12/2018 12/2019 12/2020
Cash and due from banks $2,881 $2,578 $1,940 $1,500 $2,000 $3,000 $3,000 $3,000 $3,000
Interest bearing deposits 29,632 51,112 26,349 20,000 30,000 30,000 30,000 30,000 30,000
Interest bearing time deposits 0 2,500 2,000 1,000 1,000 1,000 1,000 1,000 1,000
Securities AFS 156,693 181,409 137,518 200,000 250,000 250,000 250,000 250,000 250,000
Loans held for sale 63,234 28,610 34,671 25,000 25,000 25,000 25,000 25,000 25,000
Loans 354,490 501,153 732,426 922,000 1,072,000 1,305,600 1,586,920 1,924,704 2,306,845
Net deferred (fees)/expenses 3,671 0 0 0 0 0 0 0 0
Less allowance for loan losses -5,833 -5,426 -5,800 -8,000 -8,000 -10,000 -12,000 -14,000 -17,000
Accrued interest receivable 2,196 2,904 2,833 3,000 3,000 3,000 3,000 3,000 3,000
FHLB stock 2,943 2,943 5,350 5,000 6,000 6,000 6,000 6,000 6,000
Bank-owned life insurance 11,539 11,935 12,325 13,000 13,000 13,000 13,000 13,000 13,000
Goodwill 4,687 4,687 4,687 5,000 5,000 5,000 5,000 5,000 5,000
Other real estate owned 3,666 4,381 4,488 4,000 4,000 4,000 4,000 4,000 4,000
Premises and equipment 7,134 7,061 7,000 9,000 9,000 9,000 9,000 9,000
Other assets 6,568 6,422 4,655 5,000 6,000 6,000 6,000 6,000 6,000
Total assets $636,367 $802,342 $970,503 $1,208,000 $1,418,000 $1,650,600 $1,929,920 $2,265,704 $2,644,845
Non-interest bearing demand deposits $13,187 $19,386 $21,790 $23,000 $23,000 $23,000 $23,000 $23,000 $23,000
Interest bearing deposits 517,504 653,709 736,808 920,000 1,093,000 1,311,600 1,573,920 1,888,704 2,242,845
FHLB advances 40,686 31,793 106,897 150,000 175,000 175,000 175,000 175,000 175,000
Subordinated debt 0 2,789 2,873 3,000 3,000 3,000 3,000 3,000 3,000
Accrued interest payable 120 102 97 0 0 0 0 0 0
Accrued payroll and related expenses 948 3,655 5,253 3,000 5,000 5,000 5,000 5,000 5,000
Other liabilities 2,572 0 0 0 0 0 0 0 0
Total liabilities 575,017 711,434 873,718 1,097,500 1,299,000 1,517,600 1,779,920 2,094,704 2,448,845
Common Stock 41,508 71,378 71,774 73,000 73,000 73,000 73,000 73,000 73,000
Accumulated earnings 18,024 21,902 25,146 33,000 46,000 60,000 77,000 98,000 123,000
Accumulated OCI 1,818 -2,372 -135 0 0 0 0 0 0
Total equity $61,350 $90,908 $96,785 $106,000 $119,000 $133,000 $150,000 $171,000 $196,000
Total liabilities and equity $636,367 $802,342 $970,503 $1,203,500 $1,418,000 $1,650,600 $1,929,920 $2,265,704 $2,644,845
Equity to assets ratio 9.64% 11.33% 9.97% 8.81% 8.39% 8.06% 7.77% 7.55% 7.41%
Tang. Book value per common share $19.80 $24.52 $20.74 $22.52 $25.42 $28.39 $32.17 $36.82 $42.37
Common shares outstanding 2,862,485 3,516,462 4,439,575 4,484,513 4,484,513 4,508,000 4,508,000 4,508,000 4,508,000
Pro Forma Pro Forma Pro Forma Pro Forma Pro Forma Pro Forma
12/2012 12/2013 12/2014 12/2015 12/2016 12/2017 12/2018 12/2019 12/2020
ROA 0.88% 0.57% 0.45% 0.77% 0.83% 0.83% 0.88% 0.92% 0.94%
ROE 9.14% 5.05% 4.47% 8.79% 9.94% 10.35% 11.27% 12.13% 12.72%
Loans/Deposits 68% 77% 99% 100% 98% 100% 101% 102% 103%
Asset Growth 26.08% 20.96% 24.01% 17.82% 16.40% 16.92% 17.40% 16.73%
Loan Growth 41.37% 46.15% 25.88% 16.27% 21.79% 21.55% 21.29% 19.85%
Net Income Growth -18.07% -5.86% 115.49% 26.91% 16.38% 22.86% 22.68% 20.17%
Efficiency Ratio 68% 80% 73% 61% 54% 52% 49% 46% 44%
Valuation at P/E Ratios
20 39.07 30.12 19.18 41.34 52.47 61.06 75.02 92.03 110.59
25 48.84 37.65 23.98 51.67 65.58 76.32 93.77 115.04 138.24
30 58.61 45.18 28.78 62.01 78.70 91.59 112.52 138.04 165.89
P/B Ratios
At 20 P/E 1.97 1.23 0.92 1.84 2.06 2.15 2.33 2.50 2.61
At 25 P/E 2.47 1.54 1.16 2.29 2.58 2.69 2.92 3.12 3.26
At 30 P/E 2.96 1.84 1.39 2.75 3.10 3.23 3.50 3.75 3.92

Valuation

BOFI is the closest comparison to INBK's business model. Once BOFI's share price got above 1.5 P/B in 2010, they began to grow in the 30-40% range. BOFI's profitability measures are better, but INBK is just starting the cycle where growth isn't constrained by capital, since future offerings are accretive to book and growth becomes a virtuous cycle, instead of 'one step back and two steps forward' kind of growth or just growing as earnings will allow. BOFI has traded at a P/E of 20 to 30, and a P/B of 2.5-4.5 over the last two years, until the recent allegations of improper accounting.

Given where INBK is in the cycle, I assessed a P/E multiple of 20, or where they are currently trading and with the improving outlook believe the P/E given by the market would expand if anything. With the FY15 EPS estimate of $2.07, this yields a price of $41.40 or approximately a 35% premium to the current price of $30. The FY16 EPS estimate of $2.50 - $2.90, yields a price range of $50 - $58, or approximately 60 - 85% above the current price. In the five year outlook, EPS are estimated to be $5.53, with a 20 P/E the price would be $110.59 or about 250% above the current price, and with a P/E of 30 the price would be $165.89 or about 430% above the current price. The valuations for 2020 are based on P/E and P/B ratios that are very similar to the current ratios that BOFI trades at.

These valuations based on assumptions of a steady rate environment, continued subdued mortgage environment, lower growth than they have experienced to date and lower than they are forecasting. Any change in the rate environment would probably be a slow change, and have negligible impact. However the potential for the mortgage environment to pick up noticeably is real, which could substantially boost the EPS on the order of $0.25 quarterly. If growth does materialize as the company expects the results would be phenomenal, even though with the conservative estimates the forecasted returns for the next 5 years is 28%-40% annually. The case I laid out in the financials above would be somewhere between a bear and base-case scenario, but closer to the base case. I believe growth will accelerate now that they are listed on the NASDAQ and valuations have reached a point to where management is incentivized to find good growth, and not constrained by capital requirements.

Risk

The major risk to INBK obtaining the results outlined is:

  • A prolonged U.S. recession, causing a substantial decrease in credit quality.

INBK's past performance through the 2008 - 2009 meltdown and conservative lending practices give me confidence that although these risks may effect results in the short term, management will effectively navigate future challenges. The risk of permanent loss of capital in this investment as negligible.

Catalysts

  • Accelerated growth, because of valuation above 1.5 P/B, making future capital raises accretive to book value.
  • Easy comps for the next three quarters.
  • Earnings continue beating weak analyst estimates.
  • Increase in quantity of analyst, and quality of estimates.
  • Improvement in the mortgage environment.
  • Rising rate environment expands NIM.
  • Become an acquisition target.

See also Stable Propane Segment Supports Ferrellgas Partners' 10% Yield, Midstream Growth Could Help Increase Distribution on seekingalpha.com

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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