Earnings of Hanmi Financial Corporation (NASDAQ: HAFC) increased to $0.30 per share in the second quarter, from $0.08 per share in the first quarter of 2020. A large gain on the sale of securities was responsible for the jump in net income. Earnings will likely remain subdued in the year ahead because of elevated provision expense and normalization of gains on sales of securities. On the other hand, the accelerated booking of fees under the Paycheck Protection Program, PPP, will likely boost earnings. Overall, I’m expecting HAFC to report earnings of $0.63 per share in 2020, down 40% from last year. HAFC is currently facing very high credit risks because around 29% of its total loans required modification amid the COVID-19 pandemic. The stock price is unlikely to increase until HAFC reports a reduction in loans requiring payment concessions. Hence, I’m adopting a neutral rating on HAFC.
Modified Loans at a Disconcerting Level
As mentioned in the second quarter’s 10-Q filing, HAFC approved applications to modify $1.4 billion of loans and leases due to hardships amid the COVID-19 pandemic. These modified loans and leases made up 29% of the total portfolio at the end of the last quarter. HAFC’s substantial exposure to the hospitality segment was partly responsible for the modifications. Around $944.9 million of loans, representing 19.6% of total loans, were to the hospitality industry, as mentioned in the 10-Q filing. Altogether, the vulnerable loan segments of hospitality, food service, and retail made up 35% of the portfolio at the end of the last quarter, as mentioned in the 10-Q filing. Unlike loans in the retail sector that may resume payments soon, I’m expecting hospitality loans to continue to require assistance for the next couple of quarters because people will likely remain cautious and avoid travel until COVID-19 gets under control. Due to these factors, HAFC is currently facing high credit risks.
HAFC reported a provision expense of $25 million in the second quarter, up from $16 million in the first quarter of 2020. I’m expecting the provision expense in the remaining two quarters of the year to decline from the second quarter’s high but remain above normal. For the full year, I’m expecting HAFC to report a provision expense of $80 million, up from $30 million last year.
Normalization of Gains on Securities to Reduce Non-Interest Income
HAFC’s non-interest income increased by 236% quarter over quarter to $21 million in the second quarter of 2020. The jump in non-interest income was mostly attributable to gains of $15.7 million on the sale of securities. The normalization of these gains in the second half of the year will reduce non-interest income. On the other hand, the resumption of sales of Small Business Administration loans, or SBA, will increase non-interest income. The management mentioned in the second quarter’s conference call that they had suspended the sale of SBA loans in the second quarter due to the disruption in the secondary market. As a result, there were $17.9 million of SBA loans held for sale at the end of June, with a weighted-average trade premium of 8.97%, as mentioned in the second quarter’s earnings release. The management intended to resume the SBA loan sales in the third quarter. Considering these factors, I’m expecting HAFC to report a non-interest income of $8 million in each of the remaining two quarters of the year, as opposed to $21 million in the second quarter and $6 million in the first quarter of 2020.
Accelerated Booking of Fees Under the Paycheck Protection Program to Support Earnings
As mentioned in the 10-Q filing, HAFC had $301.8 million of loans outstanding under the Paycheck Protection Program, or PPP, at the end of the last quarter. Assuming fees of 3.2% and funding cost of 0.35%, PPP will likely add $9 million to net interest income over the life of the loans. I’m expecting most of the PPP loans to get forgiven before the year-end; hence, I’m expecting HAFC to accelerate the booking of the fees in the fourth quarter.
Due to the PPP forgiveness, the total loan balance will likely decline in the year ahead. Moreover, HAFC concentrates on commercial real estate loans, the demand for which is likely to remain low due to the uncertainties related to COVID-19. Consequently, I’m expecting the year-end loan balance to be 5.9% below the June-end balance and 2% below the 2019 ending balance. The following table shows my estimates for loans and other balance sheet items.
Expecting Full-Year Earnings of $0.63 per Share
Above-normal provision expense and normalization of gains on securities will likely pressurize the earnings in the year ahead. On the other hand, the accelerated booking of PPP fees will likely support earnings in the last quarter. Overall, I’m expecting HAFC to report earnings of $0.63 per share in 2020, down 40% from last year. The following table shows my income statement estimates.
The probability of an earnings miss is unusually high this year because of the heightened credit risks that can result in a negative surprise in provision expense.
Dividends Likely to Stabilize
HAFC cut its quarterly dividend twice this year, from $0.24 per share in the first quarter to $0.12 per share in the second quarter and then $0.08 per share in the third quarter. I’m not expecting a further cut because the earnings and dividend estimates suggest a payout ratio of 55% for the fourth quarter of 2020 and 29% for 2021, which is manageable. Moreover, HAFC is currently well-capitalized. The company reported a tier I capital to risk-weighted assets ratio of 10.86%, as opposed to minimum regulatory requirement of 6.0%. Assuming the company maintains its quarterly dividend at $0.08 per share, the leading dividend yield arrives at 3.4%.
However, there is a high credit risk that can lead to an earnings surprise in the year ahead. Due to the chance of an earnings surprise, there are chances of a dividend cut.
Risks Likely to Restrain the Stock Price, Regardless of the Attractive Valuation
I’m using the historical price-to-tangible-book ratio, P/TB, to value HAFC. The stock traded at a P/TB multiple of 0.73 in the first half of 2020. Multiplying this ratio with the June 2021 forecast tangible book value per share of $18.1 gives a target price of $13.3 for the mid of next year. This price target implies a 39% upside from HAFC’s August 31 closing price. The following table shows the sensitivity of the target price to the P/TB multiple.
As discussed above, HAFC is facing a high level of credit risk that threatens earnings and valuation. The stock price is unlikely to increase until and unless loans requiring modification decline to a satisfactory level. The risks will likely overshadow the attractive valuation in the next four to six months. Hence, I’m adopting a neutral rating on HAFC for the near term.
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 risk tolerance before investing in the stock(s) mentioned.