Hope Bancorp, Inc. (NASDAQ: HOPE) reported earnings of $0.22 per share in the second quarter, up from $0.21 per share in the first quarter of 2020. Earnings will likely continue to improve in the remainder of the year due to an expansion in net interest margin and loan growth. Moreover, the provision expense will likely decline in the year ahead. Further, the non-interest expense growth will likely remain low because of cost control measures. Overall, I’m expecting the earnings to increase by 21% in the second half compared to the first half of the year. The June 2021 target price suggests a high upside from the current market price. However, I’m expecting the stock price to remain subdued in the near term because the company is facing high credit risks. As a result, I’m adopting a Neutral rating on HOPE.
Modified Loans Reflect the High Level of Credit Risk
As mentioned in the second quarter’s investor presentation, HOPE allowed payment deferrals and modifications on around 24% of the total loan portfolio, which shows that a large portion of the loan balance is facing debt servicing problems. Further, management mentioned in the second quarter’s conference call that it expects around 60% of commercial borrowers to request a second deferral. A large part of the credit risk stems from the company’s high exposure to vulnerable industries, especially hotels, which made up 12.9% of total loans at the end of the last quarter, according to details given in the presentation. The following table gives details of vulnerable loan segments.
HOPE has already substantially built up its loan loss reserves in the first half of the year; therefore, the provision expense will likely decline sequentially in the year ahead. Company management used forecasts for various economic variables, including GDP, unemployment, and inflation, to determine the provisioning requirement for the second quarter. As mentioned in the presentation, management assumed that:
- The unemployment rate will remain above 8% through 2021.
- GDP will decline by 5.6% for FY2020.
- Inflation will decelerate through the remainder of 2020 and into 2021.
- The commercial real estate price index will decline by 16% year over year in FY2020.
The economic forecasts given above appear sufficiently stressed; therefore, I’m expecting the provision expense to sequentially decline in the year ahead. For the full year, I’m expecting HOPE to report a provision expense of $76 million, up from $7 million in 2019.
Decline in Deposit Costs to Drive Margin Expansion
HOPE’s net interest margin, or NIM, declined to 2.79% in the second quarter of 2020 from 3.31% in the corresponding period last year. As mentioned in the conference call, management expects NIM to expand in the remainder of the year due to a stable yield and declining deposit costs. Around $2.7 billion worth of Certificates of Deposits, or CDs, will mature in the second half of 2020, representing 19% of total deposits, according to details given in the presentation. Additionally, around $2.1 billion CDs will mature in the first half of 2021, representing 15% of total deposits. The CD maturity will reduce the overall funding cost.
Further, HOPE shifted its deposit mix towards low-cost deposits in the second quarter, which will ease the pressure on NIM. Non-interest-bearing deposits made up 28.6% of total deposits at the end of the last quarter, as opposed to 23.4% at the end of the first quarter. Moreover, company management expects to redeploy some of the excess liquidity into higher-yielding assets, which will drive NIM expansion in the coming quarters. Considering these factors, I’m expecting the NIM to increase by 2bps in the third quarter and a basis point in the fourth quarter of 2020.
Apart from NIM expansion, the net interest income will likely also receive support from loan growth. Management mentioned in the conference call that it expects high-single or low-double digit loan growth this year. Further, the Paycheck Protection Program loans make up just 3.7% of total loans; therefore, early forgiveness will not have a large impact on loan growth for the year. I’m expecting the year-end loan balance to be 3% higher than the June 2020 level and 7.5% higher than the December 2019 level. The following table shows my estimates for loans and other balance sheet items.
Management’s Efforts Likely to Limit Non-Interest Expense Growth
HOPE’s non-interest expense declined by 7% in the second quarter from the first quarter of 2020 as management aggressively cut back on costs amid the pandemic. The non-interest expense will likely grow in the year ahead because HOPE needs to balance investments and cost savings. However, the growth will likely remain subdued because of management’s cost control efforts. As mentioned in the conference call, it reduced the workforce by 4% in July, which will reduce salary and benefit expenses by $1.5 million per quarter. Moreover, management is reevaluating office space and occupancy costs. As mentioned in the conference call, it expects the expense run rate to be around $70 million. Considering the factors mentioned above and management’s guidance, I’m expecting the expense run rate to average $72 million in the last two quarters of the year. For the full year, I’m expecting HOPE’s non-interest expense to be almost unchanged from last year.
Expecting Full-Year Earnings of $0.94 per Share
The expected expansion in NIM, loan growth, and decline in provision expense will likely lift earnings in the remainder of the year. Consequently, I’m expecting earnings to grow by 21% in the second half of the year from the first half. For the full year, I’m expecting HOPE to report earnings of $0.94 per share, down 30% from last year. The following table shows my income statement estimates.
Actual earnings may differ materially from estimates because of the uncertainties surrounding the COVID-19 pandemic.
Risks Likely to Restrain the Stock Price Regardless of the Attractive Valuation
I’m using the historical price-to-tangible book multiple, or P/TB, to value HOPE. The stock traded at an average P/TB multiple of 0.82 in the first half of 2020. Multiplying this ratio with the June 2021 forecast tangible book value per share of $12.8 gives a target price of $10.5 for the mid of next year. This price target implies an upside of 20.8% from HOPE’s September 7 closing price. The following table shows the sensitivity of the target price to the P/TB ratio.
HOPE is also offering an attractive dividend yield of 6.4%, assuming the company maintains its quarterly dividend at the current level of $0.14 per share. There is little threat of a dividend cut because the earnings and dividend estimates suggest a payout ratio of 54% for the fourth quarter of 2020 and 52% for 2021, which is manageable.
I’m expecting the stock price to remain subdued in the near term despite the upside to the June 2021 target and the attractive dividend yield. The high level of loans requiring modifications and payment deferrals, especially the hotel portfolio, will likely keep investors jittery. I’m expecting the confidence level to not improve until the company reports a decline in the portion of the portfolio that requires payment deferrals. As a result, I’m expecting the credit risks to restrain the stock price in the near term. Consequently, I’m adopting a Neutral rating on HOPE.
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.