Macatawa Bank: Lower Average Loan Balance To Drag Earnings This Year (NASDAQ: MCBC)

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Blue Macatawa Bank Sign with drive thru, atm and flowers on green grass and blue sky

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Earnings of Macatawa Bank Corporation (NASDAQ: MCBC) will likely decline this year because of the recent declining loan trend. Although the loan portfolio will likely bottom out by the middle of this year and trend upwards in the latter part of the year, the average loan balance will most probably remain much below the average balance for 2021. Further, lower non-interest income and higher net provision expense in the second half of 2022 will likely drag earnings. On the other hand, slight margin expansion on the back of a rising interest-rate environment and improvement in the asset mix will likely support the bottom line. Overall, I’m expecting Macatawa Bank to report earnings of $ 0.71 per share in 2022, down 16% year-over-year. The year-end target price is quite close to the current market price. Therefore, I’m adopting a Hold rating on Macatawa Bank Corporation.

Average Loan Balance to Be Lower this Year Thanks to Last Year’s Decline

Macatawa Bank’s loan portfolio declined by a hefty 22.6% in 2021 partly because of a reduction in the residential mortgage and consumer loan portfolios, as mentioned in the earnings release. Further, the forgiveness of Paycheck Protection Program (“PPP”) loans throughout last year slashed the total loan portfolio size. As mentioned in the earnings release, PPP loans declined from $ 229 million at the end of December 2020 to $ 42 million at the end of December 2021.

Further decline in the loan portfolio size cannot be ruled out because the PPP loan portfolio still makes up a sizeable proportion of the total loan portfolio size. PPP loans outstanding made up around 3.8% of total loans at the end of December 2021. I’m expecting most of these loans to get forgiven in the first half of 2022; therefore, the loan portfolio size will likely decline in the first half of the year.

However, there is a good chance that the portfolio will bottom out by the middle of 2022 and start trending upwards in the latter part of the year. Macatawa Bank operates in Michigan, where economic recovery will likely drive loan growth in the second half of this year. The state’s unemployment rate is trailing most of the country but is still much better than a year-ago period.

Chart
Data by YCharts

Moreover, I’m not too concerned about the recent loan decline because the deposits have grown strongly during the same period. This shows that Macatawa Bank is not losing its customers to competitors. The loan decline seems more attributable to economic factors than to weakening partnerships. It’s very likely that customers will return for loans once the economy improves to a point that boosts credit demand. As a result, I’m expecting the loan portfolio to bottom out in the middle of 2022 once the PPP forgiveness is mostly over, and then trend upwards in the second half of the year.

Overall, I’m expecting the portfolio to increase by 0.8% by the end of December 2022 from the end of December 2021. However, the average loan balance for the year will be much below the average balance for last year because of the declining trend throughout 2021. Overall, I’m expecting the average balance in 2022 to be 11.8% below the average balance for last year. Meanwhile, the deposit growth will likely match period-end loan growth in 2022. The following table shows my balance sheet estimates.

FY18 FY19 FY20 FY21 FY22E
Financial Position
Net Loans 1,389 1,368 1,412 1,093 1,102
Growth of Net Loans 6.5% (1.5)% 3.2% (22.6)% 0.8%
Other Earning Assets 443 563 1,086 1,694 1,763
Deposits 1,677 1,753 2,299 2,578 2,683
Borrowings and Sub-Debt 101 81 91 85 85
Common equity 191 217 240 254 267
Book Value Per Share ($) 5.64 6.39 7.03 7.43 7.82
Source: SEC Filings, Author’s Estimates
(In USD million unless otherwise specified)

Excess Cash, Sensitivity to Interest-Rates to Boost the Margin

Due to the substantial decline in the loan portfolio, cash and cash equivalents continued to build up on Macatawa Bank’s books throughout last year. In fact, the company now has more cash and cash equivalents than loans. Federal funds sold and other short-term investments equaled $ 1.1 billion at the end of December 2021, up from $ 752.3 million at the end of December 2020. The following chart shows the trend of the asset mix.

Macatawa Bank

SEC Filings

Although the excess cash position hurts the top line in the past, it will benefit the top line in the coming months. This is because Macatawa Bank can easily deploy the cash into higher-yielding assets as soon as the federal funds rate starts increasing this year.

Apart from the opportunity to reposition the asset mix, the net interest income can also benefit from its sensitivity to interest rate changes. According to management’s interest-rate sensitivity analysis given in the third quarter’s 10-Q filing, a 100-basis points increase in interest rates can boost net interest income by 9.58% over 12 months.

Considering these factors, I’m expecting the net interest margin to remain stable in the first half of 2022 and then increase by six base points in the second half of the year.

Further Reserve Releases Likely in the First Half of the Year

Macatawa Bank reversed a large part of its previous provisioning in 2021. Further provisioning reversal cannot be ruled out as the allowance level appears high while the non-performing loans are almost negligible. Non-performing loans made up just 0.01% of total loans, while allowances made up 1.43% of total loans, as mentioned in the earnings release. As a result, I’m expecting a net provision reversal of around $ 1 million in the first half of 2022.

For the second half of the year, I’m expecting the provision expense, net of reversals, to trend higher on the back of anticipated loan additions. Overall, I’m expecting the company to report a net provision expense of $ 0.1 million in 2022, representing 0.01% of total loans.

Expecting Earnings to Decline to $ 0.71 per Share

The lower average loan balance this year will likely be the chief contributor to an earnings decline. Further, the tapering-off of provision reversals will likely drag the bottom line. Moreover, the non-interest income will likely be lower this year because of a reduction in mortgage refinancing activity. Income from mortgage refinancing declined throughout 2021 and will likely settle close to a normal range this year due to a rising interest-rate environment.

On the other hand, margin expansion in the latter part of the year will likely support earnings. Overall, I’m expecting Macatawa Bank to report earnings of $ 0.71 per share in 2022, down 16% year-over-year. The following table shows my income statement estimates.

FY18 FY19 FY20 FY21 FY22E
Income Statement
Net interest income 60 63 62 56 53
Commission for loan losses 0 (0) 3 (2) 0
Non-interest income 18 20 24 24 22
Non-interest expense 44 44 46 46 45
Net income – Common Sh. 26 32 30 29 24
EPS – Diluted ($) 0.78 0.94 0.88 0.85 0.71
Source: SEC Filings, Author’s Estimates
(In USD million unless otherwise specified)

Actual earnings may differ materially from estimates because of the risks and uncertainties related to the COVID-19 pandemic.

MCBC Doesn’t Seem To Be Attractively Priced

Macatawa Bank is offering a dividend yield of 3.4% at the current quarterly dividend rate of $ 0.08 per share. The earnings and dividend estimates suggest a payout ratio of 45% for 2022, which is above the five-year average of 35% but still at an easily manageable level. Therefore, I do not think the earnings outlook poses any threat of a dividend cut.

I’m using the historical price-to-book (“P / B”) and price-to-earnings (“P / E”) multiples to value Macatawa Bank. The stock has traded at an average P / B ratio of 1.48 in the past, as shown below.

FY18 FY19 FY20 FY21 Average
Book Value per Share ($) 5.6 6.4 7.0 7.4
Average Market Price ($) 11.09 10.34 7.94 8.86
Historical P / B 1.97x 1.62x 1.13x 1.19x 1.48x
Source: Company Financials, Yahoo Finance, Author’s Estimates

Multiplying the average P / B multiple with the forecast book value per share of $ 7.82 gives a target price of $ 11.5 for the end of 2022. This price target implies a 22.3% upside from the February 15 closing price. The following table shows the sensitivity of the target price to the P / TB ratio.

P / B Multiple 1.28x 1.38x 1.48x 1.58x 1.68x
BVPS Dec 2022 ($) 7.82 7.82 7.82 7.82 7.82
Target Price ($) 10.0 10.8 11.5 12.3 13.1
Market Price ($) 9.4 9.4 9.4 9.4 9.4
Upside / (Downside) 5.7% 14.0% 22.3% 30.6% 38.9%
Source: Author’s Estimates

The stock has traded at an average P / E ratio of around 11.2x in the past, as shown below.

FY18 FY19 FY20 FY21 Average
Earnings per Share ($) 0.78 0.94 0.88 0.85
Average Market Price ($) 11.09 10.34 7.94 8.86
Historical P / E 14.2x 11.0x 9.0x 10.4x 11.2x
Source: Company Financials, Yahoo Finance, Author’s Estimates

Multiplying the average P / E multiple with the forecast earnings per share of $ 0.71 gives a target price of $ 8.0 for the end of 2022. This price target implies a 15.7% downside from the February 15 closing price. The following table shows the sensitivity of the target price to the P / E ratio.

P / E Multiple 9.2x 10.2x 11.2x 12.2x 13.2x
EPS 2022 ($) 0.71 0.71 0.71 0.71 0.71
Target Price ($) 6.5 7.2 8.0 8.7 9.4
Market Price ($) 9.4 9.4 9.4 9.4 9.4
Upside / (Downside) (30.8)% (23.3)% (15.7)% (8.2)% (0.6)%
Source: Author’s Estimates

Equally weighting the target prices from the two valuation methods gives a combined target price of $ 9.8, which implies a 3.3% upside from the current market price. Adding the forward dividend yield gives a total expected return of 6.7%. Hence, I’m adopting a Hold rating on Macatawa Bank.

The upside is not high enough for me to consider purchasing a company whose earnings will likely decline this year. I would consider investing in the stock only if its market price dipped by more than 15% from the current level.



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