Independent Bank: Time for a Downgrade After a Monumental Rally (NASDAQ:INDB)

As a value investor, I prioritize the long term. That said, some opportunities reach their fair value fairly quickly. This is a blessing. And it’s something I never tire of seeing. One of the most recent examples of this can be seen watching TO Independent Bank (NASDAQ:INDB), a fairly small regional bank with a market cap of $2.69 billion. In May of this year, I wrote a article about the company that acknowledged some of the firm’s problems, but where I rated the company a “buy.” In my opinion, at the time, the action barely warranted this rating.

I would never have guessed that stocks would have skyrocketed in such a short window of time. Since that article was published, the stock is up 24.4%. By comparison, the S&P 500 rose just 7.2%. Looking at again image, I see that the company has shown some improvements in key areas. But based on how the stock is currently valued, it’s hard for me to imagine that significant upside could still be on the table. Because of this, I’ve decided to downgrade it to “hold” for now.

A look at recent growth

One of my biggest gripes with Independent Bank when I wrote about it earlier this year was that the company experienced a drop in deposits. There was an increase from the end of 2023 to the end of the first quarter of this year. But that didn’t do enough to cancel out the fact that from the end of 2021 to the end of 2023, deposits fell by 12.1%. When you see a single quarter-on-quarter increase in deposits, it’s not clear if it’s part of a new trend. But now we have confirmation that, in this case, it was. That’s because as of the second quarter of this year, deposits rose to $15.41 billion from $15.04 billion the company had at the end of the first quarter. Management attributed this growth to a few things, namely higher flows of municipal deposits and strong consumer demand for higher-cost term deposits.

It should be noted that, unfortunately, even more of the company’s warehouses are now uninsured. When evaluating a bank, I prefer that no more than 30% of all deposits be uninsured. I gave the independent bank in my original article on the company because its number had reached 31.2%. But today, that number is slightly higher at 33.1%. This disparity alone is not enough to go from bullish to neutral. But it sure doesn’t help. The reason I want this number not to exceed 30% is because the higher it is, the more susceptible the institution is to bank runs.

In my original article about the company, one thing I applauded management for was the steady increase in loan value. It is difficult to see this at a time when deposits are falling. At some point, one or the other has to break. But the good news is that as of the end of the most recent quarter, we’re seeing loans continue to grow. At the end of the first quarter, the value of loans on the company’s books totaled $14.18 billion. By the end of the second quarter, that number had grown to $14.25 billion.

There are other aspects of the balance sheet that deserve attention. Securities would be an example. At the end of the most recent quarter, the company had $2.77 billion worth of securities. That was actually down from the $2.85 billion reported at the end of the first quarter. From the end of 2022, the value of the securities on the company’s books is decreasing. So this is not terribly surprising to me. Cash and cash equivalents, meanwhile, rose from $221.3 million in the first quarter to $313.9 million in the second quarter. Apart from the increase in deposits, the best thing we saw was a decrease in liabilities. The company ended the first quarter of this year with $1.03 billion in debt. That number today is $693.4 million.

Moving on to the income statement, this is where we see continued pain. For the most recent quarter, the company had net interest income of $133.7 million. This is down from the $147.5 million reported a year earlier. A fairly significant drop in its net interest margin from 3.54% to 3.25% can be held responsible for this. That might not seem like a big difference, but when applied to the exciting assets the company had last quarter, that difference is $49.9 million more per year, or $12.5 million in every quarter. This was instrumental in the decline in net interest income for the first half of this year compared to the same period last year, from $299.3 million to $266.1 million.

There was a slight improvement in the last quarter in terms of non-interest income. This figure increased from $30.8 million to $32.3 million. Based on the data provided, this was primarily driven by an increase in deposit account fees from $5.5 million to $6.3 million and an increase in mortgage banking income from $0.7 million to 1, 3 million USD. Unfortunately, this was not enough to prevent the institution’s total net profit from falling from $62.6 million last year to $51.3 million this year. And for the first half of this year, the $99.1 million in profits the company generated ended up being quite a significant drop from the $123.9 million the company reported for the first half of 2023 .

If we annualize the results the company experienced in the first half of this year, we would anticipate 2024 net profits of $191.6 million. This translates to a price-to-earnings multiple of 14. But even if we were to use last year’s results, the price-to-earnings multiple would be 11.2. This is still above the 6 to 10 range I usually prefer in this space. In the chart above, you can see that using forward estimates, two of the five companies that we have Independent Bank against us trade at lower multiples than they are. This indicates that it is near the middle of the pack on this basis. Another way to value the company is to use the book value approach and the tangible book value approach. As the chart below illustrates, in both cases Independent Bank is cheaper than all but one of the five firms we compared it to.

Relatively speaking, Independent Bank appears to be quite attractively priced. But on an absolute basis, I’m not sold. If asset quality is high, I think that could narrow the gap. But unfortunately, this does not seem to be the case either. In the first graph below, you can see the return on assets for our candidate, for five peer companies. Three of the five have a lower return on assets than what it has. So, once again, we’re in the middle of the pack. But in the next chart, we can see that the picture is even worse when it comes to return on equity. Four of the five comparable companies have a higher return on equity than Independent Bank.

Take away

All things considered, it’s been a pretty great run for Independent Bank. The company has done much better than I expected, especially given the short period of time we’re talking about. But alas, I think the company’s valuation no longer warrants a “buy” rating. Because of this, I decided to demote it to “hold”.