Meridian Corp. : Dependence on mortgage bank revenue hurts profits

Meridian Company (NASDAQ: MRBK) is highly dependent on mortgage bank income; therefore, the normalization of mortgage refinancing activity this year will significantly hurt earnings. On the other hand, loan growth, excluding Paycheck Protection Program loans, will support the bottom line. Overall I expect Meridian Corporation to report earnings of $3.94 per share for 2022, down 31% year-over-year. Compared to my estimates given in my last report on Meridian Corporation, I have increased my earnings estimate due to an upward revision to the loan growth estimate. The year-end target price is close to the current market price. Accordingly, I maintain a holding rating on Meridian Corporation.

Revenue depends on mortgage refinance activity

Meridian Corporation’s profits have jumped over the past two years due to rising mortgage bank revenues. Non-interest income from the mortgage banking business accounted for 50.3% of total income in 2021 and 56.3% of total income in 2020. In comparison, mortgage banking income accounted for 40% of total income in 2018, before the impact of the last monetary policy. policy easing cycle (the Federal Reserve began cutting its federal funds rate in late 2019).

The expected increase in the federal funds rate, and therefore mortgage rates, will lead to a normalization of mortgage refinancing activity this year. As shown below, mortgage rates have already risen sharply so far this year.

the Mortgage Bankers Association (“MBA”) expects mortgage refinance activity to fall sharply this year to near 2019 levels. However, MBA expects buying activity to likely be much higher than in 2019.

Given these factors, I expect non-interest revenue to fall 32% year-over-year in 2022. Despite the annual decline, non-interest revenue will likely remain much higher than the 2019 level.

Growth in loans to counter the slowdown in the mortgage refinancing market

Excluding Paycheck Protection Program (“PPP”) loans, the loan portfolio grew by 2.8% in the last quarter of 2021, as mentioned in the presentation of the results. Going forward, business segment growth is likely to remain robust thanks to the economic recovery in Meridian Corporation’s markets. Meridian operates in New Jersey, Delaware, Maryland and Pennsylvania, all of which currently trail the rest of the country in unemployment rates but have still recovered well since the pandemic began.

However, the upcoming cancellation of PPP loans will likely limit loan growth this year. Meridian Corporation still has a significant portion of its PPP portfolio outstanding. According to the details given in the presentation of the results, outstanding PPP loans amounted to $70 million at the end of January 2022, or 5% of total loans. The discount over the coming year will likely have a significant impact on the total size of the loan portfolio.

Given these factors, I expect the loan portfolio to grow by 6% by the end of 2022 compared to the end of 2021. In my last report on Meridian Corporation, I estimated the growth lending at just 4% for 2022. I revised my growth estimate up because the economy now looks better than I previously expected.

Meanwhile, deposits and other balance sheet items will likely grow at the same rate as loans. The following table shows my balance sheet estimates.

Loan growth will likely be the biggest contributor to net interest income growth this year, as I expect rising interest rates to have virtually no impact on net interest margin. More liabilities than assets will be reassessed this year. As mentioned in File 10-K, the difference between repricing liabilities and assets is $173.7 million, which represents 10.1% of total assets. In addition, management’s interest rate sensitivity analysis presented in File 10-K shows that a 200 basis point increase in interest rates can reduce net interest income by 0.18 %.

However, Meridian has the opportunity to improve its asset mix in the future, which may increase net interest margin. Cash and investments represented 11% of total assets at the end of December 2021, as mentioned in the presentation of the results. Meridian may transfer a portion of excess cash to higher yielding securities as interest rates rise.

Overall, I expect the net interest margin to remain virtually unchanged this year, compared to 3.83% in the fourth quarter of 2021.

Earnings are expected to drop 31% year over year

The sharp fall in mortgage bank revenue is likely to be a major factor in lower earnings this year. In addition, the provision charge will likely return to a normal level in 2022 after a year of moderate provisioning. I don’t expect any big releases of provisions this year as the current level of reserves is quite close to the level of unearned loans in the loan portfolio. According to the details given in the earnings presentation, reserves represented 1.46% of total loans, while unaccrued loans represented 1.34% of total loans at the end of December 2021. Loan growth will likely be the main driver of provisioning in 2022. Overall, I expect provisioning charges to be around 0.25% of total loans in 2022, which is the same as the average ratio of provisioning charges to the total loans for the last four years.

On the other hand, loan growth will likely support the bottom line. In the meantime, I expect the efficiency ratio to barely change this year. Despite a “branch-lite” model, Meridian Corporation’s efficiency rate is quite high, which presents opportunities for cost savings. Nevertheless, I do not expect an improvement in the efficiency ratio because the company has not announced any significant initiatives in this area.

Overall, I expect Meridian Corporation to report earnings of $3.94 per share in 2022, down 31% year-over-year. The following table shows my income statement estimates.

In my last report on Meridian Corporation, I forecast earnings of $3.66 per share for this year. I revised my revenue estimate up because I increased my loan growth estimate for this year.

Actual earnings may differ materially from estimates due to risks and uncertainties related to the COVID-19 pandemic and the timing and magnitude of interest rate increases.

Current market price close to the target price for the coming year

The Meridian Company offers a remarkable dividend yield of 5.8%, including the special dividend of $1.00 per share and the quarterly dividend of $0.20 per share. Excluding the exceptional dividend, the dividend yield is only 2.6% for the year.

I use historical price/tangible accounting (“P/TB”) and price/earnings (“P/E”) multiples to value Meridian Corporation. The stock has traded at an average P/TB ratio of 1.054 in the past, as shown below.

Multiplying the average P/TB multiple by the expected tangible book value per share of $28.10 yields a price target of $29.60 for the end of 2022. This price target implies a decline of 4.7% compared to the April 18 closing price. The following table shows the sensitivity of the target price to the P/TB ratio.

The stock has traded at an average P/E ratio of around 8.388x in the past, as shown below.

Multiplying the average P/E multiple by the expected earnings per share of $3.94 yields a price target of $33.10 for the end of 2022. This price target implies a 6.5% upside from at the April 18 closing price. The following table shows the sensitivity of the target price to the P/E ratio.

Equal weighting of target prices from both valuation methods gives a combined result target price of $31.30, which implies an increase of 0.9% compared to the current market price. Adding the forward dividend yield gives an expected total return of 3.5%. Therefore, I’m adopting a hold note on Meridian Corporation.