After a phenomenal year, Hanmi Financial Corporation (NASDAQ:HAFC) earnings are likely to fall this year on an increase in net accrual costs. On the other hand, economic factors are likely to increase the loan portfolio, which in turn will support the bottom line. Additionally, the presence of liquid assets on Hanmi’s books and a supportive deposit mix will increase margin in a rising interest rate environment. Overall, I expect Hanmi Financial to report earnings per share of $2.63 in 2022, down 18% year over year. Despite the slump, earnings are likely to be well above pre-pandemic levels. The price target at the end of the year indicates a clear upside potential compared to the current market price. Therefore, I give a buy recommendation for Hanmi Financial.

Broad economic growth to support loan book expansion

Hanmi Financial Corporation’s loan portfolio has grown by mid-single-digit percentages for most of the past few years. The company can easily achieve similar credit growth this year due to the economic recovery. Hanmi Financial’s operations are widespread and geographically diverse, covering multi-ethnic markets from California to New York. As a result, national economic numbers are a good indicator of upcoming credit demand. The GDP growth rate was quite robust in the last quarter, while the unemployment rate in January was close to pre-pandemic levels. The nationwide economic recovery is likely to drive credit growth this year.

Additionally, Hanmi Financial has made significant investments in talent and technology, including its digital platform. These investments should support credit growth in the coming quarters. In addition, there is now only a small amount of Paycheck Protection Program (“PPP”) loans that need to be made. According to the earnings release, outstanding PPP loans totaled $3.0 million at the end of December 2021, accounting for just 0.1% of total loans. Therefore, their forgiveness will hardly move the needle this year.

Taking these factors into account, I expect the loan portfolio to increase by 6% by the end of December 2022 compared to the end of 2021. Meanwhile, deposits are likely to grow in line with loans. The table below shows my balance sheet estimates.

Balance sheet positioning to increase margin

Eventually, with deposit growth outpacing loan growth last year, Hanmi Financial had a sizeable cash position on its books. The company deployed some of its excess cash and cash equivalents in the fourth quarter of 2021, but the year-end cash balance was still fairly inflated. It’s better to have cash on the books than assets tied up at fixed rates ahead of a rate hike. Hanmi Financial can reallocate this excess cash into higher-yielding securities and loans once the Federal Reserve raises the federal funds rate target. However, since most financial institutions sit on excess liquidity, the impact of a rate hike may be delayed. There will be increased competition in the market to deploy excess cash which may result in pricing pressures.

Another factor that supports margin in a rising interest rate environment is a large amount of interest-free deposits. Hanmi Financial has successfully increased its non-interest bearing deposits from 36.0% at the end of 2020 to 44.5% of total deposits by the end of 2021. The high percentage of interest-free deposits will keep the average cost of deposits stable as interest rates rise.

However, the loan portfolio is not as well positioned as the deposit mix. Around 72% of the loan portfolio relates to commercial real estate loans, which are usually based on a fixed interest rate. Therefore, portfolio revaluation is likely to be lengthy and slow. Management’s interest rate sensitivity analysis presented in Q3’s 10Q report also shows a similar finding. According to this analysis, a 100 basis point rate hike can increase net interest income by 6.54% in the first year of the rate hike and by 9.68% in the second year of the rate hike.

Taking these factors into account, I expect the margin to be flat in the first half of 2022 from 2.96% in the last quarter of 2021. For the second half of the year I expect the margin to increase by eight basis points.

Deployment costs to stay below normal

Hanmi Financial released a large part of its previous provisions last year. Further reversals of loan loss provisions cannot be ruled out, since loan loss provisions appear excessive in relation to the credit risk of the portfolio. Allowances accounted for 1.41% of total loans, while non-performing loans accounted for just 0.26% of total loans at the end of December 2021, as mentioned in the earnings release. Management also mentioned on the conference call that it expects more recoveries, but expects future recoveries to be lower.

Given these factors, I expect 2022 provisioning expense net of chargebacks to be higher compared to 2021, but below the pre-pandemic average. I expect provisioning costs to be about 0.18% of total loans in 2022, versus an average of 0.25% of total loans from 2017 through 2019.

Earnings are expected to remain above pre-pandemic levels

Higher net provisioning expense is likely to weigh on year-over-year earnings. Still, earnings for 2022 are likely to be well above pre-pandemic levels due to strong revenue growth. The economic recovery is likely to boost credit growth, which in turn will boost revenue for this year. Additionally, the cost of permanent deposits and a large inventory of liquid assets will benefit the topline in a rising interest rate environment. Overall, I expect the company to report earnings of $2.63 per share in 2022, down 18% year over year. The table below shows my estimates of the income statement.

Actual returns may differ materially from estimates due to the risks and uncertainties related to the COVID-19 pandemic and the timing of any rate hike.

Attractive total expected return calls for a buy rating

Hanmi Financial has cut its quarterly dividend from $0.24 per share to $0.08 per share in 2020. Since then, the company has gradually increased its quarterly dividend to $0.22 per share. Current dividend levels and earnings estimates point to a 34% payout ratio for 2022, below the five-year average of 49%. Due to the below-average implied payout ratio, there’s a chance that Hanmi Financial will return to a dividend of $0.24 per share this year. However, to be on the safe side, I don’t expect the dividend level to change in 2022. The quarterly dividend of $0.22 per share implies a dividend yield of 3.3% based on the closing price on Feb. 18.

To value Hanmi Financial, I use historical Price-to-Trade Book Value (“P/TB”) and Price-to-Earnings (“P/E”) multiples. The stock has historically traded at an average P/TB ratio of 1.21, as shown below.

Multiplying the average P/TB multiple by the projected tangible book value per share of $22.5 gives a price target of $27.3 by the end of 2022. This price target implies a 1.8% increase from the Feb. 18 closing price . The table below shows the sensitivity of price target to P/TB ratio.

The stock has historically traded at an average P/E of around 13.3x, as shown below.

Multiplying the average P/E multiple by the forward earnings per share of $2.63 gives a price target of $34.9 by the end of 2022. This price target implies a 30.2% increase from the Feb. 18 close. The following table shows the sensitivity of the target price to the P/E ratio.

The same weighting of the price targets from the two evaluation methods results in a combination Price target of $31.1, representing a 16.0% increase over the current market price. Adding the expected dividend yield gives an expected total return of 19.3%. Therefore, I’m assuming a buy rating on Hanmi Financial.