There are only a few more days left in 2020 to buy stocks cheap before the new year. One bank stock that looks to be trading at a discount, but which also seems to have significant upside, is First Internet Bancorp (INBK -2.48%), a small $4.3-billion-asset bank in Indiana. As its name suggests, First Internet has no traditional branches. Instead, it offers a wide array of digital commercial, small business, consumer, and municipal banking products all over the country. Let's take a look at why this stock looks cheap right now.
In the third quarter of the year, First Internet reported record net income of $8.4 million. Almost all revenue items seemed to be firing at the bank. Net interest income in the quarter grew by more than $1 million on a year-over-year basis and more than nearly $2 million from the second quarter. While interest income did suffer from the low-rate environment, the lower repricing of deposits this year and reduction in interest expense more than offset the decline in interest income.
Furthermore, First Internet's non-interest income had a blowout quarter. Total non-interest income of $12.5 million is up more than double from the third quarter of 2019 and the second quarter of 2020. The increase is due to lots of mortgage banking fees from all of the refinancing activity. The bank has also done a nice job of ramping up its U.S. Small Business Administration (SBA) lending program, which it only began a few years ago. Those efforts are paying off as First Internet saw a nice increase in fee income from selling those SBA loans into the secondary market.
The stellar third-quarter earnings has already sparked investor interest. Since reporting earnings on Oct. 21, the stock is up about 60%. But even after the surge, First Internet was only trading at about 90% of tangible book value at Friday's prices.
A promising outlook
Although the stock has risen a good amount in the past few months, I believe it is still cheap because of First Internet's excellent outlook heading into 2021.
Banks have taken a big hit to their net interest margins -- the difference between what they pay for interest-bearing liabilities, such as deposits, and what they make on interest-earning assets, such as loans -- as a result of the Federal Reserve sharply dropping rates in March. That's because most banks have more interest-earning assets than interest-bearing liabilities, so when rates fall, more interest-earning assets than interest-bearing liabilities reprice down along with rates. Although First Internet has more interest-earning assets than interest-bearing liabilities, the difference is not huge. First Internet's net interest margin has held up very well because of how much its interest-bearing liabilities have repriced this year.
First Internet CFO Kenneth Lovik said on the bank's most recent earnings call that it still has lots of deposit accounts that will continue to mature and reprice down in 2021. Lovik expects the bank to see a $22 million reduction in interest expenses next year that will benefit the margin. As a result, Lovik thinks it's possible that the bank's margin could expand from 1.67% on a fully taxable equivalent basis at the end of the third quarter of this year to potentially as high as 2.3% or 2.4% by the end of 2021. That would be a big increase and could significantly boost revenue.
The bank also has some good tailwinds on the fee side of the business. While mortgage banking activity is expected to normalize from its insane level in the third quarter, it should still be strong in 2021. Also, the bank's SBA lending program is really gaining traction. The bank sells most of the SBA loans it originates into the secondary market, and Lovik believes the bank can do $12 million to $14 million of revenue from this business line in 2021. In comparison, the bank had only done about $4.6 million in revenue from this business line through the first nine months of 2020.
Finally, the bank's credit quality looks very solid, with net charge-offs (debt unlikely to be collected) ending the third quarter at its lowest level of the year, just 0.01% of total average loans. Non-performing loan levels are also very manageable and the bank has a very small amount of loans left on active deferral from the coronavirus pandemic.
Room to run
Still trading at a discount to tangible book value, First Internet Bancorp looks like it has plenty of room to run, with a very promising revenue outlook for 2021 including an increased margin, a growing SBA lending business, and a strong mortgage business. The bank's credit outlook looks to be in good shape as well. The strong earnings have also enabled the bank to build back up its tangible common equity through the year, leaving the possibility of share repurchases in 2021. That could be very beneficial to the First Internet's stock price, especially if the bank can repurchase below book value.