2 Risks First Internet Bancorp Investors Should Be Aware Of

First Internet Bancorp (INBK 3.71%) beat estimates in its fourth-quarter earnings report, but Fool contributor Jason Hall sees two potential warning signs.

In this episode of "Beat and Raise," recorded on Jan. 21, Hall discusses with Fool contributor Brian Withers how the company's loan bank actually declined sequentially in the fourth quarter despite the economic expansion, and that the bank stock also faces a risk from rising interest rates because too many of its loans come from CDs. 

Brian Withers: Jason, I'm excited about First Internet Bancorp's quarter. How did they do?

Jason Hall: Let's see, give me just a second I get this slide slid and then we'll talk about it.

Withers: Awesome.

Hall: This is one that we've been following for a little while here. First Internet Bancorp like a lot of other banks has done quite well. We go back to 2020 and a lot of us were really worried about banks in general. Then the federal government stepped in with substantial financial support and monetary support for the economy. People had money to pay their bills, to pay their loans. Businesses were actually actively looking to take out loans to pay and there was a lot of subsidized government loans to or guaranteed loans, I should say. Then coming out of 2020 and getting into last year. Last year was a great year. It actually ended up being about $4.82 per share, that First Internet Bancorp earned for the full fiscal year, last year, it was up 61% from 2020, No. 1. It was the best ever, it was their best year ever last year. There you go, that says a lot. Beat expectations for the quarter, which put it above expectations for the full year, of course, no outlook for the year.

Honestly, Brian, I understand why a bank, particularly a smaller bank, would not be issuing an outlook right now. We're in an environment where interest rates are almost certain to go higher. They could go higher every quarter and we could see the Fed lift rates every quarter this year. That creates a little bit of uncertainty for particularly smaller banks. In general it should increase their potential to make money. When you lend money and interest rates go up, you should be able to get better net interest margin and make money. But in my concerns I'll talk about some reasons why I think there might be some yellow flags and things investors should be paying close attention to. Highlights first, so their interest costs. It did fall slightly in the fourth quarter, but at 0.84% that's not cheap, for a bank. I don't know how many people out there are getting a yield of 0.84%. I'm guessing most people would love to be getting a 0.84% yield right now. Net interest margin is up to 2.3%, so that's good. That's the spread between what it has to pay out to depositors and what it's able to earn on its loans.

Withers: That's not too shabby.

Hall: That's good that that's growing and that great year is reflected in return on assets. This is return on average assets and return on average equity, 1.19% and 13.14%. Again, the benchmarks for those numbers are 1% and 10%. If you're a bank doing better than that, than you are doing quite well. Really good. They've been working on some expansions with a lending partnership for some franchise financing and franchise lending. That looks like it's moving forward, so that's a positive thing that's happening. Brian, some things I'm a little bit paying close attention to, the loan portfolio is down almost 2% from the third quarter, so sequentially it declined. It's bigger than it was in 2020 or in 2019, which is good but it's declined. We didn't see the roll-off of payroll protection plan loans. The ones that were forgiven, so they showed on as long-term loans. These were just loans that got paid off. I'm watching that pretty closely. This is an environment that banks should be growing their loan book and they're not. That's concerning. The last thing.

Withers: They had almost top $3 billion in the loan book and it's come back from that.

Hall: It has. It was over $3 billion last year and it's below $2.8 billion now. It's just above $2.8 billion now, it was $2.75 billion in 2019. It is still above, but this is my biggest concern.

Withers: Go ahead.

Hall: Brian, this is my biggest concern here, 40% of its deposits are certificates of deposit, CDs. Here's the thing, that's really concerning for an internet bank because that means it's got a lot of rate shoppers that are depositing money there. That's not a good position to be in when interest rates are starting to go up, because you're going to have to raise your rates. Their costs that yield that interest cost number, I predict it's going to go up substantially this year, just to keep enough deposits to support their balance sheet. I'm really concerned about that as a risk and weighing on their returns, and their ability to grow their loan book this year.

Withers: The one thing when I looked through their earnings presentation, I was pretty impressed with the mix of loans that they have. They've consumer loans, they got mortgage, they got small business loans.

Hall: It's become more diverse over the past five years. It definitely has. But what they have not done and this is really important for a bank, is they've not diversified their deposits. Six years ago, Axos Financial was like 60% CDs. Now they're like 10% CDs, and it's like business accounts and checking and savings and all of these things. Then you see with First Internet, it's still 40% of their deposits. I'm really concerned about that. I really am.

Withers: Great year may not be followed up by a good year, but they also were very poised. They had a slide or two in the earnings presentation about when rates get raised, they are well positioned to take advantage of that. They have a plan in place, so they can capitalize.

Hall: We'll see. I'm not 100% convinced Brian, [laughs] I'm really not. We'll see.