Macatawa Bank: Lower average loan balance to drag earnings this year (NASDAQ: MCBC)

Macatawa Bank Corporation’s (NASDAQ: MCBC) earnings will likely decline this year due to the recent downtrend in lending. Although the loan portfolio will likely bottom out by the middle of this year and trend upwards in the latter part of the year, the average loan balance will most likely remain well below the average balance for 2021. Additionally, lower non-interest income and higher net provision expense in the second half of 2022 will likely weigh on earnings. On the other hand, a slight expansion in margins amid rising interest rates and an improving asset mix will likely support the bottom line. Overall, I expect Macatawa Bank to report earnings of $0.71 per share in 2022, down 16% year-over-year. The year-end target price is quite close to the current market price. Therefore, I adopt a Hold notation on Macatawa Bank Corporation.

Average loan balance will be lower this year thanks to last year’s decline

Macatawa Bank’s loan portfolio declined by 22.6% in 2021, in part due to a reduction in residential mortgage and consumer loan portfolios, as mentioned in the earnings release. In addition, the cancellation of Paycheck Protection Program (“PPP”) loans throughout the past year has reduced the total size of the loan portfolio. As mentioned in the earnings release, PPP loans fell from $229 million at the end of December 2020 to $42 million at the end of December 2021.

A further decline in the size of the loan portfolio cannot be ruled out as the PPP loan portfolio still represents a significant proportion of the total loan portfolio size. Outstanding PPP loans represented approximately 3.8% of total loans at the end of December 2021. I expect most of these loans to be canceled in the first half of 2022; therefore, the size of the loan portfolio will likely shrink in the first half of the year.

However, there is a good chance that the portfolio will bottom out by the middle of 2022 and start rising in the latter part of the year. Macatawa Bank operates in Michigan, where the economic recovery will likely boost loan growth in the second half of this year. The state’s unemployment rate trails most of the country, but is still much better than a year ago.

Also, I’m not too concerned about the recent drop in lending as deposits have risen sharply over the same period. This shows that Macatawa Bank is not losing its customers to competitors. The drop in lending seems more attributable to economic factors than to the weakening of partnerships. It is very likely that customers will return for loans once the economy improves to a point that stimulates demand for credit. As a result, I expect the loan portfolio to bottom out in mid-2022 once the PPP discount is complete, and then up in the second half.

Overall, I expect the portfolio to grow by 0.8% by the end of December 2022 compared to the end of December 2021. However, the average loan balance for the year will be well below the average balance from last year due to the downward trend. throughout 2021. Overall, I expect the average balance in 2022 to be 11.8% lower than last year’s average balance. Meanwhile, deposit growth will likely match period-end loan growth in 2022. The following table shows my balance sheet estimates.

	EX18	FY19	FY20	FY21	FY22E
Financial situation
Net loans	1,389	1,368	1,412	1,093	1,102
Net loan growth	6.5%	(1.5)%	3.2%	(22.6)%	0.8%
Other productive assets	443	563	1,086	1,694	1,763
Deposits	1,677	1,753	2,299	2,578	2,683
Loans and sub-debts	101	81	91	85	85
Common equity	191	217	240	254	267
Book value per share ($)	5.64	6.39	7.03	7.43	7.82
Source: SEC Filings, Author’s Estimates
(In millions of dollars, unless otherwise indicated)

Excess cash, interest rate sensitivity to boost margin

Due to the substantial decline in the loan portfolio, cash and cash equivalents continued to accumulate on Macatawa Bank’s books throughout the past year. In fact, the company now has more cash and cash equivalents than loans. Federal funds sold and other short-term investments were $1.1 billion at the end of December 2021, compared to $752.3 million at the end of December 2020. The following chart shows the trend of the composition of the asset.

Although the excess cash position has hurt sales in the past, it will benefit sales in the months ahead. Indeed, Macatawa Bank can easily deploy the cash into higher-yielding assets as soon as the fed funds rate begins to rise this year.

Besides the ability to reposition the asset mix, net interest income can also benefit from its sensitivity to changes in interest rates. Based on management’s interest rate sensitivity analysis presented in Q3’s 10-Q filing, a 100 basis point increase in interest rates can increase net interest income by 9.58% over 12 months.

Given these factors, I expect the net interest margin to remain stable in the first half of 2022 and then increase by six basis points in the second half.

Further releases of reserves are likely in the first half of the year

Macatawa Bank reversed much of its previous provisioning in 2021. A further reversal of provisioning cannot be ruled out as the level of provisioning appears high while non-performing loans are almost negligible. Non-performing loans made up just 0.01% of total loans, while provisions made up 1.43% of total loans, as reported in the earnings release. As a result, I expect a net provision reversal of approximately $1 million in the first half of 2022.

For the second half of the year, I expect the provision charge, net of reversals, to trend higher due to planned loan additions. Overall, I expect the company to report a net provision charge of $0.1 million in 2022, representing 0.01% of total loans.

Earnings are expected to fall to $0.71 per share

The decline in the average loan balance this year is likely to be the biggest driver of lower earnings. In addition, the decrease in provision reversals will probably weigh on the net result. In addition, non-interest income will likely be lower this year due to reduced mortgage refinancing activity. Mortgage refinance revenues have been declining throughout 2021 and will likely stabilize near a normal range this year due to a rising interest rate environment.

On the other hand, the expansion of margins in the latter part of the year will likely support earnings. Overall, I expect Macatawa Bank to report earnings of $0.71 per share in 2022, down 16% year-over-year. The following table shows my income statement estimates.

	EX18	FY19	FY20	FY21	FY22E
income statement
Net interest income	60	63	62	56	53
Allowance for loan losses	0	(0)	3	(2)	0
Non-interest income	18	20	24	24	22
Non-interest charges	44	44	46	46	45
Net income – Common Sh.	26	32	30	29	24
BPA – Diluted ($)	0.78	0.94	0.88	0.85	0.71
Source: SEC Filings, Author’s Estimates
(In millions of dollars, unless otherwise indicated)

Actual earnings may differ materially from estimates due to risks and uncertainties related to the COVID-19 pandemic.

MCBC does not seem to have an attractive price

Macatawa Bank offers a dividend yield of 3.4% at the current quarterly dividend rate of $0.08 per share. Earnings and dividend estimates suggest a payout ratio of 45% for 2022, which is above the five-year average of 35% but still within an easily manageable level. Therefore, I don’t think the earnings outlook threatens to cut dividends.

I use historical price-to-book (“P/B”) and price-to-earnings (“P/E”) multiples to value Macatawa Bank. The stock has traded at an average P/B ratio of 1.48 in the past, as shown below.

	EX18	FY19	FY20	FY21	Medium
Book value per share ($)	5.6	6.4	7.0	7.4
Average market price ($)	11.09	10.34	7.94	8.86
Historical P/B	1.97x	1.62x	1.13x	1.19x	1.48x
Source: Company Financials, Yahoo Finance, Author’s Estimates

Multiplying the average P/B multiple by the expected book value per share of $7.82 yields a target price of $11.5 for the end of 2022. This price target implies a 22.3% upside from relative to the February 15 closing price. The following table shows the sensitivity of the target price to the P/TB ratio.

Multiple P/B	1.28x	1.38x	1.48x	1.58x	1.68x
BVPS Dec 2022 ($)	7.82	7.82	7.82	7.82	7.82
Target price ($)	10.0	10.8	11.5	12.3	13.1
Market price ($)	9.4	9.4	9.4	9.4	9.4
Up/(down)	5.7%	14.0%	22.3%	30.6%	38.9%
Source: Author’s estimates

The stock has traded at an average P/E ratio of around 11.2x in the past, as shown below.

	EX18	FY19	FY20	FY21	Medium
Earnings per share ($)	0.78	0.94	0.88	0.85
Average market price ($)	11.09	10.34	7.94	8.86
Historical PER	14.2x	11.0x	9.0x	10.4x	11.2x
Source: Company Financials, Yahoo Finance, Author’s Estimates

Multiplying the average P/E multiple by the expected earnings per share of $0.71 yields a price target of $8.0 for the end of 2022. This price target implies a decline of 15.7% from at the closing price on February 15. The following table shows the sensitivity of the target price to the P/E ratio.

Multiple P/E	9.2x	10.2x	11.2x	12.2x	13.2x
EPS 2022 ($)	0.71	0.71	0.71	0.71	0.71
Target price ($)	6.5	7.2	8.0	8.7	9.4
Market price ($)	9.4	9.4	9.4	9.4	9.4
Up/(down)	(30.8)%	(23.3)%	(15.7)%	(8.2)%	(0.6)%
Source: Author’s estimates

Equal weighting of target prices from both valuation methods gives a combined result target price of $9.8, implying a 3.3% upside from the current market price. Adding the forward dividend yield gives an expected total return of 6.7%. Therefore, I adopt a Hold rating on Macatawa Bank.

The upside is not high enough for me to consider buying a company that is likely to have lower profits this year. I would consider investing in the stock only if its market price drops more than 15% from the current level.