Introduction

In the fixed income portion of my investment portfolio, I still have a long position in the publicly traded fix-to-float debt security issued by First Internet Bancorp (NASDAQ:INBK). Over a year ago, I was wondering if First Internet Bancorp was just an innocent victim of the banking crisis, and I argued the fix-to-float debt security was an interesting investment idea given its steep discount to the $25 principal value at the time and the anticipated interest increase due to the floating nature of the coupon from this summer on.

And although NASDAQ:INBKZ is a debt security and not a [preferred] equity security, I still like to keep track of the bank’s financial performance just to make sure I don’t have to worry about my exposure.

The Net Interest Margin should be bottoming out

I was pleasantly surprised to see the bank’s net interest income increased in the first quarter of the year. As the income statement below shows, the total interest income increased from $52M to $68.2M and that $16.1M increase was higher than the $15M increase in the interest expenses. And this indeed meant the net interest income increased by approximately $1.15M to $20.7M. And although the size of the balance sheet increased, the increasing net interest income was mainly caused by an expanding net interest margin. Whereas the NIM was just 1.58% in the final quarter of last year, the Q1 2024 NIM increased to 1.66%. While that is still down from the 1.89% NIM in Q1 2023, I’m already happy to see the bank’s net interest margin appears to be improving.

The bank also recorded $8.35M in non-interest income, and the majority of that income was related to the $6.5M gain on the sale of loans. The total non-interest expenses barely increased on a YoY basis, and this resulted in a pre-tax and pre loan loss provision income of $8.2M. Definitely an improvement compared to the $4M in Q1 2023. Additionally, the total amount of loan loss provisions decreased.

As the image above shows, the bank recorded just $2.6M in loan loss provisions in the first quarter of the year, compared to a hefty $9.4M in Q1 2023 (when the US banking system was rattled by the failure of some smaller banks). And while the high amount of loan loss provisions in Q1 2023 pushed the bottom line into the dark red territory last year, the pre-tax earnings easily absorbed the more reasonable loan loss provisions in the first quarter of the current year.

The bottom line indeed shows a net profit of $5.2M, which represents an EPS of $0.60. And as First Internet Bancorp pays a very minimal dividend of just $0.06 per share on a quarterly basis, the majority of its earnings are retained on the balance sheet.

A closer look at the bank’s loan book

So from an earnings perspective, First Internet Bancorp appears to be attractively priced at its current valuation, but I obviously also wanted to have a closer look at the loan book to see if there is a noticeable change in the exposure to loans that are classified as ‘past due’.

Looking at the asset side of the balance sheet below, we see a small expansion to $5.34N and First Internet saw its loan book expand by just over $65M while the cash balance and the securities portfolio expanded as well.

The bank is still running a very liquid balance sheet. It has in excess of $480M in cash and cash equivalents on its balance sheet while there is an additional $718M held in securities available for sale and securities held to maturity (with the fair value of the latter being approximately $21.5M lower than the almost $236M book value of the securities held to maturity. The total size of the loan book was almost $3.91B and approximately $3.87B on a net basis after taking the accumulated loan loss provisions into account.

As you can see below, the loan book offers a decent diversification, although commercial real estate remains an important part of the loan book.

While several market commentators are getting nervous when they hear the words ‘commercial real estate’, the risk level obviously depends on the underwriting risk or purchase risk of the loans, and a low LTV ratio should shield a bank from any major issues. And as you can see below, in First Internet Bancorp’s case the commercial real estate doesn’t have a single loan that is classified as past due: every single loan in the CRE segment is current. And as the overview below shows, the main problem child is the small business lending division, which represents in excess of 55% of the total of $20.1M in loans past due.

That’s a pleasant surprise and even in the Single Tenant Lease Financing, which represents the largest block in the total loan portfolio, there are no loans past due at this time. And I think the main reason for that is the low LTV ratio in the portfolio. The average LTV ratio in the single tenant lease financing portfolio is just 46%. The Red Lobster bankruptcy will be followed up on closely, but for now, all properties remain open.

Additionally, the total exposure to office real estate is less than 1% of the total loan book. Negligible.

I still have a long position in its fix-to-float debt securities

I currently have no position in First Internet Bancorp’s common shares, but I have a long position in the listed baby bond, which has a principal value of $25 and is currently trading at $24.68. The baby bond had a 6% coupon until the end of June, and the baby bond now offers a floating rate until called or until the maturity date in 2029.

From this quarter on, the yield was supposed to be floating based on a 3 month LIBOR + 411 bps but as the LIBOR no longer is in use, this will be replaced by the 3 month SOFR plus the usual 26 bp mark-up. This means that at the current SOFR, the yield will jump to 10% and I am a bit surprised the bank hasn’t called the security yet. After all, it is a relatively small issue of just $37M, but the $1.4M in additional annualized interest expenses will be felt as well. It is possible the bank is counting on decreasing interest rates, but even if the 3 month SOFR would drop to 2.5%, the total cost of debt would still be close to 7%. I think the security will eventually be called, but First Internet Bancorp doesn’t appear to be in a rush, and perhaps it wants to see a few quarters of improving financial results before pulling the trigger.

Investment thesis

I have a long position in the baby bonds of First Internet Bancorp as I like the yield (especially now the floating yield will be quite generous in the next few quarters). That being said, now the bank’s share price has come down while the net interest margin appears to be bottoming out, the stock isn’t too expensive either, and I expect the net profit to increase again. Meanwhile, the stock is trading at a discount of approximately 35% compared to the tangible book value per share.

I will continue to add to the baby bonds on weakness (unless, of course, the financial performance of the bank deteriorates). I may also establish a long position in the common shares, but I haven’t made a decision yet.