Value Investing in Banking Sector Distress: Is First Internet Bancorp (INBK) a Bargain Opportunity?

The banking sector in 2025 is navigating a complex landscape of declining net interest margins, credit risk normalization, and regulatory shifts. Amid this backdrop, First Internet Bancorp (INBK) stands out as a potential value play, trading at a forward P/E ratio of 5.92—well below the US Banks industry average of 11.2x. This stark discount raises a critical question: Is INBK's 5x multiple a reflection of sector-wide pessimism, or does it signal an undervalued opportunity for investors willing to bet on its improving fundamentals?

Valuation: A Deep Discount Amid Sector-Wide Weakness

INBK's forward P/E ratio of 5.92 is a 39% discount to its 5-year average of 9.73 and a 48% gap below the sector average. While this could suggest market skepticism about its near-term earnings, the data reveals a more nuanced story. The stock is trading at a 40.4% discount to its estimated fair value of $37.19, implying significant upside if the market re-evaluates its fundamentals.

This valuation gap is not merely a function of poor performance. INBK's net interest margin (NIM) has expanded from 1.67% in Q2 2024 to 1.96% in Q2 2025, driven by higher loan yields and disciplined deposit cost management. The company's deposit base grew 7.1% quarter-over-quarter, reducing reliance on costly funding sources and bolstering liquidity. These metrics suggest a bank that is actively navigating sector headwinds through operational agility.

Fundamentals: Margin Expansion and Credit Resolution

INBK's second-quarter 2025 results highlight its ability to adapt to a low-rate environment. The net interest margin (NIM) increased by 29 basis points year-over-year, outpacing the sector's average NIM contraction. This was achieved through a 3.9% growth in average loan balances and a 3.7% rise in securities balances, coupled with a 6 bps decline in the cost of interest-bearing deposits.

Credit quality remains a concern but is showing signs of stabilization. Nonperforming loans (NPLs) rose to 1.00% of total loans in Q2 2025, driven by franchise finance and small business lending portfolios. However, the company has proactively applied reserves to problem loans and reduced specific reserves on charged-off small business loans, lowering the allowance for credit losses to 1.07% of total loans. This disciplined approach suggests INBK is addressing credit risks without over-reserving, preserving capital for future growth.

Efficiency and Noninterest Income: A Mixed Picture

INBK's efficiency ratio improved in Q2 2025, with noninterest expenses dropping 7.5% quarter-over-quarter to $21.8 million. This was driven by lower salaries and consulting fees, reflecting cost discipline. However, noninterest income fell 46% from Q1 2025 to $5.6 million, primarily due to a strategic shift in holding SBA 7(a) loans longer before sale. The company expects this to normalize in Q3 2025, with gain-on-sale revenue returning to historical levels.

This temporary drag on noninterest income underscores a key risk: INBK's reliance on non-core revenue streams. While the company's core net interest income grew 14% year-over-year, its ability to sustain profitability will depend on balancing credit risk, cost control, and diversification of income sources.

Sector Context: A Bank Outperforming Its Peers

The broader banking sector is grappling with a net interest margin contraction to 3% in 2025, driven by rate cuts and competitive deposit pricing. INBK's NIM trajectory—projected to reach 2.50–2.60% by 2026—positions it as a rare bright spot. The company's proactive asset-liability management, including leveraging fintech-driven deposit growth, has insulated it from the sector's margin pressures.

Regulatory tailwinds also favor INBK. The Basel III Endgame re-proposal, which reduces capital requirements for midsize banks, could amplify INBK's return on equity through share buybacks and capital optimization. Smaller banks like INBK, with $10 billion in assets, stand to benefit more from these changes than their larger peers.

Investment Thesis: A Value Play with Catalysts

INBK's 5x forward P/E is a compelling discount, but it must be contextualized with its improving fundamentals:
1. Margin Expansion: A projected NIM of 2.50–2.60% by 2026 would significantly outperform the sector's 3% average.
2. Credit Resolution: Proactive credit management is stabilizing NPLs and preserving capital.
3. Efficiency Gains: Cost discipline and deposit growth are enhancing operational leverage.

However, risks remain. The small business and franchise finance portfolios are still vulnerable to economic downturns, and noninterest income normalization is contingent on SBA loan sales resuming. Investors must weigh these risks against the potential for a re-rating if the market recognizes INBK's operational strengths.

Conclusion: A High-Conviction Value Opportunity

For value investors, INBK represents a high-conviction opportunity in a sector marked by pessimism. Its 5x forward P/E reflects a margin of safety, while its fundamentals suggest a path to margin expansion and credit resolution. The key catalysts—NIM growth, regulatory tailwinds, and normalized noninterest income—could drive a re-rating to its 5-year average P/E of 9.73, unlocking 65% of its current fair value discount.

Investment Advice: Investors with a 2–3 year horizon should consider a position in INBK as a long-term value play. Monitor credit resolution progress and NIM trends, and use any further dips in the stock price as buying opportunities. This is not a short-term trade but a bet on a bank that is outmaneuvering its peers in a challenging environment.