In banking, it’s generally best to control your own growth as much as possible – on the whole, banks that generate strong organic core earnings growth outperform those that acquire it, and banks that generate strong organic core earnings growth Above average loans tend to outperform those that rely on more on rate sensitivity. Which does Sandy Spring Bancorp (SASR) a name worth considering, especially because of its leverage on the attractive and growing Washington, DC – Baltimore metropolitan corridor.
Sandy Spring isn’t particularly rate sensitive, but with Russia’s war in Ukraine driving up commodity prices (energy in particular) and greater uncertainty, that might not be such a bad news. thing, because rising oil prices could slow the economy enough to push at least one rate hike on the table. On the other hand, the bank has shown it can generate good organic loan growth, and the pipeline to 2022 looks good.
The evaluation is not as clear as I would like. Stocks aren’t particularly cheap on a ROTCE basis or as cheap as I’d like on long-term core earnings, but the P/E isn’t that high for a bank that should be generating good growth profits in an attractive market.
A growth bank in a growing market
Leveraging a well-established brand in the affluent suburb of Washington, DC, Sandy Spring is well positioned to take advantage of loan growth opportunities in the sixth largest metropolitan area in the United States. Not only is the DC metro area attractive in terms of size and average incomes, the federal government’s influence tends to insulate the region from the cyclicality seen in other markets – in good times and bad, the government federal tends to keep growing and keep spending money.
Sandy Spring is, and will remain for the foreseeable future, primarily a real estate lender, with about half of its loan portfolio in owner-occupied and investor-occupied commercial real estate. Given the good yields on these loans and the fact that the DC real estate market tends to be much less cyclical than other markets, that doesn’t concern me that much, especially given a superior credit quality history on average.
At the same time, however, the bank has actively sought to expand its core C&I corporate lending business. C&I loans have reached almost 20% of the loan book (compared to 12% just a few years ago), and the bank continues to recruit loan officers from major banks in the market. I like this change, and I believe there’s a good opportunity for smaller banks to take a bite out of established big players on a service basis – something that should be boosted in Sandy Spring as it rolls out its new “ncino” commercial lending platform. .
Further emphasizing the potential of the DC market, I would note that Pinnacle Financial Partners (PNFP), one of my favorite growth mediums, recently made DC one of its new target markets, hiring a super-region commercial lending team to lead the initial charge. While the presence of a new high-load bank in the market isn’t exactly an unmitigated advantage for Sandy Spring, there is more than enough room in the DC area for two growing commercial lenders.
A largely DIY growth plan
Sandy Spring hasn’t shunned M&A in the past and doesn’t ignore opportunities for growth by acquisition today, but the growth plan here doesn’t revolve around M&A, and overall, this is often a good thing. While cautious M&A is a valid strategy for banking industry growth, too many banks are wasting shareholder capital on deals with limited synergies and value creation potential.
Sandy Spring finalized a banking deal in 2020, acquiring Revere Bank and expanding its presence in the DC-Baltimore corridor, and management said it potentially wants to add to its footprint in a radius of about 100 miles of its existing operating footprint – a target area that would include Richmond, VA (a deposit market of approximately $130 billion), Harrisburg, PA (a market of approximately $30 billion) and the outer edges of the Philly MSA.
Besides occasional deals, Sandy Spring’s growth will be driven by its lending operations. Loans grew more than 5% on an adjusted basis at the end of the period in the fourth quarter, an above-average level of growth, with double-digit growth in C&I loans (+13% year-on-year) and lending. real estate held by investors (up more than 10% q/q). The pipeline for 2022 looks solid, and I expect high single-digit loan growth in 22 and 23, excluding PPP liquidations, as the bank benefits from a recovering economy and shares growth opportunities in the C&I space.
One area where I don’t see a lot of leverage is asset sensitivity – the bank’s leverage at higher rates. More than half of Sandy Spring’s loans are fixed rate, and the bank’s relatively high loan-to-deposit ratio also limits rate sensitivity, with the bank estimating that a 100 basis point change in rates would only cause growth of around 2% in net interest income – well below the 5% to 6% average for most banks these days.
Below-average asset sensitivity entering a tightening cycle is less than ideal, but it’s not a huge strike against the bank. Sandy Spring will benefit from higher rates, especially as it puts more fixed rate loans on its books at higher rates, but it will be a longer process. Additionally, relative to more asset-sensitive banks, Sandy Spring is less vulnerable to rate hike disappointments if the surge in oil prices ultimately leads to a longer cycle from the Fed.
I would like to see more operating leverage from Sandy Spring. Rising operating expenses have weighed on recent quarterly results and this is an area that often gets a lot of investor attention. I don’t think Sandy Spring management is being lax with their spending, a lot of the opex seems to be going to areas that will support further growth (hiring new lending teams, reinvesting in IT capabilities, etc.) , and the efficiency ratio is not problematic, but it is a trigger for earnings growth.
On the earnings outlook, PPP runoff and a normalization of reserves (no repeat of negative reserve charge in 2021) will put pressure on 2022 reported earnings, but Sandy Spring is expected to return to elevated growth at single-digit earnings before provision in 2023 and I expect at least a few years of high single-digit core earnings growth before growth slows towards the upper end of the mid-digits. I expect Sandy Spring to remain a very profitable bank, with teenage ROTCEs.
Long-term discounted core earnings suggest double-digit long-term annualized return potential here. Likewise, a 12.5x multiple on FY23 earnings supports a fair value above $50, and I think that’s a fair P/E to the growth potential here. The ROTCE-based P/TBV isn’t as favorable, but I’m not surprised given that this metric doesn’t reward growth.
Compared to what I typically expect/ask of smaller banks, Sandy Spring is a boundary call at valuation, but I like the bank’s leverage in DC-Baltimore growth markets and the efforts targeted by the bank to develop its C&I lending business. While I can’t say it’s one of my main ideas in banking, it’s still a name worth considering.