Webster Financial: Outlook Remains Positive for Loan Growth and Margin Expansion

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tupungato

Earnings of Webster Financial Corporation (New York Stock Exchange: WBS) would benefit from high single-digit loan growth, in line with historical trend. In addition, expanding margins will support earnings growth. Overall, I expect Webster Financial to report GAAP earnings of $3.77 per share for 2022 and $6.73 per share for 2023. Compared to my last report on the business, I increased my earnings estimate because I revised up both my loan balance and my margin estimates. Next year’s target price suggests a strong upside from the current market price. Therefore, I maintain a buy rating on Webster Financial Corporation.

Loan growth to return to historic range

Webster Financial Corporation’s loan growth remained above the historical average in the third quarter, which exceeded my expectations. The portfolio grew by 4.8% during the quarter, or 19.3% on an annualized basis. Loan growth will likely return to a level closer to the historical average in the coming quarters due to high interest rates. The production of residential real estate loans is particularly sensitive to borrowing costs because buyers of new homes may postpone their purchases until next year or another more feasible period. Fortunately, Webster Financial focuses more on commercial loans than residential loans. Residential real estate and home equity lines of credit accounted for 19% of total loans, while the rest were mostly commercial loans, according to details given in the third quarter 10-Q filing.

However, I do not expect loan growth to fall below the historical range due to continued strength in labor markets. While Webster Bank’s physical presence is concentrated in the Northeastern United States, particularly New York, Connecticut, Rhode Island, and Massachusetts, the bank serves customers nationwide. Therefore, the national average unemployment rate is a good indicator of credit demand. As shown below, the unemployment rate has not been this low in decades.

Chart
Data by YCharts

Given these factors, I expect the loan portfolio to grow by 2% each quarter through the end of 2023, driving full-year loan growth of 119% for 2022 and 8% for 2023. Compared to my last report on Webster Financial, I have not changed my loan growth estimates for the fourth quarter of 2022 and the full year of 2023. However, my updated loan balance estimates are higher now because loan growth exceeded my expectations in the third quarter.

Meanwhile, I expect other balance sheet items to grow somewhat in line with lending. The following table shows my balance sheet estimates.

EX18 FY19 FY20 FY21 FY22E FY23E
Financial situation
Net loans 18,253 19,828 21,282 21,971 48,195 52,167
Net loan growth 5.4% 8.6% 7.3% 3.2% 119.4% 8.2%
Other productive assets 7,454 8,477 8,978 10,834 15,406 16,032
Deposits 21,859 23,325 27,335 29,847 55,089 59,630
Loans and sub-debts 2,635 3,704 1,696 1,249 5,880 5,999
Common equity 2,741 3,063 3,090 3,293 7,445 8,038
Book value per share ($) 29.7 33.3 34.3 36.5 42.8 46.2
Tangible BVPS ($) 23.6 27.2 28.1 30.3 27.2 30.6
Source: SEC filings, author’s estimates ($ millions, unless otherwise noted)

Further increase in margin to improve bottom line

Webster Financial Corporation’s net interest margin increased 26 basis points in the third quarter after rising 24 basis points in the second quarter of this year. The rising rate environment was the primary reason for margin growth.

Due to large balances of residential securities and loans, slightly more earning assets bear fixed rates than floating rates. Fixed rate loans and securities represented 51% while variable and periodic rate assets represented 49% of total performing assets at the end of September 2022, as mentioned in the results presentation. At the same time, a majority of deposits bore adjustable rates. Interest-bearing checking accounts, money market accounts, savings accounts and health savings accounts together accounted for 52% of total deposits at the end of the last quarter.

Although the fixed-to-floating ratio is quite close on both sides of the balance sheet, Webster Financial has widened its margin over the past two quarters, showing that the bank has a lot of pricing power. The results of the management interest rate sensitivity model also show that the revaluation of assets can exceed the revaluation of liabilities. According to the model results, a 200 basis point increase in interest rates could increase net interest income by 8% year-over-year, as mentioned in the results presentation.

Sensitivity of net interest income

Presentation of 3rd quarter 2022 results

I expect the fed funds rate to rise 75 basis points through mid-2023 from the current level of 4.0%. Given these factors, I expect the margin to increase by 20 basis points in the last quarter of 2022 and by 12 basis points in 2023. Compared to my last report on Webster Financial, I increased my margin estimates for the next five quarters because margin growth so far has exceeded my expectations. Also, my interest rate outlook is now more hawkish than before.

Expected earnings of $6.73 per share for 2023

Expected loan growth and spread expansion will drive earnings through the end of 2023. Meanwhile, the ratio of net provision expense to total loans is likely to remain at the same level as the past five-year average. .

Overall, I expect Webster Financial to report earnings of $3.77 per share for 2022 (including one-time merger-related expenses related to the acquisition of Sterling Bancorp earlier this year) and of $6.73 per share for 2023. The following table shows my balance sheet estimates.

EX18 FY19 FY20 FY21 FY22E FY23E
income statement
Net interest income 907 955 891 901 2,025 2,527
Allowance for loan losses 42 38 138 (55) 266 112
Non-interest income 283 285 285 323 447 437
Non-interest charges 706 716 759 745 1,362 1,305
Net income – Common Sh. 352 373 211 399 657 1,170
BPA – Diluted ($) 3.81 4.06 2.35 4.42 3.77 6.73

Source: SEC Filings, Author’s Estimates

(In millions of dollars, unless otherwise indicated)

In my last report on Webster Financial, I estimated earnings of $3.49 per share for 2022 and $6.07 per share for 2023. I have increased my earnings estimates for both years because I revised my margin estimates upwards. Additionally, I slightly increased my loan balance estimates as Q3 performance exceeded my expectations.

My estimates are based on certain macroeconomic assumptions which may not materialize. Therefore, actual profits may differ materially from my estimates.

Maintaining a Buy rating due to a high rising price

Webster Financial has held its quarterly dividend constant at $0.40 per share since the second quarter of 2019. This level of dividend and my earnings estimate suggest a payout ratio of 24% for 2023, which is below the average for last five years by 43%. Due to the high spread between the projected payout ratio and the historical average payout ratio, there is room for higher dividends. Nonetheless, I don’t expect Webster Financial to change its dividend level this year to remain cautious.

I use historical price/book tangible (“P/TB”) and price/earnings (“P/E”) multiples to value Webster Financial. The stock has traded at an average P/TB ratio of 1.58 in the past, as shown below.

FY19 FY20 FY21 Medium
T. Book value per share ($) 27.4 28.1 30.3
Average market price ($) 49.8 32.5 53.7
Historical P/TB 1.82x 1.16x 1.77x 1.58x
Source: Company Financials, Yahoo Finance, Author’s Estimates

Multiplying the average P/TB multiple by the expected tangible book value per share of $30.6 yields a target price of $48.4 for the end of 2023. This price target implies a decline of 10.3% compared to the closing price on November 9. The following table shows the sensitivity of the target price to the P/TB ratio.

Multiple P/TB 1.38x 1.48x 1.58x 1.68x 1.78x
TBVPS – Dec 2023 ($) 30.6 30.6 30.6 30.6 30.6
Target price ($) 42.3 45.3 48.4 51.4 54.5
Market price ($) 54.0 54.0 54.0 54.0 54.0
Up/(down) (21.7)% (16.0)% (10.3)% (4.7)% 1.0%
Source: Author’s estimates

The stock has traded at an average P/E ratio of around 12.8x in the past, as shown below.

FY19 FY20 FY21 Medium
Earnings per share ($) 4.06 2.35 4.42
Average market price ($) 49.8 32.5 53.7
Historical PER 12.3x 13.9x 12.1x 12.8x
Source: Company Financials, Yahoo Finance, Author’s Estimates

Multiplying the average P/E multiple by the expected earnings per share of $6.73 yields a price target of $85.8 for the end of 2023. This price target implies a 59.1% upside from at the November 9 closing price. The following table shows the sensitivity of the target price to the P/E ratio.

Multiple P/E 10.8x 11.8x 12.8x 13.8x 14.8x
EPS 2023 ($) 6.73 6.73 6.73 6.73 6.73
Target price ($) 72.4 79.1 85.8 92.6 99.3
Market price ($) 54.0 54.0 54.0 54.0 54.0
Up/(down) 34.1% 46.6% 59.1% 71.5% 84.0%
Source: Author’s estimates

Equal weighting of target prices from both valuation methods gives a combined result target price of $67.1, implying a 24.4% upside from the current market price. Adding the forward dividend yield gives an expected total return of 27.3%. Therefore, I adopt a buy rating on Webster Financial Corporation.

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