Sterling Bancorp’s (STL) earnings are expected to continue to grow in 2020, mostly on the back of management’s cost-cutting efforts. The recent acquisition of an equipment finance portfolio is also expected to contribute to the bottom-line growth. On the other hand, a compression in net interest margin is expected to somewhat constrain earnings growth. As implied by my valuation analysis, the stock is currently undervalued in the market; hence, I’m adopting a bullish rating on STL.

Cost-Saving Measures to Drive the Bottom Line

The biggest support for STL’s net income is expected to come from a dip in non-interest expense this year. As mentioned by the management in the third quarter conference call, the company is focusing on cutting costs that will contract non-interest expenses in 2020. STL is concentrating on growing deposits through deposit channels, like commercial or branch-based consumer, that will give the company the opportunity to turn down financial centers. The management expected to reduce their financial centers to 80 by the end of 2020, from 87 centers at the end of September 2019. Consequently, I’m expecting STL’s non-interest expense to decrease by 5% to $431 million. My estimate is less optimistic than management’s expectation, as they mentioned in the conference call that they expect a core expense run rate of $415 million in 2020.

Acquisition of Portfolio to Lead to Higher Average Earning Assets

STL completed the acquisition of Santander Bank’s (NYSE:SAN) equipment finance portfolio worth $839 million in the fourth quarter, which will lead to higher average earning assets through 2020 than 2019. As a result, interest income will be driven up by higher average earning assets in 2020. Organic growth is also expected to push up STL’s earning assets this year. On the other hand, headwinds from political uncertainties are likely to curtail loan growth. Consequently, I’m expecting STL’s net loans to continue to grow in 2020 but at a lower rate than in the past. The following table presents my estimates for loans and other key balance sheet items.

Focus on Reducing Funding Cost to Help Margins

STL has recently focused on re-positioning its balance sheet to mitigate the impact of Fed rate cut on net interest margin (NIM). As mentioned in the third quarter investor presentation, around $900 million worth of FHLB deposits were scheduled to mature in 4QFY19, which will reduce overall deposit costs for 2020. In addition, $500 million of expensive certificates of deposits, CDs, matured in the fourth quarter, and another $1 billion are scheduled to mature in the first quarter of 2020. Rolling over of these CDs into cheaper costing deposits will bring down the average funding cost this year. Moreover, STL is focusing on reducing the proportion of securities in earning assets that the management believes will help NIM, as mentioned in the conference call.

On the other hand, some deterioration in funding cost is expected from STL’s new subordinated debt. The company issued subordinated notes worth $275 million in December 2019 at a rate of 4%. This is much higher than the weighted average rate of 1.16% on interest-bearing deposits and 3% on senior debt in the third quarter of 2019. As a result, this new issue will worsen overall funding cost.

Overall, I’m expecting a subdued impact of the three Fed rate cuts on STL’s NIM. I’m expecting the average NIM in 2020 to be 6bps below the average for 2019, as shown below.

Sterling Bancorp Net Interest Margin

Earnings Expected to Rise by 5%

I’m expecting STL’s net income to grow by 5% year over year in 2020, mostly on the back of cost curtailment efforts and acquisition of equipment financing portfolio, as discussed above. Further support for the bottom-line is expected to come from a small dip in provisions charge for credit losses. The management mentioned in the conference call that it is aiming to return to provisions charge to total loans ratio of 10-20bps from the current level of around 27bps. Consequently, I’m expecting STL’s provisions for credit losses to decline by 12% in 2020 to 17bps.

On the other hand, bottom-line growth is expected to be curtailed by NIM, as previously discussed. Furthermore, non-interest income is expected to return to normal after surging in the third quarter on the back of one-off items. Non-interest income in the third quarter surged due to one-time pension gain of $12.1 million and securities gains of around $8 million. The non-recurrence of these two items is likely to result in lower non-interest income in 2020 compared to 2019.

In light of the above-mentioned factors, I’m expecting STL’s net income to increase by 5% to $442 million. On a per share basis, I’m expecting earnings to rise to $2.17, as shown in the following table.

Sterling Bancorp Income Forecast

Equity Book Value to Increase to $23.6 per Share

STL has maintained its quarterly dividend constant at $0.07 per share since 2014. As there is no indication that this policy will be changed soon, I’m expecting the dividend to be maintained at the same level again in 2020. The payout ratio implied by this dividend estimate and the earnings forecast is only 12.9%, which is below both STL’s own historical trend and peer average. Hence, there is a chance that STL might consider changing its dividend policy and increase its dividends, thereby beating my estimate. The quarterly dividend estimate of $0.07 per share implies dividend yield of 1.35%.

In light of the earnings and dividend estimates, I’m expecting STL’s equity book value to increase in 2020. I’m also expecting the implementation of the Current Expected Credit Losses (CECL), standard to reduce equity book value by $61 million. My expectation is based on management’s guidance given in the conference call, wherein it mentioned that CECL can increase allowances for credit losses by between 50% and 60%. Based on the retained earnings and CECL estimates, I’m expecting STL’s equity book value to end the year at $23.6 per share.

Adopting Bullish Rating

I’m using the historical price to book value multiple, P/B, to value STL. The stock has traded at an average P/B multiple of 1.02 in the past as shown below.

Sterling Bancorp Historical Price to Book

Multiplying this P/B ratio with the forecast book value per share of $23.6 gives a target price of $24 for December 2020. This target price implies a significant price upside of 15.4% from STL’s January 9 closing price. The following table shows sensitivity of the target price to P/B multiple.

Sterling Bancorp Valuation Sensitivity

Based on the significant price upside, I’m adopting a bullish rating on STL. As the one-year ahead target price is 15.4% higher than the current stock price, I think STL can be a feasible investment. Investors should conduct further due diligence before considering investing in the stock.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Disclaimer: This article is not financial advice. Investors are expected to consider their investment objectives and constraints before investing in the stock(s) mentioned in the article.

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2020-01-12