Wintrust Financial Corporation (WTFC) has acquired two relatively small banks in the fourth quarter of 2019 that have given the company’s earning assets a boost. Going forward, organic growth is expected to help drive loans this year, thereby leading to an increase in net interest income, which in turn will support net income. However, a rise in operating expenses due to WTFC’s expansionary efforts are likely to negate the effect of loan growth on the bottom-line. Consequently, I’m expecting WTFC’s earnings per share to decline slightly in 2020 compared to 2019. My valuation analysis shows that the market is apparently undervaluing the stock as the one-year ahead target price is significantly above the current market price. As a result I’m adopting a bullish rating on WTFC.
Higher Earning Assets Following Acquisitions to Drive Net Interest Income
WTFC completed the acquisition of two bank holding companies in the fourth quarter of 2019, namely SBC Inc and STC Bancshares. According to a press release, SBC brought $434 million in loans, while according to another press release STC added $190 million in loans to WTFC’s balance sheet. I’m expecting the combined effect of SBC and STC to have increased WTFC’s loan portfolio by 2% in the fourth quarter of 2019. Organic growth is also expected to have expanded WTFC’s loan book in the fourth quarter, as the management mentioned in the third quarter conference call that their pipeline was strong. As a result I’m expecting WTFC’s loan portfolio to have increased by around 3.5% in 4QFY19 on a linked quarter basis.
Going forward, WTFC’s loan portfolio is expected to continue to grow but at a lower rate than in the past. The company usually manages double digit loan growth in a year, but I’m expecting a single digit growth rate for 2020 partly because WTFC usually grows through merger and acquisition activity and it hasn’t announced any such plans for this year yet. In addition, political uncertainty ahead of the presidential elections is expected to constrain loan growth. On the other hand, support for loan growth is expected to come from low interest rates that are likely to boost credit demand. As mentioned by the management in the conference call, the mortgage market reacts favorably as rates decrease, thereby providing lending opportunity. In light of these factors, I’m expecting WTFC’s loan book to grow by 6.1% in 2020, as shown in the following table.
Limited Room for Funding Cost Reduction to Squeeze Margins
The positive effect of loan growth on net interest income is expected to be partly offset by a compression in net interest margin, NIM. A drop in average yields following the three Fed rate cuts in 2019 is expected to be the major contributor towards dragging down NIM. The pressure on NIM is expected to be worsened by the limited ability of WTFC’s deposit cost to drop in tandem with yields. As mentioned in the conference call, expensive brokered funds were already only 5% of total funds at the end of the third quarter so there was not much opportunity to improve funding mix. In addition, although a fall in WTFC’s loan to deposit ratio (it fell to 89.6% by the end of September 2019 from 92% in June 2019) provided an opportunity to improve funding mix, the management appeared unwilling to reduce its borrowing. This is because, as mentioned in the conference call, the company’s borrowing is already at a cheap rate. The management believes it is better to buy back shares than to pay down the borrowing. In short, there is limited room for WTFC’s funding cost to decrease further to counter the impact of falling yields; hence, NIM is likely to face compression in 2020.
In addition, the hedging method WTFC uses to guard against adverse interest rate movements increases non-interest income, not net interest income. As mentioned in the third quarter 10-Q filing, the company has entered into certain covered call option transactions related to certain securities. These option transactions are used in place of other more common hedging instruments, such as interest rate floors. The revenue received from these options is recorded as non-interest income rather than interest income, therefore WTFC’s hedging efforts are unlikely to affect NIM in 2020.
As a result of the above mentioned factors, I’m expecting the average NIM in 2020 to be around 26bps below the average for 2019. The following table summarizes my estimates for yields, costs, and NIM.
The compression in NIM is expected to only partly offset the impact of loan growth on net interest income. Consequently, I’m expecting WTFC’s net interest income to rise by 2% in 2020 over 2019. This estimate is supported by management’s guidance given in the third quarter conference call. During the call, the management appeared optimistic about the growth of net interest income in 2020 because loan growth would undermine compression in net interest margin.
Expansion, Advertising to Drive Non-Interest Expense
The growth in net interest income is expected to be negated by a growth in non-interest expense. WTFC’s bigger size following the two acquisitions will naturally result in higher operating costs. In addition, the company opened fifteen new branches in the past fifteen months, which will further keep non-interest expenses at an elevated level. Moreover, the management mentioned in the conference call that they will continue to focus on their advertising efforts, which in my opinion will lead to higher operating costs. Based on these factors I’m expecting WTFC’s non-interest expense to increase by 6% in 2020 over 2019.
The increase in net interest income and non-interest expense is expected to lead to flattish growth in net income in 2020. On a per share basis earnings are expected to decline due to a slight increase in number of shares outstanding due to the acquisition of SBC and STC. As shown in the table below, I’m expecting WTFC’s earnings per share to drop to $6.22 per share in 2020.
Dividend Expected to be Maintained at $0.25 per Quarter
Due to the expectations of slight decline in earnings per share, I’m not expecting any hike in dividend in 2020. Instead, I’m expecting WTFC to hold its dividend per share in 2020 constant at the 2019 level, i.e. $0.25 per share every quarter. This dividend estimate suggests a modest dividend yield of 1.42%. There is very little likelihood of a dividend cut as the dividend and earning estimates suggest a payout ratio of only 16%. This ratio is higher than WTFC’s past seven-year average, but is lower than peers and is low enough to be easily maintained. In addition, WTFC’s tier I risk based capital ratio was comfortably above regulatory requirement, thereby limiting any need to cut dividends. The tier I ratio was at 9.7% at the end of September 2019, above the minimum regulatory requirement of 8.0%.
Significant Price Upside Expected
I’m using the historical price to book value multiple, P/B, to value WTFC. The stock has traded at an average P/B multiple of 1.28 in the past as shown below.
Multiplying this P/B ratio with the forecast book value per share of $66.2 gives a target price of $84.7 for December 2020. This target price implies a significant price upside of 20.5% from WTFC’s January 8 closing price. The following table shows sensitivity of the target price to P/B multiple.
Based on the substantial potential for price upside suggested by the target price, I’m adopting a bullish rating on WTFC. The stock appears too undervalued in the market, hence I believe it makes a good investment. Investors should conduct further research on WTFC before considering investing in it.
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.