Banks: Correlation Between ROTCE And P/TBVVW Staff
Sterne Agee analyst Todd Hagerman says a return on equity always matters as he takes a look at some top-rated banks.
We expect the strong historical correlation between ROTCE and P/TBV for bank stocks to remain in place, barring a recession, of course. This week’s Bank Weekly highlights the ROTCE and P/TBV framework by region and four BUY-rated bank stocks that are trading at discounts relative to regional peers, based on 2015E projections. The four BUY-rated names, Ameris Bancorp (NASDAQ:ABCB), Financial Institutions, Inc. (NASDAQ:FISI), First NBC Bank Holding Company (NASDAQ:NBCB), and Susquehanna Bancshares Inc (NASDAQ:SUSQ), all are projected to have loan growth that will be above consensus expectations.
The correlation between ROTCE and P/TBV is strong…regardless of region
Across the four regions of the U.S., the correlation between ROTCE and P/TBV was 0.58%, with the Midwest ranking lowest at 48% and the Northeast the highest at 68%. In aggregate, ten U.S. banks with a market cap of $300 million to $5 billion, traded substantially below the regression line (greater than one standard deviation), four in the Northeast peer group (Customers Bancorp Inc (NASDAQ:CUBI), Susquehanna Bancshares, First NBC Bank, and First Niagara Financial Group Inc. (NASDAQ:FNFG)), two in the Southern peer group (NBCB and ABCB), three in the Midwest peer group (Great Southern Bancorp, Inc. (NASDAQ:GSBC), Flagstar Bancorp Inc (NYSE:FBC), and Heartland Financial USA Inc (NASDAQ:HTLF)) and one in the West Coast peer group (Wilshire Bancorp Inc (NASDAQ:WIBC)). While in many cases there are good reasons for banks to trade at a discount or premium valuation relative to peers, we believe the greatest opportunity to make strong returns exists in buying banks that trade below the regression line, provided there is a reasonable basis for ROTCE improvement.
Opportunity for multiple expansion exists with these banks
In the case of Ameris Bancorp (NASDAQ:ABCB), we project that EPS will improve to $1.60 in 2014 vs. an operating EPS run-rate of $1.00 in 4Q13. As a result, we project that ROTCE will improve to 16% in 2014E vs. ~10% on an operating basis in 4Q13. For First NBC Bank Holding Company (NASDAQ:NBCB), we believe that the valuation will improve as loan growth remains near 20%, which should drive strong pretax improvement Y/Y in 2014E-2015E. Also, we believe that the market will gain more comfort with the nature of First NBC Bank Holding’s tax credit business. For Financial Institutions, Inc. (NASDAQ:FISI), we believe that as the company executes its strategy of growing loans, holding expenses, and taking market share in upstate NY, Financial Institutions will begin to trade more in line with upstate NY and New England Peers at 13.0x and 193% of TBV vs. 10.6x and 161% for Financial Institutions. In the case of Susquehanna Bancshares Inc (NASDAQ:SUSQ) , we expect the valuation will improve as management focuses on delivering solid bottom line returns and an improving balance sheet profile, which should rebuild credibility after two disappointing quarters.
Stronger than expected loan growth should benefit returns
Consensus loan growth is projected to be 7% for all banks in 2015E vs. 12% for our four BUY-rated banks. When looking at P/E multiples for 2014E and 2015E, Ameris Bancorp (NASDAQ:ABCB), Financial Institutions, Inc. (NASDAQ:FISI), First NBC Bank Holding Company (NASDAQ:NBCB), and Susquehanna Bancshares Inc (NASDAQ:SUSQ) are trading for significantly lower P/Es of 12.6x in 2014E and 11.2x in 2015E relative to 15.4x and 13.8x, respectively, for U.S. banks. Once strong loan growth surfaces, among other factors, we believe that higher ROTCEs will drive P/TBV (and P/E) multiple expansion. After all, investors only care about one thing…higher returns!