Can TriState Capital Rebound?

| About: TriState Capital (TSC)
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Summary

After a lot of selling, shares of TriState Capital have come back down to earth.

The bank has traded for a large growth premium, but it's time for core earnings to catch-up.

I have concerns but TSC could impress by continuing to add assets at the rate it has maintained over the past 5 years.

Grow I'll be honest, seeing rapid growth makes me suspicious. And even more so post-financial crisis. But if there's one bank that may have found a niche that allows safety and growth to coexist, that bank is TriState Capital (NASDAQ:TSC). Seeking to provide better service to middle market businesses and high-net-worth individuals, TSC has been running circles around its competition. So far, everything has gone according to plan, but how long can it last?

TSC Chart

TSC data by YCharts

Who Is TriState?

For those unfamiliar with the name, TriState Capital could be described as two different companies that can service the same customer. In one, you have a branchless middle market commercial bank (TriState Capital Bank), and in the other, an investment management business named Chartwell Investment Partners. The bigger of the two by far is TriState Capital Bank, which accounts for ~68% of all revenues. However, don't get too comfortable with that ratio because TSC recently announced a $30-35 million acquisition that is expected to lift Chartwell's contribution up to 41%.

Before getting into the details of the deal, here is a little background on both subsidiaries:

TriState Capital Bank

As of the 3rd quarter, TriState Bank had $3.1 billion in assets and $2.6 billion in deposits. Since 2010, the loan portfolio ($2.6 billion) has grown at an annual rate of 16.9%, with the largest source of growth coming from private banking. Private banking loans ended the quarter at 45% of the loan portfolio, up from 18% in 2010 (CAGR of ~31%). Since inception, operating profits have expanded as the bank has scaled-up, but while this implies leverage, it's important to note how stable the loans in the private banking 'channel' have performed. At the expense of higher margins, these loans are backed by marketable securities and, to date, they have never produced a loss. TSC said it was angling towards the underserved, but the risk is low and these assets will continue to grow net income as they are accumulated.

On the other side of the portfolio, the bank's middle market 'channel' has also grown but at a much lower rate (5% CAGR). I think it's safe to say that part of the reason this side of the portfolio has grown at a slower pace has to do with the fact that most regional banks are targeting these asset-sensitive loans (58% of the portfolio has floating rates), but another part of the equation has to do with funding. The loan-to-deposit ratio is slightly above 100%, and management is clearly trying to stay within this range. There are capital limits, of course, but part of scaling-up and profiting from the low yielding private banking loans depends on managing down interest expenses. And I have to be honest in saying that I'm starting to feel like an advertisement for the bank (I'm not), but the results are in, and the cost of deposits has come down to 0.51% from 1.38% in 2010. I mentioned in another article recently that I like to worry, and in this case, a deviation from the bank's flawless record is my largest concern. But this isn't a novice team, and asset quality is high (NCO/Avg. Loans peaked in 2011 at 0.46%, and the YTD run-rate is a fraction of this at 0.04%).

Chartwell Investment Partners

In December, TSC announced that it had reached an agreement to acquire The Killen Group (TKG) for $30-35 million ($15 million at close and the rest based on incremental EBITDA over the base rate of $3.0 million). This deal is expected to close in the second quarter, and when it does, Chartwell's AUM will increase by 32% to $10.1 billion. I mentioned earlier that after the merger is complete, this unit is expected to increase its contribution to total revenues from 32% to 41%, but I didn't mention that these are all non-interest revenue streams. And, within this line, fee-based income is expected to increase from 28% of all revenues to 37% (~$44.1 million). For many reasons this is a big win for the bank, but the most important one is that it satisfies management's long-stated goal of diversifying revenue (i.e. less reliance on interest income). The clip below is from the third-quarter presentation so it doesn't include the proforma info, but notice that while Chartwell's margins are thin (1/7 = 14%), the subsidiary requires very little capital in proportion to the amount of net income it is producing (3% of TCE but 18% of EPS) - a very favorable combination.

Valuation and Risk

At ~$11.60 per share, TriState could be a home run. However, while I'd love to graph YTD earnings and the bank's historic growth rate out into infinity, I believe that this year's reported earnings are somewhat inflated. For example, YTD pre-tax is ~$9.3 million higher than it was last year at this time, but this year's provision expense is $10.1 million less. Part of the higher charge in 2014 was made to accommodate a larger allowance account, but net charge-offs were $6.9 million. Going forward, a growing balance sheet is likely going to require more coverage and the bank's 0.73% allowance account already looks light (covers NPL's 101%). There's nothing here setting off alarms, but $10 million is equivalent to 40% of YTD pre-tax earnings. Accounting for this, the acquisition, loan growth and a moderate allowance build gets me to $0.75-$0.80 in core income next year, which values shares at 14-15X next year's earnings.

TSC is growing and could end up blowing past my estimate, but while optimistic, I think it's fair to say that without another purchase (and due to the provision benefits), earnings could stall before the next leg up. The stock is trading 20% lower than the 52-week high, but at only 1.2X TBV there is some support. As I said before, this could end up being a great time to buy but I'm a little more cautious here due to the fact that shares have been trading on growth and a big part of this year's is nonrecurring. The market will decide, but I'm lazy and would prefer to find a bank with an easier hurdle to clear.

Bottom Line

This is definitely an interesting play. TSC has been growing fast, but even after the fall, shares still appear to have some upside already baked-in. The bank is scaling up, and I like the fee-based focus, but there are a lot of cross currents and I could see the stock flatlining for a year or so as the bank's core outgrows reported earnings. The acquisition will help, but I'm looking for a deal and we are too close to fair value.

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.