West Bancorporation (NASDAQ:WTBA) shares performed well in the third quarter, which is expected to continue in the remainder of the year. Earnings are expected to improve even further in 2020 on the back of loan growth. Due to the earnings increase, WTBA's rising dividend trend is expected to continue through next year.
WTBA showed stronger than expected loan growth in the third quarter, and I now expect the impressive growth to continue in the fourth quarter of 2019. My assumption is mostly based on the management's assertion that the pipeline for the fourth quarter is very robust. As mentioned in the 3QFY19 conference call, WTBA has a lot of construction loans on which the management anticipates continued growth. Further, the management expects "big closings" in November and early December.
I'm expecting the loan book to continue to grow next year, albeit at a lower rate as the uncertainty of election year is expected to negatively affect credit demand in 2020. Deceleration of economic growth in the United States is also expected to curtail appetite for credit next year. The Federal Reserve Bank of Atlanta's GDP Now model is forecasting GDP growth to slow to 1.1% in the fourth quarter of 2019, as opposed to an estimated 1.7% in 3QFY19 and 2.0% in 2QFY19.
On the other hand, low interest rates and decline in payoffs as monetary easing ends are expected to keep loan growth elevated. The table below titled 'Financial Position' gives my estimates for WTBA's loans and other key balance sheet items.
I'm expecting allowances for loan losses to increase only because of an increase in loans. I do not expect the credit quality to worsen that would've required higher reserves. Further, according to management's comments in the conference call, they intend to delay the implementation of the new accounting standard for loan losses, CECL (Current Expected Credit Losses), which would've resulted in a jump in allowances reserve had the standard been implemented.
WTBA's net interest margin, NIM, is expected to improve in the short term as its deposits will reprise quicker than its earnings assets following Fed rate cuts. Moreover, according to management's comments in the conference call, WTBA has excess liquidity that the company wants to direct towards loans, as opposed to parking in investments or fed funds. As loans carry much higher rates than other earning assets, the deployment of funds in loans will improve margins in the future. According to the 3QFY19 10-Q, yields on loans were more than 200bps higher than the average yields on investments.
The company had some non-recurring interest income items in the third quarter, the absence of which is not expected to have any material impact on net interest income going forward. WTBA collected $175,000 of bank interest and $340,000 prepayment penalties and unamortized deferred fees during the quarter. I expect prepayment penalties to continue to remain elevated in the fourth quarter before tapering off once interest rates stabilize, most probably by the first quarter of 2020.
The table below shows my estimates for yield, cost, and margin.
Due to the expected loan growth and stable NIM, WTBA's net interest income is expected to increase by 6% year over year in 2020. This growth will be the major driver of earnings next year.
On the other hand, normal growth in salary expenses is expected to limit earnings growth. FDIC expenses are also expected to return to normal next year after remaining absent in the third quarter of 2019. The management expects FDIC expense to be zero again in the fourth quarter of 2020. However, non-interest expenses are expected to receive some relief from the elimination of charges related to the Minnesota initiative by next year.
Considering the expected movement in individual line items of the income statement, I expect WTBA's earnings per share to increase 7% year over year in 2020 to $1.91, as shown below.
In line with previous trend, I'm expecting WTBA to increase its quarterly dividend by $0.01 per share in the second quarter of 2020 to $0.22 per share. This will bring the full-year dividend to $0.87, implying a forward dividend yield of 3.64%.
The retained earnings are expected to increase WTBA's book value per share to $14.28 by the end of December 2020.
In my previous report on WTBA I had given a price target of $22.8 for December 2019, and adopted a bullish stance on the stock. I'm now rolling over my target price to $26.9 for December 2020. To value the company, I'm using the historical price to book value, P/B, method. WTBA has traded at an average P/B multiple of 1.88 in the past, as shown in the table below.
Multiplying the average P/B ratio with the forecast book value per share of $14.3 gives a December 2020 target price of $26.9. This target price implies a 12.3% upside from WTBA's November 1, 2019 closing price.
Due to the double digit potential price upside I'm adopting a bullish stance on WTBA. The price upside of 12.3% and dividend yield of 3.64% combine to give a total expected return of 15.9% for the next one year; hence, I'm recommending to buy the stock.
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