Acquisition of Oritani is expected to drive loan growth in 4QFY19. Some organic loan growth is also expected.
Net interest margin is expected to remain stable due to a favorable re-pricing gap.
Quarterly dividends are expected to be maintained at $0.11 per share, implying dividend yield of 3.65%.
Valley National Bancorp (VLY) is planning to close acquisition of Oritani Financial in the fourth quarter of 2019, which is expected to increase loans next year. The rise in earning assets is expected to in turn lead to higher earnings in 2020 compared to 2019. Following the third quarter results I've updated my earnings estimates and rolled over my target price to December 2020. I've also decided to maintain a bullish rating on VLY.
Oritani to Boost Loan Book
Acquisition of Oritani Financial Corp (ORIT) is expected to boost VLY's loans in the fourth quarter of 2019 by $3.5 billion, as mentioned in the merger announcement. Apart from M&A activity, VLY's loans are also expected to grow organically in the remainder of 2019 and in 2020. All of VLY's operating regions, New York, New Jersey, Alabama, and Florida, are expected to see decent economic growth, leading to modest credit demand next year. I'm expecting VLY's loan book to grow by 4.5% in 2020, as shown in the table below.
Re-pricing Gap to Support Net Interest Margin
VLY's balance sheet is in a favorable position that will benefit the company's net interest margin, NIM, in a declining interest rate scenario. As shown in the illustration below taken from the 3QFY19 earnings presentation, more liabilities than assets will mature and consequently re-price till the mid of 2020.
The above displayed forward re-pricing gap will ensure that funds re-price quicker than assets, thereby benefiting NIM in the next three quarters.
The positive effect of re-pricing gap on NIM will be partly offset by the jump in expensive time deposits in the third quarter of 2019. VLY's proportion of time deposits in total deposits increased to 30.8% by the end of September, up from 28.9% at the end of December 2018.
Another factor that will constrain NIM is the acquisition of Oritani. The management estimates the acquisition to lead to a compression in NIM of about 3bps. The table below shows my estimates for yield, cost, and margin.
Based on expectations of loan growth and slight NIM contraction, I'm expecting VLY's net interest income to increase by 10% year over year in 2020. For 2019, the management has given guidance of growth range of 3.5% to 4.5%.
Oritani Acquisition to Lift Expenses
VLY's non-interest expenses are expected to jump in the fourth quarter of 2019 when the company hopes to close the Oritani transaction. I'm expecting merger related expenses to increase total non-interest expenses by 20% quarter over quarter in 4QFY19, before tapering off in the first half of 2020. On the other hand, VLY has plans to consolidate nine branches upon conversion, which will constrain salary and occupancy expenses going forward. The to-be-closed branches include six Oritani branches and three legacy VLY branches. VLY has already closed 15 branches in 2019 to-date, which will also constrain related administrative expenses.
Earnings to Rise by 4.5%
Mostly due to the loan growth, I'm expecting VLY's earnings to increase by 22% year over year in 2020. Earnings per share, however, is expected to rise by 4.5% only due to an increase in number of shares following the acquisition of Oritani. The table below summarizes my estimates for key income statement items.
Tangible Book Value to Rise to $7.86 Per Share
In line with the historical trend, I expect VLY to maintain its quarterly dividend at $0.11 per share through 2020. This dividend estimate suggests a dividend yield of 3.65%. The dividend and earning estimates also suggest retained earnings of $0.58 per share in 2020.
While retained earnings will drive up VLY's book value per share, implementation of the new accounting standard, CECL (Current Expected Credit Losses) is expected to have a slight negative impact on equity book value. In the latest comments the management has estimated CECL implementation to raise allowances for credit losses by $50 million to $70 million; consequently, I'm assuming the accounting standard to reduce equity by $61 million in the first quarter of 2020. Moreover, according to my estimates, the Oritani acquisition will increase equity by $740 million and number of shares outstanding by 71 million. Based on the earnings, dividend, Oritani acquisition, and CECL impact estimates, I'm assuming VLY's book value per share to increase to $10.54, and tangible book value per share to rise to $7.86 by the end of 2020.
Valuing at $13.8
I'm using the historical price to tangible book value per share multiple, P/TB, to value VLY. The company has traded at an average P/TB ratio of 1.75 in the past, as shown in the table below.
Multiplying the P/TB ratio with the forecast tangible book value per share of $7.9 gives a target price of $13.8 for December 2020. This price target implies a 15.6% upside from VLY's November 5, 2019 closing price. The table below shows sensitivity of the target price to different levels of the price to book ratio, with the base case in shaded column.
Conclusion: Maintaining Bullish Rating
In my previous report I had given a target price of $12.0 for December 2019 and adopted a bullish stance. I've now revised my earnings and equity estimates and rolled over my target price to $13.8 for December 2020. As this target implies 15.6% capital appreciation from VLY's November 5 closing price, I'm maintaining a bullish rating on the stock. Adding the forward dividend yield of 3.65% to the potential price upside gives a total expected return of 19.3% for the next one year; hence, I'm suggesting buying 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.