With many banks on the prowl for M&A, I believe that to some extent banks will need to “earn” their right to stay independent; if a bank cannot generate sufficient returns on capital on their own, sooner or later another bank is going to make the shareholders an offer they won’t refuse. In the case of Hancock Whitney (NASDAQ:HWC), a legacy of underperformance with respect to margins and returns (ROE, ROTCE, et al) but a good core deposit base makes this a prime candidate for a “get better or get bought” story.
Management at Hancock is still in the relatively early stages of a meaningful cost-cutting program that I believe, coupled with eventual improvements in interest rates, can drive returns on equity back to 10% or better and drive long-term core earnings growth in the mid-single-digits. That, and a low double-digit ROTCE in 2021 and 2022 should support a fair value in the low $40s and a double-digit annualized total return opportunity.
A “Just Okay” Fourth Quarter
In the fourth quarter where many banks posted strong beats relative to expectations on a core earnings basis, Hancock did not. Of course, “core” is a subjective term, and Hancock’s reported beat was positive at $1.17/share versus an expectation of around $0.90/share, but a lot of that was driven by tax items that are unlikely to reoccur.
Revenue rose about 1% yoy and a little less on a quarterly basis to $324M, beating expectations by about 2%. Net interest income (FTE basis) rose about 2% yoy and 1% qoq to $241M, beating by around 2% as greater earning asset growth offset minor underperformance in net interest margin (down 1bp qoq to 3.21%, missing by 3bp). Non-interest income was down about 1% yoy and 2% qoq, to $82M, also beating by about 2%.
Expenses were down less than 1% yoy and about 2% qoq, coming in more or less around expectations. With that, pre-provision profits rose about 6% yoy and 5% qoq to $193M, coming in a little better than expected. Hancock also did a little better on provisioning ($24M versus an expected $26M), but this was a trivial item versus many banks’ sizable provision-driven beats.
Tangible book value per share rose less than 1% yoy and more than 2% qoq to $28.79, and Hancock finished the year was a CET 1 ratio of 10.7% - good, but not really “overcapitalized”.
Absent Higher Rates, Growth Will Remain Challenging
Loan growth is tough for a lot of banks these days, and Hancock is no exception. Ex-PPP loans were down about 1% qoq in the fourth quarter, though loan yields did stabilize (up 4bp qoq to 3.99%). Were it not for the second round of PPP lending, I think Hancock would find it challenging to grow lending in 2021, and average lending balances may well still decline in 2021 relative to 2020.
Hancock has a loan book that is a little more than half skewed to variable-rate loans, as well as a low-cost deposit base (total deposit costs of just 0.13% this quarter, with non-interest-bearing deposits just over 40% of the total). That makes this an asset-sensitive bank, meaning that Hancock is more leveraged to interest rates as a source of income growth; per the bank’s fourth quarter presentation, a sudden 100bp hike in rates would drive a 4% increase in net interest income in the first year.
I don’t expect that kind of rate improvement (and certainly not a shock rise), but I do expect rates to improve over the next two or three years, eventually improving spread earning opportunities for Hancock. In the meantime, with pressures on the revenue side of the ledger, expenses will become more important.
Hancock has started to get more active on branch rationalization, closing 12 in the fourth quarter of 2020 and targeting another 8 in the first quarter, with more likely to follow. Management has characterized themselves as in the “third or fourth inning” of their expense reduction efforts, and I believe there is an opportunity to get the efficiency ratio to the mid-50%’s (from 59% in Q4’20 and 61% for the year) in a more cooperative spread environment.
Investors shouldn’t take success here for granted. For many banks, cutting costs inevitably comes at the expense of weaker revenue growth and Hancock will have to prove that it can adjust its cost structure without compromising its growth opportunities.
Credit Seems Contained
Hancock does have a larger than normal exposure to industries “at risk” from the pandemic. Management’s calculation has over 22% of the loan book at risk, though I think the truer number is likely closer to 17% (I don’t think certain medical facilities are all that risky now). Either way, about 13% of the book is made up of retail, restaurant, hotel, and entertainment, and those are certainly vulnerable, as is the 3% weighting to assisted living.
The good news is that credit quality within that book isn’t bad. Overall deferrals are quite low, and there are minimal non-performing loans in the at-risk book today (and only 4% of the loans are criticized). Overall non-performing loans declined 20% qoq, to 0.73% of total loans, and criticized loans declined 5% to about 2.6% of the total loan book.
Charge-offs remain relatively high at 0.44% of loans, and will probably peak somewhere around 0.5%. That’s higher than many peers, but I think Hancock is taking a more aggressive approach in charging off loans and I don’t believe the overall credit quality is meaningfully inferior to its peer group.
The Outlook
Hancock isn’t necessarily a complicated story, but there are some unusual cross-currents here that do complicate the analysis. For instance, while the Gulf Coast markets that Hancock serves are seeing above-average population growth, the economic growth is not keeping pace. While the deposit franchise is attractive, the loan growth prospects are less exciting than for many other banks in the Southeast.
Still, I believe a strong core deposit franchise, and one with strong share in large markets like New Orleans, is worth more than Hancock is trading for today. I could see a larger bank looking to acquire Hancock for its deposits (and cost synergy opportunities), and I could also see Hancock looking to acquire smaller banks to bring it into more attractive growth markets adjacent to its current footprint.
I do believe that Hancock will get back to a 10% ROE over the next five years, and that’s at least somewhat bullish given the company’s operating history. I expect growth to come from an improving economy, including eventual improvements in interest rates and spreads, as well as the cost-reduction program. All told, I’m expecting mid-single-digit core earnings growth over the long term.
The Bottom Line
Between discounted core earnings and a low double-digit ROTCE in the next two years (fueling my P/TBV model), I believe Hancock should trade in the low $40s. That makes these shares pretty attractively-priced in a market where bank valuations have corrected significantly over the last six months or so. There’s definitely execution risk here (delivering on those cost cuts), but I believe this deposit franchise is worth more than this, and if management cannot deliver, I think there’s a good chance of an acquisition down the line.
