Northwest Bancshares: Attractive Dividend Yield, But Earnings Likely To Dip

Nov. 25, 2021 11:59 PM ETNorthwest Bancshares, Inc. (NWBI)2 Comments1 Like
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Summary

  • After declining in the last five consecutive quarters, the loan portfolio will likely decline further in the last quarter of 2021 before rising slightly next year.
  • I'm not expecting further big loan loss reserve releases because the allowance level almost matches the credit risk.
  • The December 2022 target price suggests a small upside from the current market price. Additionally, Northwest is offering quite a high dividend yield.
Vehicle Loan Application

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Earnings of Northwest Bancshares, Inc. (NASDAQ: NASDAQ:NWBI) will likely dip next year because the provision expense will be higher after a year of net provision reversals. On the other hand, subdued loan growth will likely support the bottom line. Overall, I'm expecting the company to report earnings of $0.87 per share in 2022, down around 26% year-over-year. Northwest is offering quite a high dividend yield, but its payout ratio is also at a very high level. Nevertheless, I'm not assuming a dividend cut partly because the company has endured worse payout ratios in previous years. The December 2022 target price suggests a modest upside from the current market price. Based on the total expected return, I'm adopting a bullish rating on Northwest Bancshares.

Loans Likely to Grow Next Year After a Further Decline in 4Q’21

Northwest Bancshares’ loan portfolio has declined for the last five consecutive quarters. This protracted loan decline trend depicts the management's capabilities in a bad light. Therefore, I'm not too optimistic about the loan trend going forward.

Around 60% of Northwest’s total loans are to consumers; therefore, the unemployment rate and consumer confidence are good metrics to gauge future credit demand. Unfortunately, there are some perceived weaknesses in Northwest’s markets. The company operates in Pennsylvania, New York, Ohio, and Indiana. Out of these four states, three have a slower economic recovery than the rest of the country. According to official sources, Pennsylvania, New York, and Ohio rank in the bottom half of all states by the unemployment rate. The following chart shows the unemployment rates in these states.

Chart
Data by YCharts

Additionally, the country's consumer confidence is higher than last year but still far from the pre-pandemic level, according to the Conference Board. The University of Michigan’s Index of Consumer Sentiment is much more pessimistic, as shown below.

Chart
Data by YCharts

Moreover, the upcoming forgiveness of Paycheck Protection Program (“PPP”) loans will likely add to the company's woes. As can be calculated from information given in the third quarter’s 10-Q filing, PPP loans outstanding made up around 2.2% of total loans at the end of the last quarter.

Considering these factors, I'm expecting the loan portfolio to decline further in the fourth quarter before rising by low-single-digits in 2022. As the lingering impact of the pandemic relief stimulus would end soon, I'm expecting deposits to grow in tandem with loans next year. The following table shows my balance sheet estimates.

Table Description automatically generated

Cash Drag, Interest-Rate Hike to Keep the Margin Mostly Stable

Due to the prolonged loan decline trend, Northwest’s cash and cash equivalents and marketable securities have surged in the last few quarters. The following chart shows the trend of the cash build-up.

Chart, bar chart, line chart Description automatically generated

This build-up in excess liquidity has dragged the net interest margin of late. As I'm expecting loans to grow in tandem with deposits, the excess liquidity will likely remain unchanged next year. Therefore, the cash drag on the margin will persist.

Further, the anticipated interest rate hike next year will likely not have much of an impact on the margin because the balance sheet is not too sensitive to interest rate changes. The management's interest-rate sensitivity analysis given in the 10-Q filing shows that a 100-basis points increase in interest rates can increase net interest income by an estimated 1.1% only, as shown below.

Timeline Description automatically generated

Therefore, I'm expecting the net interest margin to decline by two basis points in the fourth quarter of 2021 and remain mostly stable in 2022.

Further Net Provision Reversals Unlikely

Northwest has posted net provision reversals of around $10 million in the first nine months of 2021. I'm not expecting further big reserve releases because the allowance level now seems less than enough for the credit risk. According to details given in the 10-Q filing, allowances made up 1.08% of total loans, while non-accrual loans made up 1.73% of total loans at the end of the last quarter. Moreover, vehicle loans, which are considered high-risk, made up 14% of total loans at the end of the last quarter.

On the plus side, net-charge-offs made up just 0.12% of average loans in the third quarter, as mentioned in the earnings release. This means that allowances for loan losses were nine times the actual loan losses, which is a comfortable level. Moreover, I'm expecting the loan growth to remain below the historical average, as discussed above. As the loan portfolio growth will be low, the required provisioning will also be low.

Considering these factors, I'm expecting the provision expense to remain below the pre-pandemic average in 2022. I'm expecting provisions expense to make up 0.19% of total loans in 2022. In comparison, the average provision expense to total loan ratio was 0.24% from 2016 to 2019. Although the 2022 provision expense will be below normal, it will still be higher than 2021 because I'm not expecting further big provision reversals.

Expecting Earnings of $0.87 per Share Next Year

The higher net provision expense will likely be the chief contributor to an earnings decline next year. Moreover, the non-interest income will likely decline because of the non-recurrence of the one-time gain on sale recorded in the second quarter of 2021. According to details given in the 10-Q filing, Northwest reported a gain on the sale of its insurance business of around $25.3 million.

On the other hand, subdued loan growth will support the bottom line. Overall, I'm expecting Northwest to report earnings of $0.20 per share in the last quarter of 2021, taking full-year earnings to $1.18 per share. This earnings estimate is higher than my previous estimate of $1.03 per share given in my last report on Northwest Bancshares. I have revised up the earnings estimate because the provisioning has beaten my expectations so far this year. For 2022, I'm expecting earnings to dip by 26% year-over-year to $0.87 per share. The following table shows my income statement estimates.

Table Description automatically generated

Actual earnings may differ materially from estimates because of the risks and uncertainties related to the COVID-19 pandemic and the timeline of an interest rate hike.

Dividend Level Likely to be Maintained

Northwest is offering a high dividend yield of 5.7% at the current quarterly dividend rate of $0.20 per share. Even though Northwest increases its dividend per share almost every year, I'm not assuming a dividend hike in 2022 because the current dividend level suggests an uncomfortably high payout ratio of 92%. I'm also not expecting a dividend cut despite the high payout ratio because of the following two factors.

  1. Northwest Bancshares has endured a payout ratio of over 100% in the years 2020 and 2016.
  2. The company had a high Tier I capital ratio of 14.707% at the end of the last quarter, as opposed to the minimum regulatory requirement of 8.5%, as mentioned in the 10-Q filing.

Hypothetically, even if Northwest Bancshares cuts its dividend to $0.15 per share to reach a more comfortable level of less than 70%, its dividend yield would still be quite impressive at 4.3%.

Total Expected Return Warrants a Bullish Rating

I’m using the historical price-to-tangible book (“P/TB”) and price-to-earnings (“P/E”) multiples to value Northwest Bancshares. The stock has traded at an average P/TB ratio of 1.66x in the past, as shown below.

Table Description automatically generated

Multiplying the average P/TB multiple with the forecast tangible book value per share of $9.3 gives a target price of $15.3 for the end of 2022. This price target implies an 8.7% upside from the November 24 closing price. The following table shows the sensitivity of the target price to the P/TB ratio.

Table Description automatically generated

The stock has traded at an average P/E ratio of around 17.2x in the past, as shown below.

Table Description automatically generated

Multiplying the average P/E multiple with the forecast earnings per share of $0.87 gives a target price of $15.0 for the end of 2022. This price target implies a 6.4% upside from the November 24 closing price. The following table shows the sensitivity of the target price to the P/E ratio.

Table Description automatically generated

Equally weighting the target prices from the two valuation methods gives a combined target price of $15.2, which implies a 7.6% upside from the current market price. Adding the forward dividend yield gives a total expected return of 13.2%. Hence, I’m adopting a bullish rating on Northwest Bancshares.

The company’s earnings will likely dip next year due to a higher provisions expense. The market seems to have overreacted to this prospect of an earnings decline because the current market price suggests a high dividend yield and decent price upside.

This article was written by

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Around 10 years of experience covering Banks and Macroeconomics. Passionate about discovering lucrative investments and generating alpha.
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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.

Additional disclosure: Disclaimer: This article is not financial advice. Investors are expected to consider their investment objectives and constraints before investing in the stock(s) mentioned in the article.

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