Northwest Bancshares: Earnings To Dip Due To Provision Normalization

Mar. 23, 2022 8:54 PM ETNorthwest Bancshares, Inc. (NWBI)2 Comments4 Likes
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Summary

  • After a prolonged loan decline trend, the loan portfolio will likely turn around on the back of economic factors.
  • The asset-liability gap is not significant. Therefore, the anticipated steep rise in interest rates will have a limited impact on the margin.
  • The provision expense will likely normalize after a year of significant provision reversals.
  • The December 2022 target price suggests a small upside from the current market price. NWBI is offering quite a high dividend yield, but the payout ratio is also too high.
Aerial view of Downtown Columbus Ohio with Scioto river

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Earnings of Northwest Bancshares, Inc. (NASDAQ:NWBI) will most probably decline this year because of provision normalization. On the other hand, slight margin expansion will likely support the bottom line. Further, I'm expecting the loan portfolio trend to finally turn around after six quarters of consecutive decline. Overall, I'm expecting Northwest Bancshares to report earnings of $0.85 per share in 2022, down 29.5% year-over-year. The year-end target price suggests a small upside from the current market price. Therefore, I'm now downgrading Northwest Bancshares to a hold rating from my previous rating of buy.

Prolonged Loan Decline Trend Likely to Finally Turn Around

Northwest Bancshares' loan portfolio declined by more than I expected in the last quarter of 2021. The total loan balance dipped by 1.7% by the end of December 2021 from the end of September 2021. The loan portfolio has now declined for the last six consecutive quarters, which reflects badly on the management’s capabilities.

There are chances of a turnaround soon because of economic factors. Northwest Bancshares operates in Pennsylvania, New York, Ohio, and Indiana. Although these four states are quite close to each other, their economies are performing quite differently, as shown by the unemployment rate and GDP data. Therefore, I believe nationwide averages are more appropriate to gauge Northwest Bancshares’ product demand than statewide metrics. The country's unemployment rate is almost back to the pre-pandemic level, according to official sources. Further, Mortgage Bankers Association expects strong GDP growth of around 3.1% this year.

Further, the pressure from Paycheck Protection Program (“PPP”) forgiveness is likely to be lower this year relative to last year. PPP loans outstanding made up just 0.7% of total loans at the end of December 2021, according to details given in the 10-K filing.

Considering these factors, I'm expecting the declining loan trend to turn around this year. However, loan growth will likely remain below the historical average. Overall, I'm expecting the loan portfolio to increase by 2% by the end of December 2022 from the end of 2021. In my last report on Northwest Bancshares as well, I projected loan growth of 2% for this year. However, I'm now projecting a lower average loan balance for this year because the loan decline in the last quarter of 2021 surprised me, which led to a lower than anticipated loan balance for the year-end.

Meanwhile, I'm expecting other balance sheet items to grow mostly in line with loans. The following table shows my balance sheet estimates.

FY17 FY18 FY19 FY20 FY21 FY22E
Financial Position
Net Loans 7,737 7,996 8,751 10,446 9,914 10,114
Growth of Net Loans 3.2% 3.4% 9.4% 19.4% (5.1)% 2.0%
Other Earning Assets 834 840 838 1,578 2,317 2,363
Deposits 7,827 7,894 8,592 11,599 12,301 12,549
Borrowings and Sub-Debt 219 346 368 457 392 400
Common equity 1,208 1,258 1,353 1,539 1,584 1,590
Book Value Per Share ($) 11.8 12.2 12.8 12.8 12.5 12.9
Tangible BVPS ($) 8.5 9.0 9.3 9.5 9.4 9.7

Source: SEC Filings, Author's Estimates

(In USD million unless otherwise specified)

Margin Barely Sensitive to Rate Changes

Despite the anticipated steep rise in interest rates this year, the margin is unlikely to expand much. The interest-sensitivity gap between Northwest Bancshares’ assets and liabilities is not big. The company had $433.5 million more assets than liabilities that could re-price within one year, according to details given in the 10-K filing. To put this number in perspective, $433.5 million makes up just 3% of total assets.

The management’s interest-rate sensitivity analysis given in the 10-K filing also shows that the net interest income is not very rate sensitive. According to the analysis, a 200-basis points increase in interest rates can boost the net interest income by just 1.9% over twelve months.

Provision Normalization to Drag Earnings

I was previously expecting the provision expense to remain below normal for 2022, as mentioned in my last report on Northwest. I've now decided to increase the provision expense estimate because the allowance level is much below the level of non-performing loans. Allowances made up 1.02% of total loans, while non-performing loans made up 1.59% of total loans at the end of December 2021. This means that the allowance-to-non-performing-loans ratio at the end of December 2021 was just 64.38%. In comparison, the allowance-to-non-performing-loans ratio was at a much more comfortable level of 129.99% at the end of December 2020.

The subdued loan growth will likely be the chief driver of provision expense this year. Overall, I'm expecting the provision expense to make up around 0.25% of total loans in 2022. In comparison, the provision-expense-to-total-loan ratio averaged 0.25% for 2017 to 2019, and 0.29% for the last five years.

Expecting Earnings to Decline to 0.85%

Earnings of Northwest Bancshares will likely decline this year mostly because of provision normalization. Moreover, the non-interest income will likely be lower this year because of lower mortgage banking income amid a rising interest-rate environment. Further, the gain on sale of insurance business recorded in the second quarter of 2021, of around $25.3 million, won't be repeated in 2022.

Overall, I'm expecting Northwest Bancshares to report earnings of $0.85 per share in 2022, down 29.5% year-over-year. The following table shows my income statement estimates.

FY17 FY18 FY19 FY20 FY21 FY22E
Income Statement
Net interest income 331 339 360 392 391 396
Provision for loan losses 20 20 23 84 (12) 26
Non-interest income 110 92 99 132 143 111
Non-interest expense 286 276 296 347 345 341
Net income - Common Sh. 94 105 110 75 153 105
EPS - Diluted ($) 0.92 1.02 1.04 0.62 1.21 0.85

Source: SEC Filings, Author's Estimates

(In USD million unless otherwise specified)

In my last report on Northwest Bancshares, I estimated earnings of $0.87 per share for 2022. I have slightly decreased my earnings estimate because I have increased my provision expense estimate, as discussed above. Further, the loan portfolio has declined more than I expected in the last quarter of 2021. As the December 2021 year-end loan balance is lower than I expected, the average loan balance for 2022 is now going to be lower than what I previously anticipated.

Actual earnings may differ materially from estimates because of the risks and uncertainties related to the COVID-19 pandemic and the timing and magnitude of interest rate hikes.

Downgrading to a Hold Rating

Northwest Bancshares is offering a dividend yield of 6.0% at the current quarterly dividend rate of $0.20 per share. The earnings and dividend estimates suggest a payout ratio of 94% for 2022. Northwest Bancshares’ payout ratio was more than 100% in 2020 and 2016. Therefore, I believe a dividend cut is unlikely at this point despite the high payout ratio. Nevertheless, investors, especially those with low risk tolerance, should remain cautious.

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 1.51 in the past, as shown below.

FY19 FY20 FY21 Average
T. Book Value per Share ($) 9.3 9.5 9.4
Average Market Price ($) 17.1 11.5 13.8
Historical P/TB 1.84x 1.22x 1.47x 1.51x
Source: Company Financials, Yahoo Finance, Author's Estimates

Multiplying the average P/TB multiple with the forecast tangible book value per share of $9.7 gives a target price of $14.6 for the end of 2022. This price target implies a 9.7% upside from the March 23 closing price. The following table shows the sensitivity of the target price to the P/TB ratio.

P/TB Multiple 1.41x 1.46x 1.51x 1.56x 1.61x
TBVPS - Dec 2022 ($) 9.7 9.7 9.7 9.7 9.7
Target Price ($) 13.7 14.1 14.6 15.1 15.6
Market Price ($) 13.3 13.3 13.3 13.3 13.3
Upside/(Downside) 2.4% 6.1% 9.7% 13.4% 17.0%
Source: Author's Estimates

The stock has traded at an average P/E ratio of around 17.0x in the past, as shown below.

FY19 FY20 FY21 Average
Earnings per Share ($) 1.04 0.62 0.85
Average Market Price ($) 17.1 11.5 13.8
Historical P/E 16.4x 18.5x 16.2x 17.0x
Source: Company Financials, Yahoo Finance, Author's Estimates

Multiplying the average P/E multiple with the forecast earnings per share of $0.85 gives a target price of $14.5 for the end of 2022. This price target implies an 8.7% upside from the March 23 closing price. The following table shows the sensitivity of the target price to the P/E ratio.

P/E Multiple 15.0x 16.0x 17.0x 18.0x 19.0x
EPS 2022 ($) 0.85 0.85 0.85 0.85 0.85
Target Price ($) 12.8 13.6 14.5 15.3 16.2
Market Price ($) 13.3 13.3 13.3 13.3 13.3
Upside/(Downside) (4.1)% 2.3% 8.7% 15.1% 21.5%
Source: Author's Estimates

Equally weighting the target prices from the two valuation methods gives a combined target price of $14.6, which implies a 9.2% upside from the current market price. Adding the forward dividend yield gives a total expected return of 15.2%.

Compared to my last report on Northwest Bancshares, I have reduced my target price due to two main reasons.

  1. I have reduced my earnings estimate for 2022.
  2. To calculate historical P/TB and P/E multiples, I have moved forward the years used to 2019-2021 from 2018-2020. Therefore, these multiples are now lower than before.

Based on the limited price upside, I'm now downgrading Northwest Bancshares to a hold rating from my previous rating of buy.

This article was written by

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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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