The past year was a more challenging one than I expected from Sandy Spring Bancorp (NASDAQ:SASR). I had concerns about the relatively low/lackluster asset sensitivity of this D.C.-area community bank going into the year, and the company has since seen lackluster earning asset yield improvement, while deposit costs have started increasing rapidly. While earning asset yields should improve from here, and 2024 could be a better year relative to peers, 2023 is looking challenging.
These shares are down about 25% from my last update, and I definitely underestimated how much the bank would be squeezed by adverse spreads, not to mention the decline of the mortgage banking business. While I do think core growth in the mid-to-high single-digits is still possible, and Sandy Spring could have some appeal to a larger bank that wants to acquire more exposure in the Baltimore-Washington corridor, the valuation looks pretty uninspiring to me right now.
This was a rough quarter for Sandy Spring, even though weaker spread income expectations were dialed in as the year and the quarter progressed. Management did do relatively well on expenses, but it was just not enough.
Revenue declined 5% year over year and about 7% quarter over quarter, missing by about 4% or nearly $0.10/share. Net interest income rose less than 2% yoy and fell almost 6% qoq, driving the miss, with net interest margin down 25bp yoy and 27bp qoq to 3.26%, while earning assets rose more than 2%.
Fee-based income isn’t a particularly large part of the revenue mix, but it was even smaller with a 35% yoy and 14% qoq decline driven by weakness in wealth management (down 5% qoq) and the ongoing pressures in the mortgage banking industry (down 50% qoq).
Operating expenses declined almost 3% yoy and about 2% qoq, which shows good cost control (an efficiency ratio of 52.7%), but it wasn’t enough to offset the revenue pressures. Pre-provision profits declined about 7% yoy and 11% qoq, missing by around $0.09/share, with provisioning adding to the per-share miss for the quarter.
As I said above, I was concerned about Sandy Spring’s asset sensitivity going into the year, as the nature of the company’s loan book (more fixed versus floating, et al) meant the company didn’t have so much to gain from higher rates. That was a headwind going into a tightening cycle, and it only got worse when the Fed ended up being more aggressive than expected.
Loans rose a little less than 2% qoq in the quarter, with over 4% growth in C&I lending and some growth (up 1.4% qoq) in CRE lending.
CRE lending has been Sandy Spring’s bread-and-butter for some time, and I do have concerns about the state of office and retail properties heading into this downturn; fellow D.C.-area bank Eagle (EGBN) expressed some caution on offices during its conference call. Retail is about a quarter of the CRE book and offices about half that, but the bank has largely focused on more suburban properties, and Sandy Spring serves some of the wealthiest counties in the country (Montgomery, Howard, Anne Arundel in Maryland, Arlington, Fairfax, and Loudon in Virginia).
I’d also note that the bank has been actively working to grow its C&I book, including hiring away revenue producers from other banks. It’s still only about 10% of the total loan mix, but I continue to believe that this can be a growth business for Sandy Spring.
Unfortunately, loan and earning asset yield growth has been lackluster, with a loan beta of 20% (half that of Eagle) and an earning asset beta of 21.5% cycle-to-date, and the average loan yield was just 4.78% at a time when many commercial lenders are seeing 5%-plus yields. (Eagle was at 5.87% this quarter).
Making matters worse, deposit costs are ramping up. Sandy Spring was pretty much average with an 8% sequential decline in non-interest-bearing deposits, but total deposit costs rose 93bp yoy and 68bp qoq to 1.03%, with interest-bearing deposit costs rising 141bp yoy and 101bp qoq to 1.57%, as the bank has moved fairly aggressively to offer competitive rates, and this has taken the deposit beta to 26% - not terrible on a comparable basis, but not great either and worse in the context of the weaker earning yield growth.
As long as the Fed is hiking, Sandy Spring is going to get pinched on rates. That should stop in the first half of 2023, though predicting rates is often folly. As tightening eases, Sandy Spring should continue to put attractively-priced new loans on the books, but demand is likely to be softer given the weaker economy. I do expect a year-over-year earnings decline in 2023, but as earning asset yields catch up, Sandy Spring should be set for above-average growth in 2024.
I still believe Sandy Spring can generate long-term core earnings growth in the range of 5% to 7%, and I think focusing on C&I lending growth is a good strategic move at this point. I also do still see M&A value, as Sandy Spring is one of the relatively few acquirable banks with meaningful deposit share in D.C.
I’m not as confident about the value now, though. Discounted core earnings support a mid-$30s value now, and ROTCE-driven P/TBV and P/E (with a 10.5x multiple) give me results in the mid-$30s, with an overall range of $34 to $35.50.
I underestimated just how aggressive the Fed would be on rates in 2023 and the effect that would have on Sandy Spring’s spread margins. At this point, I still think this is a solid community bank in an attractive market, but I just don’t see enough value today to get excited about the shares, particularly with rate risk and credit risk still in play.
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