Hero Images Inc
Inflation caused massive changes last year, and Webster Financial Corporation (NYSE:WBS) was no exception. In fact, it had mixed results, characterized by solid revenue growth and hammered margins. But its overall performance stayed stable and viable. Now that inflation has relaxed, market prospects are more enticing. It may help WBS diversify its loan and investment portfolio and manage expenses better. More importantly, its fundamentals are in good shape as liquidity levels remain high. It has adequate capacity to sustain its operations in a high-interest environment while covering capital returns. It only has to watch out for its borrowings due to its sudden increase. Also, most of these will mature within the year. It may have to restructure them or maintain high cash inflows.
Meanwhile, dividend payments continue to increase. They remain well-covered with high yields. It is consistent with the stock price, showing that shares are offered at a discount. It is more evident today since it is still at rock bottom after plummeting recently. Also, it appears undervalued relative to the intrinsic value of the company.
Company Performance
The financial sector, especially banks, is sensitive to macroeconomic fluctuations. With that, they tend to get more exposure to risks and opportunities associated with inflation. In 2022, we saw inflation peaking at 9.1%, the highest in forty years. Although it meant higher yields on loans and certain forms of investments. It also led to higher borrowing and deposit costs and even hurt many debt securities. But what should matter is how a bank can stabilize its revenues and margins. The impact on its main assets and liabilities may differ, but it must sustain its operating capacity. The same applies to Webster Financial Corporation, which saw mixed results in its performance.
Its operating revenue or interest income amounted to $2.28 billion, a 143% year-over-year increase. It was also far higher than pre-pandemic levels, showing the positive spill overs of interest rate hikes. Even in quarterly values, its revenue was in a consistent uptrend. In 4Q, it peaked at $744 million, a 215% year-over-year increase. But we can also notice that the sequential growth decreased consistently. So, we can assume that borrowers can only take so much. Fortunately, it remained a double-digit growth. Various factors served as primary driving forces behind it. Again, interest rate hikes stimulated loan yield growth. We must also note that loan volume remained high despite higher interest rates. It could show the solid customer base and domestic market presence of the company. This aspect helped the company become more flexible with its loan repricing to stabilize loan volume while generating more yields. M&A was another factor that raised its operating capacity and loan volume. In fact, organic loan growth reached 5.25% versus 3.62% in 4Q 2021 and 4.52% in 3Q 2021. Even better, it maintained solid loan quality, as shown by its decreasing non-performing loans. Its percentage to the total loans was only 0.41% versus 0.49% in 4Q 2021 and 0.44% in 3Q 2022. Indeed, the company maintained its conservative approach to loan management. It was more crucial in 2022 due to the higher risk of default and delinquencies. Its prudent loan diversification also played a vital role with its commercial segment comprising 66% of the total value. Over a quarter of loans are purely C&I loans, which are more fixed with more secure collaterals. Meanwhile, almost 40% are commercial real estate loans, which can be a double-edged sword. While risks are higher, potential yields are attractive. We will discuss more of it in the succeeding parts.
Interest Income And Interest Expense (MarketWatch)
Interest Income And Interest Expense (MarketWatch)
Investment security yields comprise 15% of the total interest income. While it is only a fraction of interest income on loans, the increase was massive at 98%. We can also see both segments with sustained increases in 2022. As such, the company maintained a prudent loan and investment security portfolio diversification. The actual value of investment securities increased, showing higher valuation amidst interest rate hikes. Most of its investments were debt securities, but they were inflation-linked. A substantial portion of them were government-backed and government-sponsored enterprise securities. Given their nature, they are more flexible to inflation, so valuation decreases are more manageable.
However, the impact of inflation and interest rate hikes also extended to borrowings and deposits. Higher interest rates and M&A led to more deposits and borrowings. Interest expenses also skyrocketed by sixteen times. Fortunately, revenue growth partially offset it. Net interest income remained high even after provisions. Likewise, non-interest expenses rose substantially, mainly due to higher prices and M&A. Unsurprisingly, the operating margin dropped to 35% versus 56% in 2021. It was also low in 4Q 2022 at 42%. Despite this, the company was still viable. Returns were enough to sustain its operating capacity, which we can confirm with the stable cash levels.
Operating Margin (MarketWatch)
Operating Margin (MarketWatch)
As we wait for its 1Q release, we can expect the persistence of near-term headwinds. It may face the same challenges, which we can associate with the anticipated mild recession. It may continue to hamper growth, but by this time, the company may have already adjusted to it. Also, improvements are on the horizon as inflation relaxes. We will discuss these aspects in the following section.
How Webster Financial Corporation May Stay Afloat This Year
Inflation and interest rate hikes had positive and negative spill overs on the company. Obviously, the impact was more intense on interest expenses. But to be fair, we can also associate it with the continued expansion. The good thing was that the operating income remained enough to cover its operations. This year, having an optimistic view of its performance is logical. Although we may expect its near-term performance to stay the same, the improvement in macroeconomic indicators may be helpful. Inflation landed at 5%, 17% lower than last month and 45% lower than the 2022 peak. Indeed, it dropped faster and further than expected. It is now more stable today, so the Fed can heave a sigh of relief. While it must maintain its conservative approach, it may start easing its monetary policy. It already started last quarter, with interest rates only increasing by 25 bps. Given the current trend, interest rates may still increase, but increments may keep cooling down. These changes may help the company manage its loan repricing, investment securities, deposit inflows, and borrowings better.
The same pattern can be seen in the real estate market. Mortgage rates are relaxing as property sales cool down. So, analysts warned individuals and entrepreneurs to prepare for a potential crash. It is a concern for the company since CRE loans are one of its primary loans. On a lighter note, its loan portfolio is more diverse than many other banks. More often than not, CRE loans comprise 70% of the total loans. But in WBS, CRE loans are only 49%. The thing is, yields remained high, showing solid loan quality and strategic loan repricing. Another thing to consider is the shortage in the US property market. It seems that property builders have already learned their lesson from the Great Recession. They have become more cautious over the past decade, leading to shortages. This is another aspect to look at since property price increases were driven by excessive demand, not by cost-push factors. As of 1Q 2023, the US property market was still short of 6.5 million houses. So while lower sales may put a downward force on property prices, shortages can slow them down.
Inflation Rate, Interest Rate, And Mortgage Rate (Author Estimation)
What makes WBS a sustainable company is its decent financial positioning. Its loans and deposits are higher amidst interest rate hikes. Meanwhile, the loan-to-deposit ratio reached 91%. It was way higher than in the comparative quarter, yet it remained acceptable. As such, the company has enough reserves to cover potential loan defaults and delinquencies. Also, it can offer more attractive deposit yields to entice more clients. Doing so can ensure high liquidity levels. It can be feasible in the second half as inflation and interest rates become more stable. Cash and investments are also higher, comprising 22% of the total assets. My only concern is the substantial increase in borrowings, most of which have current maturities. It can be risky in a high-interest landscape. Nevertheless, liquid assets are almost twice as much as borrowings. Even cash alone can pay dividends. Hence, the company can cover its operating capacity and capital returns. It balances viability, liquidity, and sustainability.
Loans, Deposits, And Loan-To-Deposit Ratio (WB 4Q Financial Release)
Cash And Investments And Borrowings (MarketWatch)
Stock Price Assessment
The stock price of Webster Financial Corporation remains in a downtrend. It has not rebounded yet from its sharp plunge. At $38.04, it’s 22% lower than last year’s price. On the flip side, it opens more opportunities for potential investors to buy shares at a low price. We can confirm it using the PB Ratio, given the current BVPS and PB Ratio of 44.7 and 1.04x. If we use the current BVPS and the average PB Ratio of 1.32x, the target price will be $58.98.
Moreover, WBS is an attractive dividend stock with consistent payments. It has yields of 4.12%, which is way higher than the S&P 500 average of 1.65%. They are also well-covered, given the Dividend Payout Ratio of 43%. To assess the stock price better, we will use the DCF Model.
FCFF $383,000,000
Cash $264,120,000
Outstanding Borrowings $1,151,830,000
Perpetual Growth Rate 4.8%
WACC 9.2%
Common Shares Outstanding 174,008,000
Stock Price $38.04
Derived Value $44.92
The derived value can also show undervaluation. There may be a 19% upside in the next 12-18 months. With that, investors can consider it an interesting stock.
Bottomline
Webster Financial Corporation maintains solid operations despite hammered margins. It has adequate reserves to sustain its operating capacity and capital returns. Dividend payments are another factor to appreciate in the company. Also, the stock price is undervalued with enticing upside potential. The recommendation is that Webster Financial Corporation is a buy.
