Earnings of West Bancorporation, Inc. (NASDAQ: WTBA) dipped in the second quarter to $0.48 per share from $0.49 per share in the first quarter of 2020. The earnings decline was mostly attributable to a hike in provision expense. Earnings will likely recover in the year ahead because of the Paycheck Protection Program. Moreover, the provision expense will likely decline after the substantial reserve build in the second quarter. Despite the decline, the provision expense will likely remain above normal because the existing loan loss reserves are not high enough for a pandemic. Overall, I’m expecting earnings to increase by 24% in the second half of the year compared to the first half. For the full year, I’m expecting WTBA to report earnings of $2.18 per share, up 25% from last year. The June 2021 target price suggests a high upside from the current market price. Nevertheless, I’m adopting a neutral rating on WTBA because the company’s elevated risk level will likely restrain the stock price in the near term. Almost a quarter of WTBA’s loans are under payment modification programs, which shows that credit risk is currently quite high.
Credit Risks Elevated Due to Loans Requiring Payment Deferrals
WTBA reported a provision expense of $3 million in the second quarter, up from $1 million in the first quarter of 2020. After the reserve build of the second quarter, WTBA’s allowances for loan losses are at 0.97% of total loans. The existing allowances-to-loans ratio is too low for a pandemic from a historical perspective as the ratio averaged 1.12% from 2013 to 2019. Consequently, I’m expecting provision expense to decline from the second quarter but remain above normal in the remainder of the year. For the full year, I’m expecting WTBA to report a provision expense of $7 million, up from $0.6 million in 2019.
WTBA is currently facing quite a high level of credit risk because around a quarter of its loans are under payment deferral programs. As mentioned in the second quarter’s 10-Q filing, COVID-19 related loan modifications totaled $553 million at the end of the last quarter. WTBA’s hotel exposure is particularly problematic as around 81% of the portfolio was under deferral, according to details given in the 10-Q filing. The hotel industry made up 7.3% of total loans at the end of the last quarter. The industry’s occupancy improved over the last quarter but it’s still far from satisfactory. As mentioned in the second quarter’s conference call, the occupancy improved from an estimated range of 10-59% in May to an estimated range of 19-64% in June. I’m expecting travelers to continue to remain cautious until at least the first quarter of next year. Consequently, I’m expecting the hotel portfolio to keep the credit risk elevated for the remainder of the year. The following table shows the details of WTBA’s exposure to vulnerable industries.
Slight Margin Compression to Partially Offset Paycheck Protection Program Impact
Net interest income growth will likely counter the above-normal provision expense in the year ahead. I’m expecting the Paycheck Protection Program, PPP, to be the chief driver of net interest income. As mentioned in the 10-Q filing, WTBA funded $223 million of loans under PPP. Assuming a fee of 3% and funding cost of 0.35%, PPP will likely add $5.9 million to net interest income over the life of the loans. The management expects PPP payback in around six months, as mentioned in the conference call. Consequently, I’m expecting WTBA to accelerate the booking of the remaining fees in the fourth quarter of 2020.
Loan forgiveness under PPP will likely reduce the loan balance in the year ahead. Excluding the impact of PPP, I’m expecting loan growth to be low due to the uncertainties related to the COVID-19 pandemic. Overall, I’m expecting the loan portfolio to decline by 9% from the end of June 2020 to $1.98 billion by the end of the year. The following table shows my estimates for loans and other balance sheet items.
WTBA’s net interest margin, NIM, increased by 21bps in the second quarter as deposit repricing outpaced asset repricing. I’m expecting NIM to decline slightly in the year ahead as deposit repricing will likely slow down after the sharp movement in the second quarter. However, WTBA has substantially improved its deposit mix over the second quarter, which will likely support NIM in the year ahead. Non-interest-bearing deposits made up 26.2% of total deposits at the end of June, as opposed to 20.2% at the end of March 2020. Considering these factors, I’m expecting NIM to decline by 5bps in the third quarter and by 3bps in the fourth quarter. The following table shows my estimates for yield, cost, and NIM, excluding the impact of the accelerated booking of fees under PPP.
Expecting Full-Year Earnings of Around $2.18
The accelerated booking of fees under PPP and a sequential decline in provision expense will likely lift earnings in the second half of the year compared to the first half. I’m expecting earnings in the second half to be 24% higher than earnings in the first half. For the full year, I’m expecting WTBA to report earnings of $2.18 per share, up 25% from last year. The following table shows my earnings estimates.
Risks to Undermine Attractive Valuation
I’m using the historical average price-to-book ratio, P/B, to value WTBA. The stock has traded at an average P/B multiple of 1.54 in the first half of 2020. Multiplying this average P/B ratio with the forecast June 2021 book value per share of $14.1 gives a target price of $21.6 for the mid of next year. The price target implies a significant upside of 27% from WTBA’s August 20 closing price. The following table shows the sensitivity of the target price to the P/B ratio.
Apart from the upside, WTBA is also offering a decent dividend yield of 4.9%, assuming the company maintains its quarterly dividend at the current level of $0.21 per share. There is very little threat of a dividend cut because the earnings and dividend estimates suggest a payout ratio of 33.4% for the last quarter of 2020, and 40.5% for 2021, which are sustainable. Moreover, the capital ratios for West Bank, WTBA’s subsidiary, are in comfortable positions. The management mentioned in the conference call that their informal policy is to maintain capital ratios that are at least 100bps above the regulatory requirements to be well-capitalized. As of the end of the last quarter, West Bank’s tier I capital ratio was 305bps above the regulatory requirement, and the common equity tier I ratio was 455bps above the requirement, according to details given in the 10-Q filing.
Regardless of the attractive valuation, I’m expecting WTBA’s stock price to remain subdued in the near term of two to three months because of the high credit risk level. The large portion of loans requiring modification is the chief driver of the credit risk. Moreover, the significant exposure to the hotel industry is a cause of concern because of the tough operating environment amid the pandemic. I’m expecting the risks to restrain the stock price in the near term; hence, I’m adopting a neutral rating on WTBA.
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