Sandy Spring Bancorp: Credit Losses To Undermine Acquisition Benefits (NASDAQ:SASR)
Earnings of Sandy Spring Bancorp (SASR) plunged by 65% sequentially in the first quarter due to a hike in credit costs amid the COVID-19 pandemic. Earnings per share will likely recover from the first-quarter hit in the remainder of the year, but stay below the 2019 level. Provision expense will likely remain elevated in the second quarter as the economic outlook has worsened since the end of the first quarter. On the other hand, the acquisition of Revere Bank and participation in the Paycheck Protection Program will drive loans, which will support earnings. Moreover, the acquisition of a fee-only advisory firm will elevate earnings. Overall, I’m expecting SASR’s earnings per share to dip by 32% year-over-year to $2.22 in 2020. The December 2020 target price suggests a high upside from the current market price. However, the COVID-19 related risks and uncertainties justify a discount to the target price; therefore, I’m adopting a neutral rating on SASR.
High Provision Expense Likely for Another Quarter
SASR’s provision expense surged to $24 million in the first quarter from $2 million in the last quarter of 2019. The management used Moody’s baseline forecasts for economic variables, including unemployment, bankruptcies, and home price index, to determine the loan loss provisioning requirement. Under the baseline scenario, the management assumed a local unemployment rate of around 5.4%, as mentioned in the first quarter’s conference call. As the national unemployment rate reached 14.7% in April, it is very likely that the actual local unemployment rate in the second quarter will exceed management’s assumption. Therefore, I’m expecting SASR to adjust its revenues upwards in the second quarter, leading to higher than normal provision expense.
SASR’s exposure to risky sectors will also drive provision expense in the remainder of the year. As mentioned in the first quarter’s investor presentation, retail commercial real estate loans made up 14%, office commercial real estate made up 10%, hotels made up 6%, and restaurants made up 2% of total loans as of March 31, 2020. Considering these factors, I’m expecting the provision expense to increase to $46 million, or 53bps of total loans, in 2020 from $5 million, or 7bps of total loans, in 2019.
Revere Bank Acquisition to Support Earnings
I’m expecting strong loan growth in the second quarter to support earnings this year. According to a press release, SASR completed its acquisition of Revere Bank in April, which will likely increase loan balances by $2.5 billion in the second quarter. Additionally, SASR’s participation in the Paycheck Protection Program (PPP) will drive loans this quarter. As mentioned in the conference call, SASR has received applications for loans worth over $1 billion under PPP. However, I’m expecting a majority of the PPP loans to get forgiven in the third quarter. Overall, I’m expecting loans to increase by 30.9% till the end of 2020 from the 2019-end. The following table shows my estimates for loans and other balance sheet items.
Further contraction in net interest margin (NIM) will partially offset strong loan growth. I’m expecting NIM to decline because of the full quarter’s impact of 150bps. PPP will also affect NIM as SASR will book fees over the life of the PPP loans. I’m expecting the company to book a majority of the fees in the second and the third quarters. Overall, I’m expecting NIM to decline by 15bps in the second quarter, and by 36bps in the full year, as shown below.
Acquisitions, Mortgage Banking Business to Boost Non-Interest Income
I’m expecting non-interest income to surge in the second quarter partly due to robust mortgage banking revenues. Refinance activity will likely remain heightened in the second quarter due to low interest rates, which will push up mortgage banking revenues. Further, SASR’s acquisition of an advisory firm, Rembert Pendleton Jackson (RPJ), in the first quarter will likely drive non-interest income in the remainder of the year. As mentioned in the presentation, RPJ has $1.3 billion worth of assets under management as of December 31, 2019. Moreover, the addition of customers following the acquisition of Revere Bank will boost non-interest income. Consequently, I’m expecting SASR’s non-interest income to surge by 33% year-over-year in 2020.
Expecting Earnings to Decline to $2.22 per Share
The expected hike in provision expense and dip in NIM will likely drag earnings this year. On the other hand, growth in earning assets and an increase in non-interest income will likely support the bottom-line. Overall, I’m expecting SASR’s earnings per share to decrease by 32% year-over-year to $2.22 in 2020. The following table shows my estimates for income statement items.
The duration and severity of COVID-19 are unknown. As a result, there is a chance that the provision expense will exceed expectations. Additionally, there is uncertainty surrounding the duration of PPP loans, which will affect the net interest income for the year. Longer than expected duration can lead to lower net interest income this year. These uncertainties have increased the riskiness of the stock.
I’m expecting SASR to maintain its quarterly dividend at the current level of $0.30 per share in the remainder of 2020. Dividends are currently fairly secure as the dividend and earnings estimates suggest a payout ratio of 54%, which is sustainable. Additionally, SASR is well-capitalized, which minimizes the threat of a dividend cut from regulatory requirements. The common equity tier I capital ratio was reported at 10.23% as of March 31, 2020, versus the minimum regulatory requirement of 7.0%. The dividend estimate implies a dividend yield of 5.2%.
Risks Warrant a Discount to the Target Price
SASR’s price to book ratio (P/B) has been quite volatile in the past, so I’m using only 2019’s average P/B multiple to value the company. SASR traded at an average multiple of 1.08 last year. Multiplying this average ratio with the forecast book value per share of $33.6 gives a target price of $36.2 for December 2020. The price target offers a hefty 57.5% upside from SASR’s May 21 closing price. The following table shows the sensitivity of the target price to the P/B multiple.
The high upside suggests that SASR is offering a good opportunity for a high return. However, due to the risks and uncertainties, SASR deserves to trade at a discount to its target price in the near-term. Consequently, I’m adopting a neutral rating on the stock.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any 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.