Wintrust Financial: A Cheap Growth Bank
Apr/110
A winning strategy to owning bank stocks is to focus on banks with superior loan generating and deposit gathering capabilities. Another way to succeed in bank stocks is to own acquisitive banks during a period of low valuations such as in the early 1990’s coming out of the S&L crisis or today coming out of the credit crisis of 2008. One bank stock that is compelling is WinTrust Financial (WTFC) because it is one of the few banks with the ability to grow organically, and they are enhancing their franchise through low cost acquisitions. In addition, Wintrust’s valuation is reasonable given their ability to grow.
Background
Wintrust is the bank holding company for a group of community banks in suburban Chicago and Milwaukee markets. The bank was formed in 1991 by a group of experienced Chicago bankers when they formed Lake Forest Bank & Trust. They have grown the company by starting nine de novo banks and purchasing 12 other existing banks. After consolidating some of the acquisitions, the company owns 15 banks with 87 total branches. Each of these banks is used as a growth platform to grow loans and deposits in their respective communities. Wintrust has a history of organic growth.
Investment Thesis for Wintrust:
- Organic Growth – Wintrust has one of the best tracks records in the industry for organic loan and deposit growth. Since its formation, Wintrust has focused on taking market share from the large banks in Chicago. The company focuses on providing a better customer service to its customers by providing a local relationship. Wintrust expects each of its banks to grow loan balances $75 million in 2011.
- Valuation is low historically and in-line with peers – Wintrust trades at about 140% of tangible book value. From 2001 until the credit crisis hit in 2007, Wintrust traded between 215% and 360% of tangible book value. As the company’s credit costs decline and the bank’s earnings power is realized, I expect the valuation to reach at least 200% of tangible book value. Wintrust trades in-line with many of its peers who have lower growth rates. Some analysts will point to Wintrust’s more expensive Price-to Earnings multiple, but I believe these analysts underestimate the earnings power of Wintrust.
- Earnings power is underestimated – Wintrust has more earnings power than most investors believe. The two sources of their earnings power are lower credit costs and redeploying their excess liquidity into higher yielding assets. Most analysts correctly forecast the benefit of lower credit costs, but they underestimate the power of excess liquidity. WTFC has $2.5 billion of excess liquidity. If the bank redeployed $1.5 billion into assets yielding 5%, it would add $1 after-tax earnings per share. There are additional boosts to earnings power through lower FDIC assessments and the eventual paying of dividends by the FHLB of Chicago.
- Opportunistic acquisitions – In the current environment, Wintrust is able to make opportunistic acquisitions. In the last 12 months, Wintrust has bought five failed banks through FDIC-assisted transactions. Additionally, Wintrust bought a life insurance premium finance operation from AIG in a distressed sale in 2009. The FDIC deals are attractive because they drastically reduce the credit risk of the acquired bank through an FDIC guarantee of the assets, and Wintrust is able to acquire the deposits for either a very low or no premium. Wintrust may also take advantage of the low bank stock environment to purchase a whole bank in an unassisted deal, but there are probably 20 banks in the Chicago area that may be sold through FDIC-assisted deals in the next two years.
- Credit quality is manageable – Wintrust’s credit quality has outperformed its peers through the recession. As early as 2006, Wintrust pulled back from loan growth because they wouldn’t lower the credit underwriting guidelines. This conservatism kept credit quality reasonable.
Conclusion
We bought Wintrust for the Gator Small Cap Portfolio because we thought the valuation was compelling given the organic growth capabilities of the bank. We believe there are several drivers to a higher stock price: continued organic growth, additional low cost acquisitions, Wintrust’s stock rerated higher compared to peers due to higher growth, and bank stocks generally getting rerated higher due to lower credit costs.
Texas Capital Bancshares: Credit Trend is Not Good
Aug/100
Texas Capital Bancshares (TCBI) is an interesting organic growth banking story, but the bank’s declining credit metrics make it a better short from here. The bank is 12 years old and has grown by lifting out relationship bankers from the big banks. These relationship bankers bring their best customers over to TCBI. This is an efficient and capital friendly growth strategy. This strategy also allows the bank to grow even in periods of weak loan demand.
However, the credit metrics of the bank have deteriorated significantly over the past 4 quarters. The only potential catalyst that matters is a sign stability in the bank’s credit metrics. The next data point won’t be for another 7 weeks when the bank releases Q3 numbers.
Here’s a look at the credit numbers for TCBI
| 2009 Q2 | 2009 Q3 | 2009 Q4 | 2010 Q1 | 2010 Q2 | |
| Loans Outstanding | $4,211 | $4,290 | $4,457 | $4,443 | $4,463 |
| Loan Loss Provision | 11.0 | 13.6 | 10.1 | 13.1 | 15.7 |
| Net Charge-Offs | 6.8 | 2.8 | 8.0 | 9.3 | 12.6 |
| Loan Loss Reserve | 54.3 | 65.8 | 67.9 | 71.7 | 74.9 |
| Non-Accrual Loans | 49.6 | 85.3 | 95.6 | 115.9 | 138.2 |
| Other Real Estate Owned | 31.4 | 34.7 | 27.3 | 28.9 | 42.1 |
| Non-Performing Assets | 81.0 | 119.9 | 122.9 | 144.8 | 180.3 |
| Non-Accruals/Loans | 1.18% | 1.99% | 2.15% | 2.61% | 3.10% |
| Reserves/Loans | 1.32% | 1.54% | 1.55% | 1.63% | 1.68% |
| Reserves/Non-Accruals | 109% | 77% | 71% | 62% | 54% |
| Tangible Common Equity | 456 | 466 | 473 | 491 | 504 |
| Texas Ratio | 16% | 23% | 23% | 26% | 31% |
TCBI’s numbers are showing a disturbing trend. Non-accrual loans have accelerated the past two quarters. Plus, it looks like management has not been adding to the loan loss reserve aggressively as non-accruals have climbed.
One could argue that TCBI has been under reserving for loan losses during the past 4 quarters. The loan loss reserve to non-accrual loan ratio has declined from 109% to 54% over the past 12 months. If management had kept this ratio constant, TCBI would have report a losses instead of profits over the past 4 quarters.
TCBI shares trade 1.15x tangible book. I think the profitability of the bank is questionable given the declining reserve ratios. If you add in the worsening credit metrics, I think TCBI will have a lid on its stock price until it reports a quarter with stable credit metrics. Since TCBI is well-capitalized, the viability of the bank is not in question. But, the decline in the credit quality suggests that the credit issues are open-ended. I think investors should demand a discount to book value to own a bank stock with credit quality continuing to worsen at rate like this. At 70% of tangible book, the stock would trade at $9.50 or a decline of 35% from the current price.
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