LBAI - Lakeland Bancorp: Not Capitalizing On Rising Interest Rates Efficiently

2023-10-11 21:03:21 ET

Summary

• Lakeland Bancorp has not been seeing the rise in the bottom line as I would have liked following rising interest rates.
• The company has, on some fronts, done a solid job like raising the loans steadily over the last several years.
• The dividend yield is appealing enough that it makes sense to have a hold still for the company.

Introduction

The rise in interest rates has been a significant factor in a lot of companies in the banking sector being able to post strong earnings results. This has not been the case for Lakeland Bancorp (LBAI) as they have not managed to offset the often lower amount of transactions and volumes that come with higher interest rates into stronger earnings. The last report was quite frankly a little disappointing and I find that investors are right now better off looking elsewhere if they wish to add exposure to the regional banks' industry. Given the current divide yield for the company investors already having an existing position in the company may see it as beneficial to hold onto that for the momentum though.

Company Structure

Lakeland Bancorp, Inc. operates as the bank holding company for Lakeland Bank and offers various banking products and services for individuals and small to medium-sized businesses. It provides commercial banking services, including savings, money market, and time accounts, as well as demand deposits.

Looking at the results from the company it seems that they have a stronger efficiency ratio than a lot of the peers in the industry as per their description and presentation. The efficiency ratio is at 53.9, below the peer average of 56.06 which indicates a stronger earnings potential with LBAI. Where LBAI still has some work to do is the net interest margin which sits below both median and average peer values. This will be improved by further growing the loan portfolio, but also retaining activity even in higher interest rate environments.

I don’t think it should be taken away from the company that they have grown very well over the last several years. The book value for example has improved by 14.09% annually in the last decade. This has had a positive impact on the bottom line of the business as LBAI has exhibited a double-digit growth rate here. This has ultimately led to the strong dividend profile of the company as well.

With LBAI you are getting a divine aristocrat as it has been climbing 6.17% annually over the last 5 years and still is at a payout ratio of just 35%. Now, I have said earlier that because of the decline in the noninterest income, the company will have a higher payout ratio going forward if it's to distribute the same $0.58 annual rate. I think that the low payout ratio for LBAI still leaves room for it to grow in the coming years as I will be discussing more in-depth below here as well.

Earnings Transcript

There are some useful comments I found from the last earnings report that the company posted where the CEO of LBAI Thomas Shara provided some insights into the recent performance.

“We are quite pleased with our continued steady loan growth of 3% year-to-date. Overall, deposit balances remain fairly stable while customers shift funds toward time deposits and higher yielding accounts. Asset quality remains stellar and continues to improve with lower nonperforming assets year-over-year which reduces our concern over any significant near term credit degradation in our loan portfolio”.

Seeing a continued YTD improvement in the loans is reassuring I think and underscores that LBAI is still at the core a solid bank that can grow loans over the long term at an appealing rate. The lack of capitalizing on interest rates now though is what discourages me from investing though. If the company manages to prove me wrong in the coming quarters I can see a higher rating being applicable, but for the moment a hold is my course of action.

“We continue our interaction with the regulators and have been providing additional information in order to further support our applications for approval of the merger. The companies have made significant progress in various integration initiatives through outstanding teamwork from both banks. We look forward to receiving regulatory approval and combining our two great franchises into the best bank in New Jersey”.

As we know, LBAI is also aiming at merging with Provident and the progress seems to continuing steadily, but I think that positive news on this matter could send the share price higher as investor optimism is climbing. It has been facing some pushback as activists were raising concerns about the size that the combined two companies would have. I think this won't play out enough to warrant the deal to be put down. Both businesses have solid models and I don't think there is evidence to suggest they would get an overexaggerated part of the market share. The latest news around it though is really from the management in the last report as they continue to reassure investors that the deal is coming along the lines very well.

Valuation & Comparison

Given the decrease that the bottom line saw in the previous report from the company, I think that even if LBAI is trading below peers and the regional bank's industry, it is more expensive now. If the net income continues to decline like they are LBAI could be trading at an FWD p/e of around 10 - 11 instead in just a few years if the same double-digit NI declines continue.

Before a more positive view can be had on LBAI I want to see the NI start climbing once again. Until then investors are faced with too much potential downside risk in my opinion. Right now LBAI is trading below its 5-year average p/e and I think it may continue given some of the risks I have laid out like lower NI. On a p/b basis, it looks quite cheap as well as it's below 1 and closer to 0.7. This is a decent discount to what I normally look for in financial companies, which is 1 for the p/b. But as we have discovered there seem to be some difficulties for LBAI to properly take advantage of the equity they have and drive higher profits, the ROE is 9.32%, below the sector and the 5-year average for LBAI. My thinking here is that LBAI will continue to trade at these discounts until the bottom line shows improvements again, because of this it remains a hold in my opinion as I see no significant catalyst that could catapult the valuation upwards.

Risk Associated

LBAI has faced challenges in mitigating the effects of reduced activity as interest rates have risen, which has impacted their earnings. The company's existing loan portfolio has seen limited improvement, leading to a decline in net income. Consequently, maintaining the same distribution levels would increase the company's payout ratio. If upcoming performance reports continue to disappoint, the market may respond with a significant decline in the company's share price to reflect these associated risks.

An important factor contributing to a potential earnings decline this year for LBAI is the above-average provisioning. However, anticipated loan growth is expected to provide support to earnings through the end of 2023. Additionally, the margin is likely to remain stable, exerting little impact on the company's bottom line. In Q2 FY2023, the provision for credit losses amounted to $1.9 million, reflecting a notable decrease from the $3.6 million reported in the same period in 2022. This provision in 2023 includes $2.4 million allocated to credit losses on loans, a positive development of $171,000 attributed to credit losses on investment securities, and an additional benefit of $304,000 related to off-balance-sheet exposures.

Nevertheless, there may be concerns if there are any weaknesses in LBAI's foundation, such as a slowdown or decline in loan growth. In such a scenario, the company's earnings potential could rapidly decrease, and the market might continue to hold a negative perception of the business. This underscores the importance of monitoring the company's loan growth trends closely.

Investor Takeaway

The rise in interest rates has shown which companies are solid and which ones have cracks in the foundation. I am sorry to say that LBAI has not been able to capture the potential earnings improvements that often come along with higher interest rates. The last quarter showed a decline in the bottom line as less activity and deposits were felt by the company. If this is a trend that continues then LBAI looks quite expensive and no investor should get in or add more until there is a clear reversal on this front in my opinion.

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