PEBO - Peoples Bancorp: The Cost Of Deposits Is Still Very Low
2023-08-06 07:13:15 ET
Summary
- Peoples Bancorp maintains low deposit costs and a high net interest margin, with no significant concerns in the short term.
- The acquisition of Limestone brings potential benefits such as cost savings and new strategic locations, but also incurs expenses and a negative impact on diluted EPS.
- The bank's loan portfolio shows growth in construction loans, but also exposes a significant weight on commercial real estate, which may affect valuation and multiples.
Just as in the previous quarter , Peoples Bancorp (PEBO) is keeping the cost of deposits low due to its dominant position in the regions in which it operates, and as a result the net interest margin has not slowed down. On the loan side, the construction segment has been the fastest growing, while commercial real estate is not a concern for the time being. Overall, as also expressed by CEO Chuck Sulerzyski , it is difficult to find a weakness in this quarterly, as everything is proceeding without any particular hiccups.
It scares me to say, but I have very little concerns. It's almost early too good to be true. But we had really good, as I indicated in the script, really good improvements during the quarter. You always have issues and things that you are working on, but I think we are optimistic on the vast majority of the stuff that we have. So, we don't see any issues in the short-term.
Limestone acquisition
One of the most awaited factors of this quarter concerns the completion of the acquisition of Limestone for $208 million . That deal was found as early as the end of 2022, but it was in this quarter that it manifested its accounting effects.
Much was discussed during the conference call, and management sees Limestone as an opportunity for Peoples Bancorp to exploit synergies and offer new services to its customers. In addition, this acquisition should bring significant cost savings as well as new strategic geographic locations in which to operate. In any case, these are the potential benefits that can be seen in the future, at the moment, however, there are still downsides from the acquisition. Namely:
- Costs associated with the acquisition of $10.70 million this quarter and $4-5 million expected in Q3 2022.
- Negative impact of about $0.25 in diluted EPS this quarter.
Specifically, $10 million resulted from higher allowances for credit losses from Limestone operations, the impact of which was -$0.23 on diluted EPS. Essentially, most of the expenses were related to Q2 2023; from the next quarter, expenses related to this acquisition should be minimal.
Loans and securities portfolio
In a macroeconomic environment of such high interest rates, it is difficult for both households and businesses to apply for a loan or mortgage. For this reason, it will not be as easy as in the past for Peoples Bancorp - as well as the entire banking sector - to originate new loans. For the time being, however, growth continues, albeit at a moderate pace.
Excluding the Limestone acquisition, the organic loan portfolio grew by $146 million or 12 percent annualized over Q1 2023. Growth was mainly driven by construction loans, which increased by $71 million. As of June 30, 55 percent of loans were fixed-rate, while the remaining 45 percent were variable-rate.
Excluding the loans obtained from the Limestone acquisition, organic loan growth is expected to be between 6-8% in 2023: in short, not exciting growth, but it has to be contextualized in the far from easy economic environment.
Including the Limestone acquisition, Peoples Bancorp has encompassed loans worth about $1.10 billion.
As we can see from this image, more than half of them were concerning the commercial real estate segment, which to date has assumed a significant weight on the entire portfolio, about 41.80 percent.
Typically, investors frown on banks with such exposure to this segment, as it is considered one of the most fragile in a recession. This overexposure is seen as a weakness and may partly explain why Peoples Bancorp is trading at lower multiples than its competitors. In fact, the PE ((FWD)) is only 8.24x, while the industry average is 10.29x. What's more, much of this exposure of more than $2 billion has a maturity of more than two years, in fact only $120 million will mature this year and $225 million next year.
In any case, CEO Chuck Sulerzyski does not seem worried and is confident about the debtors' solvency.
We are very comfortable with the ability of our borrowers to absorb the higher rates when these loans were underwritten. I can't tell you that we stress them 5%, but we stress them 3%. And basically, what we are lending to proven developers, sponsors with deep balance sheet.
As for the securities portfolio, it is not currently a priority for management, which will take a fairly passive approach. This portfolio is capable of generating monthly cash flows between $15-20 million, and these funds will be used to finance the origination of new loans. So, at least momentarily, the focus is on originating new loans at current rates and then considering the purchase of low-risk securities with a decent yield.
Finally, total assets stand at about $8.80 billion, and it is not long before the $10 billion threshold is crossed. Reaching it would mean for Peoples Bancorp the achievement of a historic milestone, but it also presents a number of pitfalls. Indeed, when this threshold is crossed, banking regulators typically take a more stringent approach to risk management. The preparation period to meet the new requirements can take time and economic resources.
In any case, according to the CEO's vision , there is no need to accelerate this process, and the growth strategy will remain unchanged. New strategic acquisitions similar to that of Limestone will be sought, but at the same time if the $10 billion threshold were to be reached through organic growth it would still be a success.
We are in no rush. We have a lot of room. We are at $8.8 billion. We can continue to take down the investment portfolio. We will continue to grow organically. We continue to have conversations with institutions of all sizes. And as we get closer, we will make the best strategic decision that is in front of us. And so maybe we have a whisker of a preference to do a large deal to shoot us over $10 billion. But I wouldn't be crushed if we went organically, and I wouldn't be crushed if we did a small deal.
Deposits continue to be cheap
In the previous quarterly report I had highlighted how Peoples Bancorp's strength is its low cost of deposits, and in this Q2 2023 it continues to be so.
As we can see from the average balance sheet, total interest-bearing liabilities are 59 basis points more expensive than the previous quarter, but their cost remains low, 1.55 percent. Also, unlike many other banks, Peoples Bancorp has not experienced a significant drop in non-interest bearing deposits over the past year.
All this obviously has a consequence on the net interest margin, which is still very high, 4.54 percent. This is fully within the guidance for FY 2023, where management expects it to be between 4.40- 4.60%.
But how is it possible for this bank to be unaffected by rising rates on the deposit side?
The answer lies in the geographic expansion strategy: Peoples Bancorp has a dominant market share in many small towns that most competitors have left behind. This is the main driver of growth, and new deals are on the horizon in the coming years to continue operating in markets with little competition.
Our footprint lends itself well to our growth. As many of our big four banks, including Wells Fargo, Chase, Bank of America and Citi do not have an extensive network within many of the communities we serve. If you look at the counties that are within a 90-minute drive from our headquarters in Marietta, there are approximately 600 bank branches. Of those 600 branches, the big four banks only have 26 and we have 51. Those counties generated 30% of our total revenue for the first half of 2023. We believe this leads to opportunities to expand our business and offerings to new clients.
The results of this strategy are obvious: stable deposits and customers who are satisfied with getting relatively low interest on their deposits. Moreover, the average Peoples Bancorp customer presents a deposit of only $29,000.
Conclusion
As stated by the CEO, there are no particular challenges at the moment as the cost of deposits remains low, the net interest margin stays high, and CRE is not a concern. The acquisition of Limestone could lead to improved efficiencies and new growth drivers to areas such as fee-based income and to strategic geographic positions.
Regarding the current valuation, as already anticipated, the multiples of this bank are quite low when compared to both its historical values and its competitors.
With a rating of A- on Seeking Alpha and a dividend yield of 5.55 percent, Peoples Bancorp looks interesting at the current price. Moreover, its average price/book value over the past 10 years has been 1.08x, while today it is only 0.96x. Multiplying the historical average by the current book value per share of $28.75, the fair value is about $31 per share.
Overall, based on this data and the performance of the last few quarters, I believe Peoples Bancorp is slightly undervalued, which is why I am changing my rating to buy.
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Peoples Bancorp: The Cost Of Deposits Is Still Very Low