WSBCP - WesBanco Preferred: An 11%+ Yield To Call Opportunity

2023-03-22 15:07:55 ET

Summary

• WesBanco's preferred shares trade at a discount to the redemption price.
• The reset rate margin of 6.557% is well above typical market premiums suggesting the preferred shares are likely to be called in November 2025.
• At the current quotation the yield-to-call is approximately 11.5%.

WesBanco ( WSBC ) is a $17 billion bank holding company primarily serving West Virginia with additional operations in the surrounding region. The company’s preferred shares, which are our focus for this article, have been impacted by the recent turmoil in the banking industry. However, at the current quotation we consider the preferred shares a compelling opportunity. The current yield of approximately 7.5% is attractive in its own right, but is further boosted by the high probability that the preferred shares will be called for redemption in November 2025. The current quotation’s discount to the redemption price plus the preferred dividend results in a potential annualized return through maturity of around 11%-12%. However, our enthusiasm is tempered slightly by our recognition that WesBanco’s financial position is not as robust as some other institutions though by no means at great risk.

In many respects the WesBanco preferred shares are very similar to those issued by Wintrust Financial Corporation ( WTFCP ) which were also issued in 2020. Wintrust’s preferred shares were a recent subject for us with a positive recommendation as a compelling option for conservative and income-oriented investors. However, those shares have appreciated more quickly than WesBanco’s preferred in recent days and now provide a less attractive, though still decent, return opportunity through likely redemption.

In this regard we should note that the quick-paced recovery in many banking preferred shares and the ongoing volatility means that calculations of current yield and yield-to-call can vary dramatically from day to day. The initial draft for this article was written when the company’s preferred shares provided a 14% yield-to-call which we considered highly attractive. The rate has since declined to around 11%-12% and may be lower by the time this article is published, so prospective shareholders would be well advised to review current market pricing to assess yield-to-call at the time of purpose.

Preferred Shares

The WesBanco Series A preferred stock ( WSBCP ) is a series of non-cumulative reset rate preferred stock with a liquidation/redemption price of $25.00 per share. The preferred stock yields a fixed 6.75% of the stated value, payable quarterly, until November 15, 2025, at which time the dividend rate is reset every five years at a premium of 6.557% over the then applicable rate on the five-year U.S. Treasury bond.

The preferred shares are redeemable at the company’s option at the redemption price on November 15, 2025, and on November 15 every five years after the initial potential redemption date. In addition, the preferred shares are subject to potential redemption, as with many bank preferred shares, in the event that regulatory changes no longer permit the preferred shares to be included as a component of Tier 1 capital for regulatory purposes.

The preferred shares were originally issued on August 4, 2020, in the aftermath of the pandemic panic in markets which saw a number of companies seek to raise additional capital in an uncertain environment, thus the rather wide premium over five-year bond rates incorporated into the reset provision.

Issuer Strength

The attractiveness of a bank’s preferred securities is based on the attractiveness of the bank’s core operations. In assessing the strength of the underlying issue we consider financial condition, operating results, asset/liability composition, the nature of the institution’s deposit, and capitalization ratios adjusted to include unrealized losses on investment securities. A thorough review of WesBanco is not within the scope of this article but, in our assessment of the bank, we find that the issuer on balance has sufficient strength to support the preferred shares.

In this regard WesBanco’s financial condition is sufficient although not quite as robust as we would generally prefer once adjusting for the significant losses in the company’s held-to-maturity securities portfolio. In addition, we recognize that the bank’s investment securities portfolio is more heavily weighted towards longer duration – and therefore more interest rate sensitive – securities than some peer institutions. Our estimates of the bank’s loss adjusted Tier 1 capital to risk-weighted assets ratio fall roughly in the range of 6.9% to 7.5% depending on the assumptions made which is just under the thresholds for well capitalized institutions before any consideration of the capital conservation buffer which essentially represents an increase in bank capitalization requirements. In comparison, we estimated that WinTrust Financial’s adjusted capitalization ratio to be closer to 10.1% which would leave the institution well capitalized even if significant unrealized losses were realized into income and shareholders’ equity. However, on the whole, this adjusted ratio still leaves the company in a decent position especially relative to some peer institutions.

In addition, it’s necessary to consider the proportion of total deposits represented by uninsured deposits as this can be an indicator of the potential for significant withdrawals in the event of a loss of confidence in the institution or the overall banking sector. In this regard, accounting to the company’s filings with the FFIEC, uninsured deposits represent a relatively modest 33% of total deposits more in line with smaller community banks and well below the 50% to 65% range common among larger regional banks.

Moreover, the bank’s asset/liability composition, interest rate sensitivity, and operating performance are all consistent with a strong regional lender. We will refrain from a detailed assessment of the company’s overall performance as that is not a specific focus of this article but we will note that the company’s interest rate sensitivity insofar as net interest income is concerned has been reduced over the last year and falls within a range which we consider quite acceptable for a financial institution of this type.

Probability of Redemption

The wide margin associated with the reset rate – 6.557% over the applicable five-year treasury rate – reflects the pandemic conditions under which the company issued the preferred stock. In more normalized conditions (which excludes the current environment of elevated concerns about the banking industry) the reset rate margin would likely be closer to 4.0% to 5.5% based on the company’s financial condition. A reference point for potential reset rate margins can be found in relatively recent reset rate preferred stock and subordinated notes issued by roughly similar financial institutions. The potential reference securities would include Ellington Financial’s preferred stock (EFC.PR.C) (although we consider Ellington inferior to WesBanco based on the nature of its business), Merchants Bancorp’s preferred stock ( MBINM ), and Associated Banc-Corp’s recently issued subordinated notes. It’s also worth noting that immediately prior to the recent banking related turmoil the preferred shares were trading at a slight premium to redemption value with a yield slightly below the stated 6.75%. The five-year treasury bond rate currently being approximately 3.5%, this would imply a required risk premium over the five-year treasury bond of approximately 3.25% versus 6.557%. In the current market, if the reset rate were to adjust today, the stated dividend rate would approach a remarkable 10%.

Moreover, in the event the company did not call the preferred shares for redemption in 2025, preferred shareholders would likely secure a robust preferred dividend yield for the next five years until the next potential redemption date.

We therefore view a redemption of the preferred shares in late 2025 as highly likely assuming interest rates do not significantly decline in the next two years. Indeed, even if rates decline over the next two years, we consider a redemption still more likely that not given the reset rate margin premium. In the event the preferred share are redeemed, based on the current market quotation, the compound average annual return to preferred stock holders (yield to call/redemption) would be approximately 11.5%. However, as mentioned earlier, potential investors should note that given the recent volatility in banking shares the yield to redemption can change, sometimes quite substantially, day to day. In the days before this article was published the yield-to-redemption ranged as high as 14%.

Conclusion

The preferred shares at the current market quotation (of about $22.50) provide a robust compound yield to redemption of approximately 11%-12%. In combination with WesBanco’s financial position, current market environment, and the relatively short duration until likely redemption, we believe the preferred shares represent a reasonably compelling opportunity, particularly for income-oriented investors, disproportionate to the realistic company and market risks.

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