2023-04-11 11:06:58 ET
Summary
- Washington Trust, a Rhode Island regional bank, is currently yielding 6.7%.
- The bank has significant paper losses in its AFS securities account, but it does not have any "hidden" losses in HTM accounts.
- They are not highly leveraged because they have only a very small amount of long-term debt and no preferred shares.
- It is an old conservative bank that can trace its history back to 1800, which is appealing to customers looking for security.
The banking industry imploded over the past month, which means it is time to buy a cheap bank stock. After doing an extensive screening process I found an interesting regional bank in Rhode Island that I bought last week. Washington Trust Bancorp ( WASH ) was hit hard and now yields an impressive 6.7%. This is not a very long-term investment - it is only a 12-18 month trade to when the stock price increases back to yielding 5.0%, which implies a price of $45. This would give investors a respectable dividend income and a 33% capital gain. WASH stock might be a way for investors to make money from this financial storm that has sunk a few banks.
My Screening Process
Researching regional banks requires looking at their specific market area. I did not want a bank that is exposed to commodities such as oil/gas or agricultural products. That screened out a large part of the country. I also did not want a high growth area because that also increases risk when the growth slows/stops/or even reverses. That screened out more banks. I did not want a bank with a large amount of hold-to-maturity HTM securities in their investment portfolio because their paper losses are not reported on either the balance sheet or income statement - you have to read some footnotes buried near the end of their 10-K to find that data. I also did not want a bank with a lot of long-term debt or a lot of preferred stock because I did not want a highly leveraged financial structure that increases risk, especially if we are headed into a recession.
I wanted a bank that is "old" because many consumers are currently looking for secure/reliable banks and are avoiding banks perceived as potentially risky. Since most consumers do not understand banking financial statements, they might use a "proxy" to determine reliability and that "proxy" often could be how long they have been in business. I wanted a bank that had a very large decline in stock price from its 12-month high. I also wanted a bank that had a relatively secure dividend and was currently yielding over 6.0%.
I found a few that screened in but many of them do not have a very liquid market for their stock, so I thought it was inappropriate to write an article about them on Seeking Alpha. (While I bought or I am trying to buy them.)
This Is How Washington Trust Was Screened In
*Washington Trust Bancorp can trace its history back to 1800. That is old. It is an old conservative bank that is boring. Boring is good in bad times. I think customers feel relatively safe keeping their deposits at this old bank and do not feel that they have to transfer their business to a "too big to fail bank'.
*They only have $22.7 million junior subordinated debentures and no preferred stock compared to $454 million shareholder equity. So, they are not highly leveraged.
*The bank does not hold any securities in an HTM account. Their securities are held in an AFS account. Yes, those paper losses are large. The cost basis as of December 31, 2022 is $1.166 billion and the fair value was $0.994 billion or a paper loss of $172 million. That paper loss is $10.03 per WASH share. These paper losses are not reported on the income statement but do impact the shareholder equity area of the balance sheet via accumulated other comprehensive income (loss) - AOCI. Comparing the paper loss on securities I use a number of different metrics to determine the significance of the losses. WASH had a total shareholder equity of $454 million as December 31, 2022 and that already includes the impact of the AFS paper losses. I add back the paper losses of $172 million to the $454 million shareholder equity to get a total of $626 million. I then compare the $172 million to $626 million, which is 27%. That is significant, which helps to partially explain the sharp decline in stock price. The AFS paper loss of $172 million is also about 15% of the total cost of the securities. Many other banks have even worse numbers especially after factoring in the paper losses on their HTM securities.
*Most of their market area is in Rhode Island, the western part of Connecticut, and the southern part of Massachusetts. This region's economy does not directly depend on commodities. There are no oil/gas fields in the area and very limited agriculture production. There is a modest amount of diversified manufacturing, such as ship building. CVS Health ( CVS ) is headquartered in the state and is the largest private employer. The state's per capita income of $39,603 is somewhat higher than the national average of $37,638.
*WASH currently yields 6.7% based on the last quarterly dividend of $0.56. This dividend seems secure relative to their last quarterly income of $0.95 per share (57% payout rate). They have increased their dividend each year for the last twelve years.
This 6.7% is significantly outside their normal yield trading range as can be seen by the chart below. Even trading at a yield of 5.0%, which implies a stock price of $45 based on their current dividend, is near the high of their yield trading range.
*I did not actually screen for bank regulation metrics. I figured I would look at those once I screened down to a small number of banks. As can be seen by the metrics reported below, Washington Trust had a significant margin of safety in 2022. These metrics, however, were not as strong as in 2021.
Bank Regulation Metrics
Negatives Impacting WASH Current Stock Price
There are legitimate reasons why WASH and other bank stocks got destroyed over the last few weeks. Much of the attention has focused on paper losses on the securities because interest rates have soared since early 2021. Another area of concern is mortgages on commercial and residences. WASH does not really have a diversified loan portfolio. For example, the bank does not issue credit cards. That is often a very profitable area for other banks, but if we are headed into a recession not having exposure to potentially large credit card charge offs is actually a positive for WASH. Their problem is much of their loan portfolio is associated with real estate - both commercial and residential.
Loan Portfolio
Their operating results last year were really hurt by a major drop in mortgage banking revenue to $8.773 million from $28.626 million. Higher interest rates last year put the brakes on home buyers willing to borrow to buy a home.
Income Statement
As can be seen in their income statement, their wealth management area was also hurt last year because four of their wealth management advisors left. It seems they may have taken a number of the clients with them because the bank had $673 million in client "outflows" in 4Q. Management also has indicated that there could be additional outflows.
I am somewhat confused by their business model. According to their website , the bank is offering CDs at rates under 0.75% and for very short-term CDs only 0.10%, but for new customers they are offering 5.0% on 11-month CDs with $500 minimums and the requirement that the new customer open a checking account. In my opinion, this could annoy current customers and it might mean that after the 5.0% CD matures the customer would have no incentive to keep their accounts open. The expense of opening and then potentially closing new accounts seems an expensive way to get new deposits, in my opinion.
Finally, their total return over the last ten years is only modestly better than the S&P Regional Banking ETF ( KRE ), but I am really just looking for a total return over the next 12 to 18 months and I am expecting that WASH will outperform this ETF.
Impact of Change in the Level of Interest Rates
Interest rates rose from the end of last year until March 2, which spooked a lot of investors because they began to finally focus on the increased paper losses in AFS and HTM portfolios. Most of the rates have now declined below December 31 levels, which should mean that AFS paper losses at Washington Trust should be less than at the end of last year. Without knowing the details of any of their trades during 1Q, it is impossible to accurately estimate the actual AOCI impact on their 1Q shareholder equity, but I am assuming there will be an improvement.
Yields-U.S. Treasuries
12/31/2021 | 12/30/2022 | 3/2/2023 | 3/31/2023 | |
3 month | 0.06 | 4.42 | 4.91 | 4.85 |
6 month | 0.19 | 4.76 | 5.18 | 4.94 |
1 year | 0.39 | 4.73 | 5.04 | 4.64 |
2 year | 0.73 | 4.41 | 4.89 | 4.06 |
5 year | 1.26 | 3.99 | 4.32 | 3.61 |
10 year | 1.52 | 3.88 | 4.08 | 3.48 |
30 year | 1.91 | 3.97 | 4.03 | 3.67 |
Conclusion
I am old fashion investor and often "buy on blood and sell on love" to take advantage of a crisis. After completing an extensive screening process of regional banks, I elected to buy Washington Trust Bancorp.
While the bank has a number of serious problems, I think the dividend is secure even if profits this year are lower than in 2022. When the financial storm begins to fade, I expect WASH stock will rise to where it yields 5.0% or $45 per share using the current quarterly dividend of $0.56. I rate WASH stock a buy.
For further details see:
Washington Trust Might Be A Way For Investors To Make Money From The Current Financial Storm