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Regional bank Webster Financial (WBS) has been recovering successfully from the financial crisis, steadily increasing both earnings and tangible book value. A recent pullback, from a 52 week high of 23.73 to the 20 area, represents a buying opportunity.
I wrote the stock up favorably in September 2009, when it traded at 12.45, as a follow the smart money play. Warburg Pincus made an equity investment at 10 per share, received a board seat, and has been rewarded with handsome profits. I originally saw 27 within a 2 to 4 year time frame, and still believe that a target of 26 is realistic for late 2013.
This article is an update, focusing on recent events, valuation, and an options strategy.
Overview
Per the 10-Q:
Webster Financial Corporation (together, with its consolidated subsidiaries, "Webster," the "Company," our company, we or us), is a bank holding company and financial holding company under the Bank Holding Company Act of 1956, as amended, headquartered in Waterbury, Connecticut and incorporated under the laws of Delaware in 1986. Webster’s principal assets at March 31, 2011 were all of the outstanding capital stock of Webster Bank, National Association ("Webster Bank").
Webster, through Webster Bank and various non-banking financial services subsidiaries, delivers financial services to individuals, families and businesses throughout New England and into Westchester County, New York. Webster provides business and consumer banking, mortgage lending, financial planning, trust and investment services through 176 banking offices, 488 ATMs, mobile banking and its Internet website (websteronline.com). Webster Bank offers, through its HSA Bank division, health savings accounts on a nationwide basis. Webster also offers equipment financing, commercial real estate lending and asset-based lending.
Trajectory
Date | EPS | Book Value | Tangible BV |
03/31/10 | -0.08 | 19.41 | 12.44 |
06/30/10 | 0.15 | 19.75 | 12.79 |
09/30/10 | 0.22 | 20.02 | 13.09 |
12/31/10 | 0.30 | 20.01 | 13.78 |
03/31/10 | 0.36 | 20.42 | 14.21 |
According to Jaywalk, analyst opinions have been developing favorably so far this year. While WBS is not rated highly on an absolute basis, it is rated higher than 94.5% of its industry. A rose among the thorns. Certainly the steady improvement in earnings and book value merits consideration.
TARP and Warrants
The company received 400 million of TARP assistance, which has been repaid, partly from earnings, and partly by the issuance of additional shares. Treasury announced that the 3.28 million warrants received as part of the TARP transaction were to be auctioned Thursday, June 2nd.
The warrants, which entitle the owner to buy the stock for 18.18 until 11/21/2018, sold for 6.30 at auction, with Webster repurchasing 69.5% of them. The repurchase implies that shares will be worth at least 24.48 before the options expire, and Webster's involvement at the price demonstrates management's opinion as to the future value of the shares.
Well-Capitalized
Webster is well-capitalized by regulatory standards. From the 10-Q:
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Dividend
During the crisis, the dividend was cut to .01 quarterly. On April 26, the company announced an increase, to .05. That works out to 1% at today's share prices: there is room for improvement. Future increases will depend on performance and capital needs.
Performance Ratios
Net interest margin as of 3/31/2010 was 3.44%, up from 3.28% as of the same quarter last year. For 2008 through 2010, net interest margins were 3.28%, 3.13% and 3.34%.
The efficiency ratio at 67.61% continues to disappoint. Full year ratios for 2008 through 2010 were 62.38%, 65.92% and 66.49%. A ratio of 55% is attainable for a bank of this size, and this is developing in the wrong direction. According to the 1Q 2011 earning conference call presentation, the company's goal is to manage to a ratio of 60% or lower, over the 2011 to 2013 period.
It should be noted that Webster is service oriented, and that providing proper service in the wake of the financial crisis may be labor intensive. Nevertheless, the efficiency ratio does constitute a reservation for this investment and I plan to monitor it quarterly.
Valuation
At an Investor Day on 9/23/2010 (no longer available on the website, but I secured a transcript) Gerald Plush, CFO at the time, suggested a range of 9% to 11% would be appropriate for return on capital. Projecting tangible book to increase to 15.66 over the next two years, and applying 10% return on capital to that, earnings of 1.57 would be indicated. A P/E of 15, considering the conservative returns and expected growth, would call for a share price of 24.
FINVIZ lists a target price of 24.17.
Consensus estimates for 2013 currently stand at 1.76. The investment banks are coming under hostile scrutiny and potential regulatory pressure in the form of capital requirements intended to reduce systemic risk. Under those conditions, large and well capitalized regional banks may do well. A period of consolidation is likely, which should increase values as deals are done. I'm investing on the basis that shares will trade at 26 by the end of 2013. If that target is reached, shares will return 11% appreciation plus the 1% dividend.
Options Strategy
WBS is optionable, no LEAPS, with implied volatility at 27.85%. There is not a great deal of open interest, and quoted spreads are wide. However, I've been able to get pricing which I regard as fair over the year and a half I've been trading this situation. After the recent dip brought share prices back into a buy area, I made the following trade:
The outcome as of the first expiration date is presented in 4 scenarios - static, expected, 52 week high and 52 week low. The expected case assumes that share prices advance 11% annualized, which amounts to a 4.3% increase by the first expiration date in October. The attraction here is the 40% annualized return on the expected case. I'm not asking this stock to do much, just meander up toward a conservative target. If it performs as expected, returns will be excellent.
The best and worst cases considered illustrate one drawback of this strategy - the maximum probable loss exceeds the maximum possible gain. However, book value and tangible book value are available as margin of security. Also, the January 2012 12.5 call will still have 3 months remaining in October, and the investor can sell another covered call, collecting income while waiting for the share price to recover.
Disclosure: I am long WBS. I'm long WBS by a combination of diagonal and vertical call spreads
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