Does Webster Financial's 2.6% Dividend Justify a Buy?
Over the next month, banks will be releasing results for the second quarter. In advance of these releases, let's take a moment to review the state of some of these banks as of the end of Q1.
In this post, we'll look at Webster Financial Corp. , a $21.2 billion bank headquartered in Waterbury, Conn. You can find information on other banks at my Motley Fool article feed, available here. All data in this analysis was sourced from the FDIC's Quarterly Banking Profile and Capital IQ.
Source: Company website.
When I evaluate banks, I follow a model made famous by former Wachovia CEO John Medlin: soundness, profitability, and growth. As investors, we then take a look at valuation and the potential for investment after gaining a better understanding for each bank.
Soundness refers to the bank's asset quality. Generally speaking, this means loans. If a bank makes loans that are never repaid, that bank will fail, and fail quickly. The best banks put risk management first, ensuring that shareholder capital is protected if a portfolio of loans turns sour.
To measure this, we'll look at both non-performing assets and Webster Financial Corp.'s provision for loan and lease losses. A simplified definition of non-performing assets is loans or other assets that have fallen seriously delinquent or are in foreclosure.
The provision for loan and lease losses is a reserve of money that the bank pulls out of its income each quarter to guard against future losses in the loan portfolio. Banks are required by regulation to maintain certain levels of reserves, but within that, management has plenty of wiggle room to over- or under-reserve. Over-reserving increases protection but hurts net income; under-reserving increases risk but keeps net income high.
For the quarter ending on March 31, Webster Financial Corp. had 7.2% non-performing assets as a percentage of total assets. The FDIC reports that banks with total assets greater than $10 billion on average had 1.47% non-performing assets as a percentage of total assets.
Webster Financial Corp. reserved $9 million for the first quarter, which represented 4.4% of operating revenue. That compares with 5% for the $10 billion-plus peer group, according to the FDIC.
Webster Bank, the bank subsidiary of Webster Financial Corp., is a traditional bank with exposure to mortgage lending, asset-based lending, commercial real estate, and other concentrations hit hard during the recession. Even though the bank faced a stacked deck in the financial crisis, it's still concerning as an investor that the company hasn't more fully resolved its non-performing assets.
Non-performing assets this high is of serious concern.
After establishing an understanding of a bank's risk culture and soundness, next we can focus on profitability. Any investment in a business is an investment in that company's future earnings, so profitability is a particularly important consideration for any bank investor.
The first question, perhaps most obviously, is whether the bank generates a profit at all. According to data from the FDIC, 7.3% of U.S. banks failed to generate a profit at all in the first quarter. That's one in every 14 banks!
For Webster Financial Corp., the first calendar quarter of 2014 wasn't that bad. The company generated total net revenues of $205.1 million for the quarter -- that's total interest income plus non-interest income minus interest expense.
Over the past 12 months, Webster Financial Corp. has generated $763.8 million in total net revenue. Of that revenue, 76% was attributable to net interest income, the difference between interest earned on loans and paid out to depositors. The remaining 24% was through fees, trading, or other non-interest revenue sources.
The bank's primary focus is obviously on lending products, specifically to commercial and retail borrowers. The company does have a specific division that offers asset and wealth management, private banking, and other fee-centric businesses. Based on the company's asset quality review and high reliance on lending in terms of revenue, I can't help questioning what value that division is bringing to the table for Webster.
The bank was able to turn a profit margin of 25% on that revenue.
For the first quarter, the company reported return on equity of 9.1%. Of the banks covered in this series of articles, the average return on equity was 8.9%. The FDIC reports that the average ROE for U.S. banks with total assets greater than $10 billion was 9.1%.
In summary, Webster relies very heavily on its lending business to generate revenues. The company's profitability is underwhelming, though, with slightly above average profit margins and spot-on with the average return on equity.
Leverage is a double-edged sword for banks and could easily fit into either the soundness or profitability categories. We'll call it a subset of both and discuss it here.
Leverage is just part of the game with banks, so if you're a conservative investor who really focuses on conservative capital structures, the banking industry may not be the best place for your money. Adding leverage is an easy way to juice return on equity, which is, generally speaking, a good thing. The bank increases assets and thus earnings, while maintaining a lower capital level.
The result is a higher numerator, a constant denominator, and a larger return-on-equity number. The math does the heavy lifting for you.
On the flip side, too much leverage can put the bank on thin ice if the loan portfolio takes a turn for the worse. A stronger equity base protects the bank from bankruptcy and bailouts, two outcomes that are both politically charged and downright terrible for shareholders.
Banks use all kinds of esoteric and overly complex accounting methods to determine leverage. We'll keep it simple here with an old-fashioned assets-to-equity ratio. The lower the number, the less levered (and more conservative) the bank.
Webster Financial Corp.'s assets-to-equity ratio comes in at 9.5. The average of the 62 banks analyzed in this series of articles was 9.1.
Growth and valuation
Webster Financial Corp. saw its revenues change by 1.4% over the past 12 months. That compares with the 5.7% average of the 62 banks analyzed.
This change in revenue corresponded with a 6.2% rise in net income over the same period. The peer set averaged 14.1%.
Fifty-four percent of all U.S. banks saw year-over-year earnings growth in the first quarter.
Moving now to valuation, Webster Financial Corp. traded at a forward price-to-earnings ratio of 14.8, according to data form Capital IQ. That compares with the peer set average of 16.7.
Webster Financial Corp.'s market cap is, at the time of this writing, 1.8 times its tangible book value. The peer set average was 1.9.
Many investors use a general rule of thumb of buying a bank stock when the price-to-tangible book value is less than 0.5 and sell when it rises above 2. For me, that method is just way too oversimplified.
It sometimes makes sense to pay a premium for a bank stock that places a high value on credit culture and asset quality. These banks will survive and prosper while others fall by the wayside. That security can be worth a premium. Likewise, a bank that relies heavily on leverage to achieve above-average return on equity may not be worth the price, even if price-to-tangible book value is low. That risk may not justify even a healthy discount in price.
Based on the factors we've discussed here -- soundness, profitability, and growth -- Webster Financial doesn't stack up.
The company's valuation metrics are on the average to low end, and that is justified by the company's asset quality issues. For me, questions about asset quality are a pretty serious obstacle to overcome. Taken alongside the company's decidedly average profits, near 10-times leverage, and below-peer growth numbers, Webster simply doesn't fit the bill for a long-term, valued-oriented investment.
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The article Does Webster Financial's 2.6% Dividend Justify a Buy? originally appeared on Fool.com.Jay Jenkins and The Motley Fool have no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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