Valley National Bancorp (NASDAQ: VLY) reported earnings of $0.23 per share in the second quarter of 2020, up 10% from the first quarter. Earnings will likely continue to increase in the year ahead, due to the accelerated booking of fees under the Paycheck Protection Program. Additionally, lower provision expense will likely increase the net income in the second half of the year compared to the first half. Moreover, the maturities of Certificates of Deposits in the remainder of the year will support the bottom line. Consequently, I’m expecting earnings to increase by 36% in the second half of the year compared to the first half. For the full year, I’m expecting VLY to report earnings of $1.03 per share, up 18% from last year. The June 2021 target price suggests a high upside from the current market price; therefore, I’m adopting a bullish rating on VLY.
Paycheck Protection Program, Deposit Repricing to Drive Net Interest Income
The Paycheck Protection Program, or PPP, will likely be the chief driver of net interest income in the remainder of the year. VLY funded $2.3 billion worth of loans under PPP with an average rate of 3%, as mentioned in the second quarter’s investor presentation. Assuming a funding cost of 0.35%, PPP will add an estimated $61 million to net interest income over the life of the loans, which is a maximum of two years. A majority of the loans will likely get forgiven before the year-end; therefore, I’m expecting VLY to accelerate the booking of the fees in the remainder of the year.
Excluding the impact of PPP, the net interest margin, or NIM, is likely to slightly increase in the third quarter and then decline. Like several other banks, VLY experienced excess liquidity in the second quarter amid the COVID-19 pandemic. The excess liquidity shrank NIM by 8bps in the second quarter, as mentioned in the presentation. VLY will likely gradually redeploy this liquidity into higher-yielding assets as opportunities arise; therefore, NIM will likely fare better in the third quarter compared to the second quarter.
Moreover, around $4 billion of Certificates of Deposits, or CDs, carrying costs of around 1.4% will mature over the next three quarters, as mentioned in the second quarter’s conference call. The maturity will ease the pressure on NIM. Further, as mentioned in the presentation, more liabilities than assets will reprice in the third quarter, which will buoy NIM. However, more assets than liabilities will reprice in the December 2020 and March 2021 ending quarters, which will likely pressurize NIMs. The following chart from the presentation shows the repricing gap.
Considering the factors mentioned above, I’m expecting NIM to increase by a basis point in the third quarter and then decline by two basis points each in the following two quarters. The table below shows my estimates for yield, cost, and NIM.
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The expected forgiveness of PPP loans will likely reduce loan balances in the year ahead. Excluding the impact of PPP, loans will likely grow at a low rate on the back of residential mortgages. Management mentioned in the conference call that the refinance market was strong. On the other hand, the demand for commercial loans will likely remain subdued amid the COVID-19 pandemic, which will pressurize loan growth. Overall, I’m expecting VLY to end the year with loans of $30 billion, down 6% from the end of June 2020 and up 1% from the end of last year. The following table shows my estimates for loans and other balance sheet items.
Economic Outlook Unlikely to Worsen Beyond the Forecasts Incorporated in Existing Reserves
VLY reported a provision expense of $41 million in the second quarter, up from $35 million in the first quarter of 2020. Management used forecasts for GDP and unemployment to determine the provisioning requirement for the last quarter. The following quote from the conference call gives details of management’s economic forecasts:
Our model reflects some amount of GDP recovery in the third quarter of 2020, followed by GDP declines in the beginning of 2021 with the slow recovery throughout that year. We also expect unemployment to climb above 11% in early 2021 and remain in double digits for the foreseeable future. Future provisioning activity will be largely dependent on the degree that economic outcomes track our expectations.”
The above quote shows that the loan loss reserves already incorporate quite a stressed economic outlook. I believe it’s unlikely that the economy will deteriorate beyond management’s forecasts; hence, I’m expecting the provision expense to trend downwards in the year ahead. For the full year, I’m expecting VLY to report a provision expense of $106 million, representing 35bps of total loans, as opposed to 8bps of total loans in 2019.
VLY has a moderately high credit risk because of COVID-19 and the company’s exposure to pandemic-sensitive industries. As mentioned in the presentation, vulnerable industries, including nursing and residential care and retail trade, made up 14.9% of total loans, excluding PPP, at the end of the last quarter. Moreover, around 8% of total loans were in an active payment deferral program.
Expecting Earnings to Increase by 36% in the Second Half of the Year Compared to the First Half
The accelerated booking of PPP fees and a decline in provision expense will likely increase earnings in the year ahead. Moreover, management mentioned in the conference call that it had additional expense levers to help mitigate revenue challenges. Therefore, I’m expecting non-interest expense growth to be subdued going forward. Overall, I’m expecting earnings in the second half of the year to be 36% higher than the earnings in the first half. For the full year, I’m expecting VLY to report earnings of $1.03 per share, up 18% from last year. The following table shows my income statement estimates.
Actual earnings may differ materially from estimates because of the uncertainties surrounding the COVID-19 pandemic. If the pandemic worsens beyond expectations, then the provision expense can take a hit, leading to a negative earnings surprise. Due to the high level of risks, VLY appears unsuitable for low-risk tolerant investors.
Adopting a Bullish Rating Due to High Upside
I’m using the historical price-to-tangible book value per share multiple, or P/TB, to value VLY. The company has traded at an average P/TB ratio of 1.26 in the first half of 2020. Multiplying the P/TB ratio with the June 2021 forecast tangible book value per share of $7.7 gives a target price of $9.6 for the mid of next year. This price target implies a 19.5% upside from VLY’s August 14 closing price. The table below shows the sensitivity of the target price to different levels of the P/TB ratio. The base case is in the shaded column.
VLY is also offering an attractive dividend yield of 5.5%, assuming the company maintains its quarterly dividend at the current level of $0.11 per share. There is little threat of a dividend cut because the earnings and dividend estimates suggest a payout ratio of 47% for 2020 and 49% for 2021, which is sustainable.
Based on the upside and dividend yield, I’m adopting a bullish rating on VLY. However, when making an investment decision, investors should keep in mind that the company carries a high level of risk.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Disclaimer: This article is not financial advice. Investors are expected to consider their investment objectives and constraints before investing in the stock(s) mentioned in the article.