Stock Yards Bancorp’s (SYBT) earnings will likely plunge this year due to an increase in provisions expenses following the surge in unemployment. Moreover, the federal funds rate cut will squeeze net interest margin this year, which will further drag earnings. Furthermore, income from the wealth management business will likely decline as assets under management will shrink amid the stock market turmoil. Consequently, I’m expecting SYBT’s earnings to decrease by 22% year-over-year in 2020. The impact of the COVID-19 pandemic on provisions expenses is still uncertain, which makes the stock a risky investment. The December 2020 target price suggests a high upside from the current market price. However, I’m adopting a neutral rating on SYBT due to the risks and uncertainties.
Hike in Unemployment to Worsen Credit Quality
SYBT’s focus is on mortgages, which made up around 59% of total loans at the end of December 2019. The COVID-19 pandemic and the resultant surge in unemployment has increased the credit risk of these mortgages. According to news sources, 16 million people lost their jobs in the United States in the three weeks ended April 4, 2020. Further, a survey of 45 economists prepared by the National Association for Business Economics predicted an unemployment rate of nearly 10 percent at the end of 2020, and 6 percent through 2021, according to news reports. Based on the unemployment outlook and its implications for credit quality, I’m expecting provisions expenses to increase to $12 million in 2020 from $1 million in 2019.
Margin Compression to Negate Loan Growth
SYBT’s net interest margin (NIM) will decline this year due to the 150bps federal funds rate cut in March. Around 38% of SYBT’s total loans are variable-rate based, which will make the NIM somewhat rate-sensitive this year. Additionally, low-cost core deposits constitute 96.5% of total deposits, which will constrain deposit beta this year, thereby increasing NIM’s rate-sensitivity. According to the results of a simulation disclosed in the latest 10-K filing, a 100bps decline in interest rates can reduce net interest income by 4.99% over twelve months. The following table shows the results of the simulation.
Considering the interest rate sensitivity, I’m expecting NIM to decline by 11bps in the first quarter and by 25bps in the second quarter of 2020, on a linked quarter basis. The following table displays my estimates for yield, cost, and NIM.
Loans will likely continue to grow in 2020, which will offset the adverse effect of NIM compression on net interest income. I’m not expecting any merger activity this year; therefore, loan growth will be lower in 2020 compared to last year when SYBT acquired King Bancorp. Additionally, the lockdown amid the COVID-19 pandemic will hinder loan production this year. Moreover, the presidential elections in November will encourage businesses to postpone their investment and borrowing plans until after the formation of the new government. Based on these factors, I’m expecting loan growth in 2020 to decelerate to 4.06% from 11.7% in 2019. The following table shows my estimates for loans and other balance sheet items.
I’m expecting loan growth to cancel out the effect of NIM compression, leading to a slight decline in net interest income of 0.2% year-over-year.
Stock Market Crash to Reduce Wealth Management Revenue
I’m expecting SYBT’s non-interest income to decline this year on the back of lower wealth management income. Around 45% of the company’s non-interest income is attributable to wealth management and trust revenue. I’m expecting the stock market to be bearish again in the coming months, which will further reduce the equity portfolio’s size following the market crash in March. Around 33% of the assets under management were individual equities, while 31% were mutual funds and ETFs at the end of 2019, as mentioned in the fourth quarter’s investor presentation. The expected reduction in equities, and consequently assets under management, will decrease income from the wealth management division this year. On the other hand, income from interest rate swaps will likely drive up non-interest income. Overall, I’m expecting SYBT’s non-interest income to decline by 4% year-over-year in 2020.
Expecting Earnings Decline of 22%
The expected increase in provisions charges and decline in non-interest income will drag earnings this year. On the other hand, non-interest expenses will likely decline this year, which will support the bottom-line. Due to the acquisition of King Bancorp, merger-related charges were high in 2019. The absence of these charges in 2020 will cause a decline in non-interest expenses relative to last year.
Considering the factors mentioned above, I’m expecting earnings to decrease by 22% year-over-year in 2020 to $2.25 per share. The following table shows my income statement estimates.
Due to the uncertainties surrounding the duration and impact of COVID-19, the earnings estimates can differ materially from actual results. If the pandemic lasts beyond my expectations (i.e., mid of the third quarter), then provisions expenses can exceed the estimates. Moreover, if the Federal Reserve cuts rates to below zero, then NIM can miss its estimate. These uncertainties make SYBT a risky investment.
I’m expecting SYBT to maintain its quarterly dividend at the current level of $0.27 per share for the remainder of 2020. Despite the expectations of earnings decline, the threat of a dividend cut is low because the earnings and dividend estimates suggest a payout ratio of 48%, which is sustainable. Additionally, SYBT is well-capitalized with a tier I capital ratio of 12.02% as opposed to the minimum requirement of 8.5%. The strong capital position will minimize the need to cut dividends. The dividend estimate suggests a dividend yield of 3.38%.
Year-End Target Price Implies High Upside
I’m using the historical price-to-tangible-book multiple (P/TB) to value SYBT. The stock has traded at an average P/TB ratio of 2.0 in the past, as shown below.
Multiplying the average P/TB ratio with the forecast tangible book value per share of $18.4 gives a target price of $36.7 for December 2020. This price target implies an upside of 15% from SYBT’s April 9 closing price, as shown in the shaded column below. The full table shows the sensitivity of the target price to the P/TB ratio.
The high price upside shows that SYBT is a good investment for a holding period of at least nine months. However, the COVID-19 related uncertainties make the stock a risky investment. Due to the risks and uncertainties, I’m adopting a neutral rating on the stock.
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.