People's United Financial: Analysts Do Not Like This Stock

I recently was looking over a list of S&P 500 financial and insurance stocks and their average sell-side analyst ratings, and I was surprised to see that one of the firms with the worst ratings is People's United Financial (PBCT). The stock has a pretty significant following of 18 analysts. Of these, according to Thompson Reuters, 2 have buy ratings on the stock, 11 have hold ratings, and 5 have reduce or sell ratings. Analysts are a notoriously optimistic bunch on the whole, so this is a truly remarkable set of ratings. Very few stocks are as unloved by analysts as PBCT. Perhaps that's why the stock has gone nowhere for the last few months even while the S&P 500 and XLF have both rocketed higher. While I don't think that PBCT is the 'buy of the century' or anything close, I also don't think it deserves this level of condemnation either.

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PBCT is a mid-sized bank based in Bridgewater, CT that has raised its market share in its home market considerably with two major acquisitions in the last few years. 2011 saw the acquisition of Danvers Bancorp, while in 2010 PBCT bought out LSB Corp. Both of these acquisitions have helped to considerably strengthen PBCT's presence in its home footprint in and around the state of Connecticut. Basically, PBCT came through the financial crisis as a fairly healthy bank which is why it was able to buy other banks so soon after the crisis. This relatively good health is reflected in a very healthy set of portfolio metrics including good capital levels and very good loan credit quality (1.02% of outstanding loans were nonperforming as of September 30, 2013). PBCT also has had pretty healthy loan growth over the last year (likely to clock in around 8.5% for the year once 4Q 2013 is reported), and 2014 looks set to be pretty strong as well. (I'm forecasting 9.5% loan growth, after the bank reported 10% YOY growth in Q3 led by a massive 19% pop in commercial real estate lending and an 8.9% jump in residential mortgages.)

Does this sound like a terrible bank stock to you so far? I certainly admit that the firm isn't doing quite as well as some peers, but it is doing much better on these metrics than many banks.

PBCT operates more than 400 branches in CT, VT, MA, NH, ME, and NY and holds roughly $22B in deposits. Just about half of this comes from CT where the bank has more than 150 offices and roughly 10% deposit market share (number 3 in market share at last check). PBCT is big in VT as well holding the number 1 market share there (18.2%), but in its other markets, the company is a more mid-tier player holding markets positions in the middle of the pack. The point is that the company has lots of room for growth… if it can get its act together.

I think there are two factors about PBCT bothering a lot of analysts though; net interest margin compression (a fairly common malady for many banks these days), and high levels of non-interest expenses compared with many peers (and this is a bigger deal). The net interest margin compression is undoubtedly vexing to shareholders, but it's not really PBCT's fault. It's largely a function of the interest rate environment. Very few banks (only SBNY that I can name off the top of my head), have sufficient differentiating factors that will allow them to lend at above market rates. PBCT's net interest margin (likely to have fallen from 3.63% to 3.30% YOY for the 4th quarter of 2013) is not great, but it's not bad either. And as interest rates bottom and start to rise, this problem will be slowly corrected.

On the other hand, the higher than average non-interest expenses are really symptomatic of an excessive cost structure at PBCT. To be fair, part of this stems from being located in an expensive area of the country where wages and branch locations are simply going to be more costly. But that's a poor excuse for inefficiency given that there are obviously many other regional banks located in the northeast that face the same issues. No, the high costs are simply a matter of insufficient attention to cost structure by management. At this point, expenses as a percentage of total revenues are likely to come in around 75% for 2013 up from 71.5% in 2012. This is largely driven by compensation increases across the bank. While I'm all for paying the going market rate to keep the bank's talent in place, the company also needs to find enough money to pay shareholders a reasonable return otherwise shareholders, like the bank's employees, will simply go find a new opportunity. This compensation structure issue is something management needs to deal with if they want to see good returns on their stock. I see it as a key factor in the pessimism of the analyst community.

This compensation expense issue presents an opportunity to improve for the future, but for now it is a persistent drag on the shares. In fact, despite the rather stellar loan growth I mentioned above, PBCT will be lucky to see any material revenue growth at all this year. (I am forecasting 1.1% growth for 2013 vs. 2012, but revenue could easily be flat instead.) This is due in large part to that falling NIM, but the persistently high costs don't help matters either. Adding to the bank's troubles, it has little in the way of excess allowances (because it has very few bad loans), so reserve releases are not much of an option for cookie jar accounting here.

While none of these factors are good, the only real unique dilemma here is the high cost structure for PBCT, and in fact the bank will likely manage to increase EPS YOY despite lackluster revenue growth and falling NIM (I see $0.75 for 2013 vs. $0.72 for 2012). Given this, I think analysts are probably overly pessimistic about the stock. With the stock having gone nowhere for the last six months, it is probably pretty close to fair value in my opinion. Tangible book value on the firm was around $8.14 as on September, but the P/E ratio on the firm is fairly steep (around 20X). This latter issue undoubtedly bothers a lot of analysts, but frankly cleaning up the expense levels at the firm through a significant restructuring to eliminate redundancies would help fix this problem quickly (expenses are at least 10% too high in my view, probably due in part to overlap that has not yet been eliminated following the two recent acquisitions of Danvers and LSB). In any event, the stock does reward shareholders with a pretty decent 4.3% dividend (which it increased by 0.3 cents quarterly in February - not a big hike, but every little bit helps). On the whole then, PBCT may not be my top pick in the regional banking space, but investors could do a whole lot worse, and if an activist shareholder gets involved here, or the Board decides to do some house cleaning with management, the stock price could see a big upturn quickly.

Source: People's United Financial: Analysts Do Not Like This Stock

Disclosure: I 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. (More...)

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