Umpqua Holdings Corporation (NASDAQ: UMPQ) reported earnings of $0.24 per share in the second quarter, as opposed to a loss of $8.41 per share in the first quarter of 2020. The large loss was attributable to goodwill impairment and high provision expense in the first quarter. After declining in the second quarter, the provision expense will likely decline further in the year ahead due to the easing of economic factors. Moreover, accelerated booking of fees from the Paycheck Protection Program will likely lift earnings in the fourth quarter of this year. Additionally, revenue from mortgage banking business will likely remain above normal in the remainder of the year. For the full year, I’m expecting UMPQ to report a loss of $7.39 per share. Adjusting for the one-time goodwill impairment, I’m expecting UMPQ to report earnings of $0.71 per share in 2020. The June 2021 target price suggests a high upside from the current market price; hence, I’m adopting a bullish rating on UMPQ.
Paycheck Protection Program, Better Deposit Mix to Support Net Interest Income
UMPQ’s net interest income will likely increase in the year ahead mostly due to the government’s stimulus program. UMPQ funded $2 billion of loans under the Paycheck Protection Program, PPP, as mentioned in the second quarter’s investor presentation. Assuming fees of 3% and funding cost of 0.35%, PPP will likely add an estimated $53 million to net interest income over the life of the loans. The management expects most of the loans to get forgiven in the fourth quarter, as mentioned in the second quarter’s conference call. Hence, I’m expecting UMPQ to accelerate the booking of fees in the fourth quarter, which will boost the net interest income.
Excluding the impact of PPP, the net interest margin, NIM, will likely continue to decline in the year ahead, which will pressurize the net interest income. The NIM declined by 23bps in the second quarter following the 150bps Federal Funds rate cuts. The decline will likely continue in the year ahead, albeit at a slower pace. According to details given in the presentation, fixed-rate loans and variable/adjustable rate loans at floors made up 58% of total loans at the end of the last quarter, which will likely mitigate the impact of interest rate decline on average portfolio yield. Moreover, UMPQ substantially improved its deposit mix during the last quarter, which will ease the pressure on NIM going forward. UMPQ increased the proportion of non-interest-bearing deposits in total deposits to 36.9% by the end of June 2020, from 31.6% at the end of March 2020. Considering these factors, I’m expecting NIM, excluding the impact of PPP, to decline by 8bps in the third quarter and 4bps in the fourth quarter of 2020. The following table shows my estimates for yields, cost, and NIM, excluding the impact of accelerated fees under PPP.
The PPP loan forgiveness in the remainder of the year will likely reduce loan balances. Excluding PPP, there is not much opportunity for loan growth because of the uncertainties related to COVID-19 that will keep the demand for commercial loans subdued. On the other hand, the management expects residential mortgages activity to remain strong in the second half of the year, as mentioned in the conference call. As UMPQ originates many residential loans for resale purposes, the strength of the mortgage market will affect both non-interest income and loans. Considering these factors, I’m expecting UMPQ to report year-end loan balances of $20.6 billion, down 7.9% from June 2020, and down 2.3% from the end of last year. The following table shows my estimates for loans and other balance sheet items.
Robust Mortgage Activity to Keep Non-Interest Income Elevated
UMPQ reported non-interest income of $115 million in the second quarter, as opposed to $41 million in the first quarter of 2020. The strong surge in non-interest income was attributable to a hike in mortgage banking volumes amid low interest rates. Moreover, a high gain on sale margin drove mortgage banking revenues during the quarter. The management expects the activity to remain strong in the second half of the year but margins to narrow over time. As a result, I’m expecting non-interest income to decline from the second quarter in the year ahead but remain above normal. I’m expecting non-interest income to decline in 2021 as the mortgage volume will normalize.
Credit Costs Remain Contained
UMPQ’s provision expense declined to $87 million in the second quarter from $118 million in the first quarter of 2020. The management based the loan loss provisions on forecasts of different economic variables, including GDP and unemployment, as mentioned in the presentation. The management assumed that the recession would end in the third quarter of 2020, which appears reasonable. I’m not expecting the economy to deteriorate beyond the management’s forecasts; hence, I’m expecting the provision expense to continue on a downtrend in the year ahead. For the full year, I’m expecting UMPQ to report a provision expense of $285 million in 2020, as opposed to $73 million in 2019.
UMPQ has lower credit risks than other banks because it has limited exposure to COVID-19-sensitive industries. According to details given in the presentation, vulnerable industries made up just 4.8% of total loans at the end of the last quarter. Moreover, only 5.7% of total loans were in payment deferral programs at the end of the second quarter, as mentioned in the presentation.
Expecting UMPQ to Report Adjusted Earnings of $0.71 per share in 2020
The accelerated booking of fees from PPP and the decline in provision expense will likely help earnings continue to increase in the year ahead. Moreover, the non-interest income will likely remain above normal in the second half of the year due to robust mortgage banking volume. For the full year, I’m expecting UMPQ to report a loss of $7.39 per share. Adjusting for the one-time goodwill impairment, I’m expecting UMPQ to report earnings of $0.71 per share in 2020. The following table shows my income statement estimates.
Actual earnings may differ materially from estimates because of the uncertainties related to the COVID-19 pandemic.
June 2021 Target Price Suggests a 24% Upside
I’m using the historical price-to-tangible-book ratio, P/TB, to value UMPQ. The stock traded at an average P/TB ratio of 1.17 in the first half of 2020. Multiplying the average P/TB ratio with the June 2021 forecast tangible book value per share of $12.5 gives a target price of $14.6 for the mid of next year. The price target implies a 24% upside from UMPQ’s August 18 closing price. The following table shows the sensitivity of the target price to the P/TB ratio.
UMPQ delayed the latest announcement of its quarterly dividend by two months but maintained the level of $0.21 per share. Assuming the company maintains its quarterly dividend at $0.21 per share and doesn’t miss any dividends through 2021, the stock will offer a leading twelve-month dividend yield of 7.2%. I think the chances of a dividend cut are low because the earnings and dividend estimates suggest a payout ratio of 54% for the second half of 2020 and 74% for 2021, which is manageable.
Based on the price upside and decent dividend yield, I’m adopting a bullish rating on UMPQ.
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 risk tolerance before investing in the stock(s) mentioned.