Earnings of Great Western Bancorp, Inc. (NYSE: GWB) declined to $0.10 per share in the June-ending quarter from adjusted earnings of $0.52 per share in the March-ending quarter of 2020. The earnings decline was mostly attributable to a decrease in the value of loans at fair value. Earnings will likely remain under pressure in the quarters ahead because of elevated provision expense. Moreover, the net interest margin will likely pressurize earnings. Overall, I’m expecting earnings to decline further in the September-ending quarter, leading to adjusted earnings of $1.45 per share for the fiscal year 2020. For the fiscal year 2021, I’m expecting earnings to decline further to around $1.41 per share. GWB is currently facing high credit risks because of exposure to vulnerable industries, especially hotels. Additionally, around 17% of total loans were under modification and payment deferral programs, which reflects the high level of credit risk. The risks will likely keep the stock price subdued in the near-term; therefore, I’m adopting a neutral rating on GWB.
Hotel Exposure is Disconcertingly High
GWB is currently facing high credit risk because of its exposure to some industries. Around 21% of GWB’s total loans were to COVID-19 sensitive industries at the end of the June-ending quarter, according to details given in the third quarter’s investor presentation. Mostly due to the exposure to vulnerable industries, a large portion of total loans is under payment deferral status. GWB deferred payments on around 17% of total loans for a period of 90 days in the first round. Some of these modified loans will return to payment soon; however, hotels are likely to continue to remain a problem. The hotel industry made up 11.6% of total loans at the end of the last quarter, and GWB modified around 72% of the portfolio in the first round, according to details given in the presentation. I’m expecting most of the hotel loans to require a second round of deferrals because people will likely remain cautious and avoid travel until after the pandemic comes under control. Currently, the modifications do not impact the provision expense, but the management mentioned in the third quarter’s conference call that if deferrals exceed six months then GWB may have to consider classifying the modified loans as Troubled Debt Restructurings, TDRs. If the loans get classified as TDRs, then they will drive up the provision expense. The following table shows details of the vulnerable loan segments.
Further, GWB will adopt the new accounting standard for credit losses, called Current Expected Credit Losses, or CECL, on October 1, 2020, as mentioned in the last quarter’s 10-Q filing. Under the new standard, GWB’s loan loss provisioning will depend on expected credit losses instead of incurred credit losses. Hence, there is a risk that provision expense could jump in the year ahead.
On the positive side, the management appeared to be optimistic about the agriculture sector in the conference call, mostly due to an improvement in milk prices as shown in the chart below. The sector made up 17.5% of total loans at the end of the last quarter, according to details given in the presentation.
Considering the factors mentioned above, I’m expecting GWB to report a provision expense of $152 million in the fiscal year 2020, and $100 million in the fiscal year 2021, compared to $41 million in 2019.
Paycheck Protection Program to Drive Net Interest Income in 1Q FY2021
GWB funded $724 million of loans under the Paycheck Protection Program, PPP, as mentioned in the presentation. Assuming fees of 3.2% and funding cost of 0.35%, PPP will likely add an estimated $21 million to the net interest income over the life of the loans. The management mentioned in the conference call that it expects the PPP loans to get forgiven in the December-ending quarter and calendar year 2021. Hence, I’m expecting GWB to accelerate the booking of PPP fees in the first half of the fiscal year 2021, which starts in October 2020.
Excluding PPP, the net interest margin, NIM, will likely decline in the coming quarters because of asset repricing and origination of new loans at lower rates. On the other hand, the substantial improvement in the deposit mix in the last quarter will likely ease the pressure on NIM. Non-interest-bearing deposits made up 23% of total deposits at the end of the last quarter, as opposed to 19% of total deposits at the end of March 2020. Further, the management mentioned in the conference call that it believes there is room for a further decline in deposit costs. Considering these factors, I’m expecting NIM to decline by 6bps in the fourth quarter of the fiscal year 2020, and 7bps in the fiscal year 2021.
The PPP forgiveness will likely reduce the loan balance in the first half of the fiscal year 2021, which starts in October 2020. Excluding the impact of PPP, there is little opportunity for loan growth because the uncertainties related to the pandemic will constrain the demand for commercial loans. Overall, I’m expecting loans to decline by 2% in the fiscal year 2021. The following table shows my estimates for loans and other balance sheet items.
Expecting Full-Year Adjusted Earnings of $1.45 per Share
The elevated provision expense and NIM compression will likely restrain earnings in the year ahead. I’m expecting GWB to report adjusted earnings of $1.45 per share in the fiscal year 2020. On a GAAP basis, I’m expecting GWB to report a loss of $12.48 per share in the fiscal year 2020 due to the large goodwill impairment in the second quarter. The following table shows my income statement estimates.
Actual earnings may differ materially from estimates because the pandemic-related uncertainties make the provision expense quite difficult to predict.
Risks Likely to Restrain the Stock Price
GWB has traded at an average price-to-book multiple, P/B, of 0.83 from March to June 2020. Multiplying the P/B ratio with the June 2021 forecast book value per share of $21.4 gives a target price of $17.8 for the mid of the calendar year 2021. This target implies a 31% upside from the September 8 closing price. The following table shows the sensitivity of the target price to the P/B multiple.
Apart from the price upside, GWB is also offering a decent leading dividend yield of 4.4%, assuming the company maintains its quarterly dividend at the current level of $0.15 per share. The earnings and dividend estimates suggest a payout ratio of 43% for the fiscal year 2021, which is manageable. Hence, I’m not expecting a dividend cut.
Despite the attractive valuation and modest dividend yield, I’m expecting the stock price to remain subdued until some of the risks abate. A large portion of total loans requires payment deferrals, which will likely restrain the stock price. I’m expecting price gains to be unsustainable until GWB reports a decline in loans requiring modifications. As a result, I’m adopting a neutral rating for the next three to four months.
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.