Webster Financial: Solid Dividend With Potential For A Higher Payout Ratio (NYSE:WBS)

Introduction

The latest quarterly performance from Webster Financial Corporation (NYSE:WBS) showed decent growth as loans and deposits grew by 2.3% during Q1 FY2023. Looking at the profitability of the bank for the quarter, they managed to achieve a return on average tangible common equity of 20.98%.

Looking at the historical performance of WBS during times of higher interest rates they benefited greatly during 2019 as the ROTE was near 17%. But results were hammered as inflation was biting the margins of the business. The share price has been in a steady decline and the FWD p/e is 47% below its 5-year average. With interest rates still rising and WBS recently upgrading its prime lending rate to 8.25% I think we will see stronger earnings ahead. In terms of valuation, we are seeming to reach some sort of bottom and I think WBS deserves a buy rating at these price levels.

Company Structure

Webster Financial Corporation operates as the bank holding company for Webster Bank and National Association. They focus on offering financial services for both individuals and families in the shape of mortgages but also loans for businesses.

Headquartered in Stamford, CT, the company has amounted to a total of $54 billion in deposits. As far as segments within WBS go, they divide it into three various ones, Commercial Banking, HSA Bank, and Consumer Banking.

Commercial Banking focus on real estate equipment financing but has also exposure to asset-based lending. The HSA Bank focuses on health savings accounts and spending accounts. Lastly, Consumer Banking offers clients and consumers deposit and fee-based services regarding mortgages and secured and unsecured loans.

WBS has over the years been able to steadily decrease its efficiency ratio and with the recent increase rate increase we are seeing the effect of it. One spike during the pandemic in 2020 doesn’t concern me and I find it unlikely we will see such movement again. That year was unprecedented regarding the economic environment.

Fundamentals

WBS has focused on maintaining a diversified portfolio for its loan balance but also maintaining a high level of liquidity. The current liquidity for WBS can cover all of the uninsured deposits. In total WBS has over $13 billion of uninsured loans but a liquidity profile of over $16 billion. This bolsters the company’s position if there were to be a failure in paying back these loans.

As mentioned earlier WBS has maintained a solid ROE and the TTM sits at 10.79% currently. The company seems to have achieved this through a diversified loan balance. Commercial real estate makes up the largest portion at $15.4 billion, representing around 30% of the total loans. I am not that worried about perhaps this being a little overweight, the primary clients that WBS has are already established real estate investors and firms that have collateral for their loans. This protects WBS and ensures they aren’t overleveraged.

Earnings Call Transcript Q1 FY2023

The last earnings report from WBS was actually a miss based on street estimates. The EPS missed by $0.09 and the revenues by $42.19 million. The earnings call transcript highlighted some of the difficulties the company had in the quarter. The CEO John Ciulla said the following “In light of the market dislocation and out of an abundance of caution, we took actions to augment our balance sheet liquidity including increasing our cash position and utilizing higher cost funding sources”. In my opinion I don’t find the miss on earnings as a discouraging factor to an investment thesis around WBS. The fact that the management realized that the market is tough to navigate and choose to “de-leverage” themselves somewhat and focusing on keeping a more flexible balance sheet proves they are very competent.

Measuring the TTM ROE WBS is actually above its 5-year average of 10.54%. So it seems to me that even though they are taking measures like increasing their liquidity position when client financing activities decreased it hasn’t drastically impacted important profit measurements for the company. That reflects stability in the way the company makes a return on its equity. In conclusion, the last quarter was in my opinion neither a success nor a failure, it was proof that WBS can take necessary steps to maintain returns on their portfolio.

Valuation Profile

Over the last 3 years, the performance of WBS compared to the SPY is very similar. The SPY is only slightly outperforming by 39.77% compared to 37%. During that time, however, investors will have been able to enjoy a decent dividend yield from WBS of between 3 -4%.

As WBS continues to focus and capture the potential earnings of higher interest rates they are seeing the effect of this as the efficiency ratio decrease and WBS can secure its dividend yield. What might be a little off-putting I have to admit is that the dividend per share hasn’t been increased since 2019, but the company has neither decreased it either. The payout ratio sits at under 30% right now and I think there is room for an increase here too. As WBS operates with less expenses compared to their earnings it lifts them to a position where they can afford to increase the dividend. Even if not, I find it unlikely we will see a decrease in it. WBS has paid out a quarterly dividend for 33 consecutive years, making WBS both a strong but also very reliable dividend addition.

Setting a target price for WBS I think we land somewhere under $40 per share. The company has a 5-year average dividend increase of 7.59%. I am using a 6% increase to be a little bit more on the safe side when using a GGM model. As I like bank stocks mostly for the dividend yields that they have, using a valuation model which is based on that seems the most suitable. Looking at 2023 for example where I have a target price of $40 per share to get a 10% return on investment the calculations look a little something like this: Target Price ($40) = 1.61/(10% – 6%). As discussed previously the chance that WBS could also grow its dividend seems likely as the payout ratio remains quite low at around 27.4% and which the strong liquidity that WBS has they are in a strong position to make this announcement.

Risk Associated

The primary risks that I associate with WBS aren’t necessarily on the balance sheet or for the loan portfolio the company has. Rather it’s about interest rates and mortgage rate delinquencies.

A worrying trend appearing is that more and more people are failing to pay mortgage bills on time. Causes for that could be the rise of inflation which has put a lot of pressure on families to make ends meet. But also higher interest rates are causing people to reevaluate their financials and perhaps realize that paying bills for the mortgage will be difficult. In terms of WBS, this seems like a small concern so far but could amount to something in the medium term.

Investor Takeaway

For investors seeking a company that has a solid history of paying out a dividend then WBS should be up there. The company hasn’t failed to pay out a quarterly dividend for 33 years and has a 5-year average dividend increase of over 7%. In the valuation segment, we realized that paying under $40 per share right now could help net a return on investment of around 10%. WBS is trading 5.3% below that currently and I find that enough to make it a buy right now. Apart from that, WBS is also trading below historical measurements like the p/e which has a 5-year average of 12. If you are seeking a diversified lending bank then WBS is a solid option and a buy under $40 per share.