Hancock Whitney (HWC): Moderately Undervalued Despite A More Challenging Environment

Times are starting to get a bit tougher for banks. Funding costs are rising, there is upward pressure on operating expenses, and loan growth appears to be moderating – all of which could squeeze pre-provision earnings. Bad debt provisioning, too, is on the up. Granted, we are simply heading back into ‘normal’ territory off a very low base, but that still means downward pressure on net income. Although my bank coverage is usually confined to lenders with clear funding cost advantages, the current environment does make an edge on funding a particularly helpful quality right now.

That brings me nicely to Hancock Whitney (NASDAQ:HWC). Impressed with its funding position and having tightened previous weak links, I opened with a ‘buy’ rating on Mississippi-based Hancock in the first half of last year. This wasn’t the cheapest bank out there, but its high quality provided some leeway on valuation, while there were also some Hancock-specific near-term drivers that made this an interesting name.

Hancock stock has been flattish in that time, falling a little (with dividends) but outperforming regional banks by around 6.5-7 percentage points depending on which index you use. In turn, these shares are also broadly unchanged in terms of headline valuation metrics; the stock is a hair more expensive relative to tangible book value, but marginally cheaper on current-year P/E.

With that, I’m sticking with my ‘buy’ rating for now, as although conditions are getting more challenging for the industry I think Hancock has the right ingredients to stand out from the pack.

Cost Leverage Comes In As Expected

Hancock was in a relatively interesting position when I first covered it early in Q2 last year. Its interest rate sensitivity was reasonable, but the bank was also one of not many guiding for a year-on-year fall in operating expenses, and that set the stage for a nice bump in pre-provision operating income.

In terms of the top line, higher interest rates and solid loan growth have been a boon as expected, with net interest income up 13% last year to $1.05B and the bank’s full-year net interest margin up 31bp to 3.26%. Loans increased by a little over 9% on an end-of-period basis, with core loan growth (i.e. excluding PPP loans) up around 12%, way ahead of expectations at the start of the year. Full-year pre-provision operating income was up nearly 30%, helped by aforementioned operating cost leverage.

For the fourth quarter, net interest income of circa $298m was up 5% sequentially and almost 30% year-on-year. Net interest margin of 3.68% was up 14bp sequentially and 88bp year-on-year, helped by mix-shift as higher-yielding loans took up a bigger slice of earning assets. Pre-provision operating income of $182m was up 6% sequentially and over 30% year-on-year, with operating expenses lower 2% sequentially.

No Major Worries On Funding

Funding costs are on the up as a result of Fed rate hikes, and with deposit balances falling and the mix shifting toward interest-bearing products some banks will find themselves under a degree of pressure.

Hancock isn’t immune to these issues, but with a very attractive core deposit franchise and a suitably liquid balance sheet I’m not too concerned. Non-interest-bearing deposits fell 4.5% sequentially on an end-of-period basis in the fourth quarter, but at just over $13.6B they still form a very chunky 47% of total deposits. Overall the NIB deposit balance is good for funding around 40% of the bank’s asset base, while expensive time deposits are still under 5% of total deposits despite increasing last quarter.

As a result of its sticky deposit base, Hancock’s deposit beta has remained relatively low cycle-to-date. The annualized deposit cost in the fourth quarter came in at around 50bp, putting the cycle-to-date deposit beta in the very low double-digit area. Alongside the Hawaiian banks that’s among the lowest of the banks that I cover. On liquidity, the loan/deposit ratio ended last year just under the 80% level, while short-term investments and available-for-sale securities are around 20% of earning assets – by-and-large in line with the industry.

The Outlook

This year is going to be a tighter one for Hancock on the earnings front, with the bank facing both higher operating expenses and higher credit loss provisioning.

Starting with the former, FY23 operating expenses are expected to land around 6-7% higher versus last year. NIM has basically topped out now; there may be a few basis points of expansion left depending on further Fed rate hikes, but for the most part this is it. Comps in the early part of the year are obviously soft, so a flattish NIM will still produce healthy year-on-year income growth. Management is guiding for 3-5% annual loan growth and similar non-interest income growth, and with that I’m penciling in 11-12% annual pre-provision income growth for FY23.

In terms of the bottom line, higher bad debt provisioning is going to eat a chunk of that operating profit growth up. Credit quality is still outstanding here – nonperforming loans (~0.18% of total) and net charge-offs (~0.02%) were flat sequentially in Q4, and both remain way below pre-pandemic levels – but we are lapping a reserves release which I expect to turn into a build this year.

I’m not concerned on asset quality despite a possible recession looming – Hancock is well provisioned (ACL of 1.48%) and generates significant pre-provision operating income – but normalizing levels of bad debt expensing will be a slight drag on EPS growth over the next few years.

Shares Still Offer Upside

Hancock Whitney stock trades at $49.10 per share at time of writing, putting it at around 1.7x tangible book value per share (“TBVPS”) and around 8x my FY’23 EPS estimate.

I like to value a mature bank like this on both a P/TBVPS basis as well as using modified dividend discount model (“DDM”). On the former, I argued in the last piece that a valuation closer to 2x TBVPS was fairer for Hancock given its ROTE profile, and I don’t see any reason to change that. That would support a fair value in the mid-$50s per share region.

In terms of the modified DDM, I estimate a sustainable total payout ratio (~75-80% in this case) based on its ROTE profile and ~4-5% per annum growth under a mid-term forecast period, followed by low single-digit terminal growth discounted at a 10% hurdle rate. That gets me to a fair value in the low-$60s per share area. While not an exact science, with the current share price under $50 I do think there’s a decent margin of safety here, and I’m happy to stick with a buy rating.