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If you try to look at Westamerica Bancorporation (NASDAQ:WABC) (“Westamerica”) as a typical bank you’re not going to come away impressed, and indeed I don’t think this is an investment that suits all, or perhaps even most, investors. While Westamerica is indeed a bank, it doesn’t make all that many loans and it may be better to think of this as a quasi-bank/quasi-bond fund hybrid instrument. Seen in that context, it could have appeal for investors who would otherwise be put off by its ultra-conservative banking operating philosophy.
At this point Westamerica does look undervalued to me on the assumption of $5.83 in earnings next year and/or long-term core earnings growth of around 4% Investors should again realize that this is not a typical bank stock and will likely not outperform other banks in an eventual bank stock rally.
Fourth Quarter Results Look A Lot Like Those Of A Good Bank
Westamerica may not be a typical bank, but the results that the bank produced for the fourth quarter, though largely in line with expectations, were still not at all bad or deficient relative to many other quality banks.
Revenue rose almost 48% year over year and almost 10% quarter over quarter. Net interest income rose nearly 61% yoy and 14% qoq, with net interest margin up 146bp yoy and 51bp to 3.95%, while earning assets declined almost 2% sequentially. Fee-based income isn’t that large a part of the business, but did decline 3% yoy and 11% qoq, with merchant processing down 10% yoy and 8% qoq.
Operating expenses rose 5% yoy and a little more than 1% qoq, with Westamerica continuing to operate a very efficient low-cost model that delivered an efficiency ratio of 31.5% in the quarter. Pre-provision profits rose 82% yoy and 14% qoq, and Westamerica remains exceptionally profitable, with a ratio of pre-provision profits to earning assets of 3.15% and 0.74% to total average assets.
Provisioning isn’t an issue with earnings, as it wasn’t a meaningful line-item this quarter.
Bottom-Of-The-Barrel Deposit Costs, And Ongoing Reallocation To Securities
One of the keys to understanding the Westamerica model is that the bank isn’t particularly interested in using its capital to make loans. The bank has demanding underwriting standards and a conservative culture and would rather buy securities than make loans unless the loans meet its exacting standards.
To that end, loans have declined at an annualized rate of 7.6% over the last decade and increased in only one year (2020, driven by PPP lending). In that context, then, a 10% yoy and 2% qoq decline in lending was not at all surprising. Likewise with the 5%-plus decline in C&I loans and 2% decline in consumer loans.
Loans make up just under 14% of earning assets, while securities make up more than 90%, and securities declined about 1% on an end-of-period basis. Security yields improved 134bp yoy and 48bp qoq to 3.81%.
Deposit costs are rock bottom, with an interest-bearing deposit cost of just 0.05% and a total deposit cost of 0.03%. Deposit beta, a major topic of conversation given rising funding costs, was zero. Non-interest-bearing deposits did decline 4% in the quarter, and I do see a little risk of further outflows, but Westamerica’s deposits are skewed to business operating accounts that typically do not move in pursuit of higher rates (moving these deposits is highly disruptive to operations and few institutions offer meaningful interest for them).
I won’t say that credit quality doesn’t matter here (due to the low level of lending), but with a non-performing loan ratio of 0.08% and a reserve equal to 2.12% of loans, I’m not worried about even a severe recession.
A Hybrid Option?
As I said in the open, in some respects I think of Westamerica as a hybrid between a bank and a bond fund. Around half of the securities portfolio is in corporate securities, with the largest allocations to A-/BBB+ securities, and another quarter or so is in collateralized loan obligations, which have coupons that adjust every three months based on three-month LIBOR/SOFR rates. Most of these (around two-thirds) are AA-rated, and it does have the effect of giving Westamerica exposure to loans and loan yields during periods of higher rates, but with some added security and diversification.
Looking at total annual returns over the past decade, Westamerica seldom rallies as much when banks (as represented by the SPDR S&P Bank ETF (KBE)) are strong, but likewise doesn’t sell off as much in the bad times. The shares have also generated better returns than the Morningstar Intermediate Core-Plus Bond category over the past decade.
| 2022 | 2021 | 2020 | 2019 | 2018 | 2017 | 2016 | 2015 | 10 Yr Return | |
| WABC | 5.1% | 7.4% | -16% | 24.6% | -3.8% | -2.9% | 38% | -1.5% | 4.9% |
| KBE | -14.8% | 33.5% | -8.7% | 29.8% | -19.6% | 10.4% | 30.8% | 2.6% | 8.6% |
| Intermed. Core-Plus Bond | -13.3% | -0.7% | 8.1% | 8.9% | -0.6% | 4.3% | 3.9% | -0.5% | 1.6% |
The Outlook
I believe that Westamerica can continue to generate core earnings growth around 4% over the next decade. I’m below the Street for both FY’23 and FY’24 earnings (by about $0.06 each), but I regard this amount as more just minor modeling differences than any substantial difference in opinion (I don’t have a thesis that Westamerica is going to meaningfully underearn).
Between discounted earnings, ROTCE-driven P/TBV, and P/E (using a 10.5x multiple), I believe these shares can trade between $62 and $66.
The Bottom Line
Westamerica definitely isn’t for everyone. While the bank has a solid core of low-cost business-driven deposits in Northern California (Marin, Sonoma, Fresno, Merced, et al), this just isn’t a traditional lender and never will be. That said, management has produced over 6% adjusted tangible book value growth over the past decade and that’s better than many conventional banks. For investors who want a more conservatively-run investment (with a decent yield as well), this could be a name to consider, but it doesn’t really fit with my portfolio needs.
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