Earnings of Lakeland Bancorp (LBAI), a bank holding company, are expected to increase slightly the remainder of 2019 and in 2020, mostly on the back of an increase in loan portfolio. While loan growth is expected to slow in the wake of trade uncertainties, it is still expected to be high enough to counter the negative effects of a dip in net interest margin and a rise in non-interest expense. Due to the expected increase in income, I expect LBAI’s dividend trend to continue rising.
Loan Growth to Decline to a Below Normal Level
As the majority of LBAI’s loan book comprises the commercial real estate segment (70% of total loans as at end of June 2019), I expect the company’s portfolio to be sensitive to the overall business sentiment. Currently the outlook for the economy is gloomy due to trade uncertainty, which has soured business sentiment. I expect LBAI’s growth of net loans to decline to 4.5% in 2020, below its normal growth rate of around 7%. Growth was unusually high in the first half of 2019 because of the acquisition of Highlands Bank.
The economic downturn is not expected to affect credit quality in 2020 as an economic slowdown has only just started and is unlikely to be severe enough to significantly affect borrowers’ ability to service debt. The only reason why the allowance for loan losses is expected to be higher (see table above) is greater amount of loans.
Net Interest Margin Decline of Around 11bps Expected
The 50bps rate cut in 2019 is expected to lead yields on earnings assets down by 14bps in the second half of 2019 and 4bps in the first half of 2020. The lagged effect is attributable to loans with fixed rates.
Cost of funds is also set to go down with the rate cut, but to a lesser extent than yields. LBAI has a significant amount of borrowings that will make its funding cost downward sticky. In 2QFY19, cost of borrowings made up 18.5% of total interest expense. The table below shows estimates for yields and costs, and their effect on net interest margin, which I expect to dip by 11bps in 2020.
Earnings to Increase Slightly Due to Net Interest and Non-Interest Income
LBAI’s earnings are expected to increase by around 2% in 2020 due to an increase in earnings assets. Higher non-interest income is also expected to contribute to earnings growth. LBAI’s non-interest income jumped in the first half of 2019 due to an increase in number of accounts maintained, which led to greater fees and commissions income. For full year 2019, non-interest income is expected to grow by 12%, while for 2020 it’s expected to grow by a lower rate of 5%.
On the other hand, growth in non-interest expense is expected to drag earnings. LBAI’s non-interest expense jumped in the first half of 2019 as it completed the acquisition of Highlands Bank, which led to merger related expenses of $318,000. Higher taxes will also drag earnings, due to tax bulletin issued by the New Jersey Division of Taxation, as mentioned in the 2QFY19 10-Q filing. The management expects an effective tax rate of 24.5% for 2019, as opposed to effective tax rate of 21% for 2018. The table below summarizes estimates of key income statement items.
Based on prospects of earnings growth and the upwards trend of LBAI’s dividend, I’m expecting the company to increase dividends again in 2020. My expectation is supported by LBAI’s well capitalized books. Tier I Capital Ratio was reported at 11.11% at the end of June 2019 versus the minimum regulatory requirement of 8.50%. I expect LBAI to increase dividends to $0.53 per share in 2020, from $0.49 in 2019 (expected) and $0.45 in 2018 (actual). The dividend estimate for 2020 implies a forward dividend yield of 3.51%.
Target Price of $17.8 Implies Double Digit Upside
To value LBAI I’m using its historical price to book multiple, which has averaged 1.20x since 2013, as shown in the table below.
Multiplying the average price to book ratio with the forecast book value per share of $14.8 gives a target price of $17.8 for December 2020. This target implies an upside of 18.2%. The table below shows sensitivity of the target price to price to book ratio.
Adding the dividend yield estimate to the potential price upside gives a total expected return of 21.7%. Based on the return I’m advising investors to buy LBAI, and I’m adopting a bullish stance on the stock.
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.