PBCT Initiated as Neutral – Analyst Blog

Recently, we initiated coverage on People’s United Financial Inc. (PBCT) with a Neutral recommendation. The company’s fourth quarter earnings of 8 cents per share were in line with the Zacks Consensus Estimate. While commercial loan portfolio and deposits experienced growth, bottom-line results declined due to higher non-interest expenses and loan loss provisions.

 

PBCT continues to benefit from a healthy business portfolio that has grown inorganically over time. While the company’s R.C. Knox and Chittenden acquisitions continue to generate income flow, the latest addition − Financial Federal − is a leader in equipment financing and provides a valuable complement to People’s United’s existing business lines.

 

This transaction is expected to generate meaningful earnings accretion without diluting the capital ratios, which will provide tremendous strategic flexibility to the company in the current volatile markets.

 

Besides, People’s United remains committed to its organic growth throughout its business franchise. Despite the ongoing economic turmoil, the company performed modestly with continued growth in its core loan portfolios as well as deposits in 2009. The company’s deposits and loan portfolio is well positioned to experience higher growth once the markets rebound and provide interest rate stability.

 

Besides, People’s United continues to work rigorously on maintaining a low-cost business model that is reflected in its declining expenses, both interest and non-interest, thereby providing buoyancy to the bottom line. Moreover, declining non-performing loans are also helping the company overcome challenges faced due to the global economic credit crisis in the last couple of years.

 

These positive indicators get further reflected in the company’s efficiency ratio that increased to 73.5% in 2009 from 66.6% in 2008 and 56.1% in 2007. Going ahead, these improvements in the efficiency ratios are expected to translate to improved profitability in the intermediate term.

 

However, People’s United continues to be pressured by its asset-sensitive balance sheet due to the historically low interest rate environment, which reprises variable-rate loans at lower prime rate and increases callable and mortgage-backed securities prepayments, thereby exacerbating the volume cash flows and earnings. This also led to a declining wealth management income in 2009 from 2008 on low assets managed and administered (AMA), primarily reflecting a decline in the market value of fixed income assets.

 

Further, People’s United continues to experience losses in its commercial, real estate, residential mortgage and consumer loan portfolios on declining prices since the second half of 2007. This has also compressed dividend income from short-term investments and securities and total loan interest.

 

The financial health of the company continues to worsen on weak credit metrics over the last couple of years. While higher net loan charge-offs and provision for loan losses increase portfolio risk, increase in non-performing assets enforces a downward pressure on the yield from average earning assets.

 

Besides, profitability metrics − a significant earnings indicator − revealed a weakness from historical levels due to a low net interest income (NIM). NIM decreased to 3.19% in 2009 from 3.62% in 2008 and 4.12% in 2007. Further, returns on average assets, shareholders’ equity and earnings along with book value per share declined in 2009 from 2008. Going ahead, overall growth appears weak in 2010 given the unhealthy growth metrics.

 

Overall, People’s United is desperately trying to overcome the challenging economic environment through opportunistic acquisitions, expense control, modest loan growth and lower net loan charge-offs. However, the company’s operating leverage and balance sheet remains sensitive to weak asset quality, increasing loan loss provisions and non-interest expenses against decreasing interest income.

 

We believe the historically low interest rate environment is expected to have a depressing impact on People’s United for some more time before it rebounds with the slowly recovering economy.