Sandy Spring Bancorp, Inc. (NASDAQ: SASR) reported a loss of $0.31 per share in the second quarter compared to earnings of $0.28 per share in the first quarter of 2020. The loss was attributable to merger-related expenses and a higher provision expense. Earnings will likely recover in the year ahead because of the growth in earning assets in the second quarter. Further, the provision expense will likely trend downwards in the remainder of the year, which will help earnings. Despite the decline, the provision expense will likely remain above normal because of the worsening of the economic outlook beyond the forecasts that the management incorporated in the existing reserves. Overall, I’m expecting SASR to post earnings of $1.86 per share in 2020, down 43% from last year. The June 2021 target price suggests a limited upside from the current market price; therefore, I’m adopting a neutral rating on SASR.
Deterioration in Unemployment Rate to Require Another Sizable Reserve Build
SASR reported a provision expense of $59 million in the second quarter, representing 57bps of total loans, up from 36bps in the first quarter. The increase in provision expense was attributable to the acquisition of Revere Bank during the second quarter and worsening of the economic outlook due to the COVID-19 pandemic. As mentioned in the second quarter’s investor presentation, the management used forecasts for the local unemployment rate, business bankruptcies, and the Case-Schiller home price index to determine the provisioning requirement. The following table shows the forecasts for these economic variables.
The local unemployment forecast appears too optimistic under the current economic environment. The United States reported an unemployment rate of 10.2% in July, which is much higher than the management’s third-quarter average forecast for local unemployment of 5.32%. Furthermore, among the states that SASR operates in, Maryland reported unemployment of 8.0% and Virginia reported an unemployment rate of 8.4% in June 2020, according to the U.S. Bureau of Labor Statistics. Moreover, I’m expecting the national unemployment rate to remain in high single digits through the mid of next year. Consequently, I’m expecting SASR to make another sizable reserve build in the third quarter to incorporate the deterioration in the outlook for unemployment. For the full year, I’m expecting SASR to report a provision expense of $118 million, representing 128bps of total loans, as opposed to 7bps of total loans in 2019.
SASR currently faces a high level of credit risk because of its sizable exposure to COVID-19 sensitive industries. According to details given in the presentation, the vulnerable loan segments made up a hefty 26.9% of total loans at the end of the last quarter. If the pandemic worsens further, then provision expense can take a magnified hit because of the pandemic sensitive segments. Moreover, SASR made payment accommodations on around 16% of total loans, which shows that the threat of defaults is material. The following table shows details of the exposure to vulnerable loan segments.
Revere Bank Acquisition, Paycheck Protection Program to Drive Net Interest Income
SASR’s loans surged by 53% quarter-over-quarter in the second quarter mostly due to the acquisition of Revere Bank. Moreover, SASR funded $1.09 billion worth of loans under the Paycheck Protection Program (PPP) which the management expects to lead to fees of $34.8 million over the life of the loans, as mentioned in the presentation. The management mentioned in the second quarter’s conference call that it expects loan forgiveness to start in the fourth quarter. I’m not expecting SASR to book any accelerated fees this year, to be conservative. Excluding the impact of PPP, I’m expecting loans to decline in the year ahead because of the slowdown in business activity amid the COVID-19 pandemic. Consequently, I’m expecting the year-end loans to stand at $9.1 billion, down 10.5% from the end of June 2020, and up 37% from the end of last year. The following table shows my estimates for loans and other balance sheet items.
Considering the amortized fees from PPP and the surge in earning assets, I’m expecting SASR’s net interest income to increase by 51% year-over-year to $401 million in 2020.
Expecting Full-Year Earnings Per Share to Decline by 43%
The increase in earning assets in the second quarter will likely increase earnings in the remainder of the year compared to the second quarter. Moreover, the provision expense will likely decline from the second quarter, which will boost earnings sequentially. However, the provision expense will likely remain above normal due to the deterioration in the economic outlook. Overall, I’m expecting SASR to report earnings of $1.86 per share in full-year 2020, down 43% from last year. The following table shows my income statement estimates.
Actual earnings may differ materially from the estimates because of the uncertainties related to the COVID-19 pandemic. If the pandemic worsens beyond expectations, then SASR’s high exposure to pandemic sensitive industries can magnify the impact of the pandemic on the provision expense.
June 2021 Target Price Suggests a Limited Upside
I’m using the historical price-to-book multiple (P/B) to value SASR. The stock traded at an average multiple of 0.94 in the first half of 2020. Multiplying this average ratio with the June 2021 forecast book value per share of $31.1 gives a target price of $29.2 for the mid of 2021. The price target offers a limited upside of 13.8% from SASR’s August 14 closing price. The following table shows the sensitivity of the target price to the P/B multiple.
SASR is also offering a dividend yield of 4.7%, assuming the company maintains its quarterly dividend at the current level of $0.30 per share. The earnings and dividend estimates suggest a payout ratio of 28% for the fourth quarter of 2020, and 36% for 2021, which is easily sustainable. Hence, there is little threat of a dividend cut.
In my opinion, the price upside mentioned above is not high enough to compensate for SASR’s elevated risk level amid the COVID-19 pandemic. Based on the limited price upside, I’m adopting a neutral rating on SASR.
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.
Additional disclosure: Disclaimer: This article is not financial advice. Investors are expected to consider their investment objectives and constraints before investing in the stock(s) mentioned in the article.