The Webster-Sterling Merger Creates a Strong Bank, But Can it Continue to Create Value?

[ad_1]

The announcement from Webster Financial Corporation (NYSE:WBS) and Sterling Bancorp (NYSE:STL) that the two plan to partner in a merger of equals marked the second such deal in the regional banking space in April. It was also the second merger of equals that was met with skepticism from the market. Shares of Webster, the technical buyer and surviving institution in the deal, dropped considerably following the deal. While shares have since recovered decently, I was surprised to see such a sudden drop when the deal creates such a high-performing bank.

But investors may be wondering whether the deal can offer substantial upside from the returns each bank could generate on their own. Let’s take a look at the deal and whether it can create value for shareholders.

Creating a high-performing bank

Headquartered in Connecticut, Webster is a $33 billion asset bank that operates largely in New England and a small portion of New York. The bank’s main differentiator is that it runs a national health savings account (HSA) business that helps it generate a very low-cost deposit base. This business also involves offering health reimbursement arrangements and flexible spending and commuter benefit account services. Sterling Bancorp is a roughly $30 billion asset bank that largely operates in New York, but also runs some national and more specialized lending businesses. The bank is also in the process of launching a banking-as-a-service (BaaS) operation in which it helps digital non-bank companies offer banking services by essentially using Sterling to handle the back-end operations.

READ:  3 Competitive Advantages Airbnb Holds Over Hotels

The deal makes a lot of sense in several regards. It creates a much bigger $63 billion asset bank at a time when scale in the banking industry is greatly needed, where bigger banks can spread a larger pool of revenue over a smaller expense base. The larger balance sheet will also help the two heavy commercial lenders take advantage of larger lending opportunities. And the two regions that the banks operate in are contiguous, creating a natural expansion of both geographies.

Two people in an office shaking hands, surrounded by others.

Image source: Getty Images.

The added size and excess capital the combined bank generates will also allow it to further invest and build out the HSA business through better technology and product offerings. Webster’s HSA business has generated 11% compounded annual account growth over the last five years, compared to 2% for banks between $20 billion and $100 billion in assets, so it’s a very important part of the bank’s strategy. Continuing to foster and invest in this product set will be more achievable at the bigger bank.

Overall, management expects the combined institution to generate some pretty compelling returns including a 1.4% return on average assets and a 17% return on average tangible common equity. The combined bank’s efficiency ratio (expenses as a percentage of revenue, so lower is better) is expected to run around 45%, which would be very good for any bank, and the cost of deposits at the pro forma bank will be just 0.12%.

READ:  3 Virtual Reality Stocks to Buy in June

Market doubt

The market may be pausing and choosing to take profits on the thought that each of the banks was doing just fine on their own.

Prior to the transaction, Webster traded at 192% to tangible book value.  Meanwhile, Sterling traded at 186% to tangible book value. While the deal is 20% accretive to Webster’s earnings per share, meaning the earnings of pro forma bank will be 20% higher than Webster’s on a stand-alone basis, it’s only 10% accretive to Sterling’s earnings. And while the combined bank is expected to generate a 1.4% return on average assets (ROAA) in 2022, Sterling was already expected to generate a 1.25% ROAA on its own. Sterling also had a similar efficiency ratio as what the combined bank will have.

Investors also may be wondering how the merger truly helps the Webster’s HSA business, which already runs on a national basis. Webster CFO Glenn MacInnes said that the merger will free up more capital to “grow sales capabilities, products, [and] accelerate some of the technology roadmap that we have right now in terms of employee and employer portals that we are in the process of building.” While that certainly makes sense, investors may want to see proof that this will actually help make the HSA business stronger than it already it is.

Will it create value?

Although both banks seemed to be working well on their own, the tie up does excite me for several reasons. For one, the combined bank offers more balance sheet capacity to make larger loans. Also, one of the main reasons banks are merging right now is to better invest in their digital capabilities, so I think investing in the HSA bank’s technology is important. The compelling financial metrics including profitability and the great deposit base also speak for themselves, so long as the pro forma bank can hit its targets.

The larger Webster Bank really has the potential to become a strong niche bank, and niche banks tend to outperform the banking sector. The HSA business offers the differentiator on the deposit side, and Sterling’s BaaS business, which CEO Jack Kopnisky said will start to show benefits next quarter, could turn into something special as well. There are likely opportunities for the HSA and BaaS businesses to overlap and create some innovative products because a lot of BaaS products are already used in the healthcare space. While there is likely a good deal of technology work to do, I certainly see great potential from the deal.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

READ:  3 Reasons I Don't Buy Crypto



[ad_2]
View more information: https://www.fool.com/investing/2021/04/26/the-webster-sterling-merger-creates-a-strong-bank/

Xem thêm bài viết thuộc chuyên mục: investing

Related Articles

Leave a Reply

Back to top button