Umpqua Executing Well, But Momentum Is Slowing

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All good things come to an end, and many of the tailwinds that have aided Umpqua’s (NASDAQ:UMPQ) earnings momentum are starting to fade. The bank still has positive asset sensitivity, a strong deposit base, and attractive loan growth opportunities, as well as growth opportunities in fee-generating businesses, but loan demand is starting to ease off and deposit costs are going to head higher.

Still, I like the fundamentals at Umpqua and I like the outlook for the combined post-merger Umpqua and Columbia Bank (COLB), and that deal should close in the first quarter of 2023. I still believe in a mid-single-digit post-deal core earnings growth rate, and that still supports a double-digit long-term annualized return at today’s valuation.

Core Results Comfortably Ahead Of Expectations

Umpqua didn’t post a blockbuster set of third quarter results, but the core results still were better than expected, with a respectable $0.03/share core EPS beat. Readers should note that I do make adjustments to the reported results to arrive at “core” operating results and there are differences in the adjustments I make versus the adjustments that other sell-side analysts or the company may make.

Core adjusted revenue rose about 12% year over year and 12% quarter over quarter, coming in around 6% above expectations. This strength was driven by the core spread business (lending), where net interest income rose 22% yoy and 16% qoq. Umpqua did get some leverage from volume this quarter (earning assets rose about 1%), but improved net interest margin was the dominant driver, with NIM improving 67bp yoy and 47bp qoq to 3.88% (ahead of expectations).

Non-interest income fell 23% yoy and 4% qoq on an adjusted basis, with mortgage banking down 50% yoy and 43% qoq as the market continues to shrink and Umpqua strategically repositions itself here. While initiatives in areas like payments technology are still relatively new, there has been some progress, with management pointing out 43% growth in commercial card fees.

Core operating expenses declined almost 2% yoy and rose less than 1% qoq. Expenses were a bit better than expected in absolute terms, but the company really shone on efficiency ratio, with the ratio dropping from 58% a year ago (not bad, not great) to 51%, which is quite good. This improvement is the end-result of prior efficiency steps taken by management, and I don’t think this tailwind is totally played out, though post-merger cost synergies will kick in 2023 and beyond.

Pre-provision profits rose 30% yoy and 28% qoq, a strong result, and the company beat by around $0.06/share here. Provisioning expense was higher than expected (taking a couple of pennies out of earnings), with the increase tied to higher loan growth as well as a softening economic outlook.

Healthy Loan Growth And Funding, But Likely To Slow From Here

Umpqua exceeded expectations for loan growth in the third quarter, with 16% yoy and 4% qoq growth that was also better than the overall banking sector, though more in line with peers like WaFed (WAFD) (which I recently covered here). Loan yields improved less than for many other banks (up 39bp yoy and 47bp qoq), but that was in part due to higher starting yields, with the bank exiting the quarter with a 4.41% average loan yield.

Umpqua saw the strongest lending activity in mortgages (up 26% yoy and 6% qoq), multifamily (up 34% yoy and 7% qoq), and leasing (up 15% yoy and 6% qoq), while C&I lending was also decent on a sequential basis (up 3% qoq).

I don’t expect mortgage lending to remain this healthy given affordability issues (higher home prices, higher rates), but I do think leasing and multifamily can remain quite healthy. There’s a shortage of multifamily housing in most regions, and many of Umpqua’s core markets are seeing above-average population growth. While there are “NIMBY” issues with multifamily projects, I do see this as a healthy market. Commercial real estate looks less healthy, with management talking about customers pulling back a bit in response to higher rates.

Umpqua did well on deposits on a relative basis, with a slight year-over-year decline and nearly 3% qoq growth. Non-interest-bearing deposits also rose 1% (both yoy and qoq), bucking a trend of NIB deposit shrinkage. That helped keep deposit costs very low (up 8bp qoq to 14bp, which is quite low on a relative basis), and Umpqua’s deposit beta is likewise very low relative to peers.

Looking ahead, Umpqua’s balance sheet is going to see more challenging conditions. CRE loan growth has already tempered some, and I expect mortgage demand to decline. Multifamily and leasing look good, but C&I lending could be at risk as the economy slows. Fortunately Umpqua has a diverse loan book (and lending capabilities) and strong relationship-based banking. That said, the loan/deposit ratio is uncomfortably high now (95%), and Umpqua will likely have to either turn to more expensive funding sources (FHLB advances, debt, brokered deposits, et al) or turn away less appealing lending business (or some combination of both).

Credit quality isn’t a concern, though, as the non-performing asset ratio is stable, as is the charge-off ratio. Delinquencies have increased in the C&I and leasing categories, but not to a worrying degree, while delinquencies in real estate are quite good.

The Outlook

I’ve talked before about the value of Umpqua’s client-focused service-oriented offerings, and that seems to be playing out in the deposit performance. Longer term, I think this foundation of service will serve the company well as it looks to expand its corporate services and payments operations.

The Columbia deal is still the biggest milestone ahead for the company, and management expects the deal to close in the first quarter of 2023. There has been some progress, including an agreement with the DOJ to sell some branches, and I don’t see why the deal wouldn’t close.

I haven’t changed my expectations for the combined entity all that much, though I do see some risk of a rougher slowdown in ‘23/’24, with some offsets from improved operating efficiency and sensitivity. At the bottom line, I’m still looking for long-term core growth around 4% to 6%.

The Bottom Line

Between discounted long-term core earnings, ROTCE-driven P/TBV, and P/E, I believe Umpqua is set up for long-term annualized returns in the double-digits, with a shorter-term fair value in the low $20’s. That’s admittedly not superb upside, particularly given weak sentiment on bank stocks and the risk of further estimate cuts for ‘23/’24, but I do think this is a very well-run bank, I think the merger will create a better combined entity, and I think there are still GARP attributes to these shares, even though it will likely take some time for the shares to get going again.

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