尽管收益率曲线倒置，但仍对TriState Capital保持信心

The inversion of the yield curve has been a drag on TSC’s 2019 results, thus far.\n

Management remains confident in its 2019 goals, which should translate to consistent earnings growth by year-end.\n

The market continues to view TSC as a typical financial as opposed to an intriguing growth story.\n

TriState Capital Holdings (NASDAQ:TSC) is a regional bank with an impressive growth trajectory. What makes TSC unique is its focus (and ability) to grow earnings organically, as opposed to focusing on the net interest spread between its assets and liabilities. In fact, TSC markets itself as “interest-rate neutral”, as 90%+ of its loans and deposits are variable. Therefore, TSC increases shareholder value by growing its loan portfolio in an aggressive, yet cost-efficient manner. For further information regarding TSC’s strategy and 2019 outlook, please refer to the research report posted in March: The Market Underestimates TriState Capital.

As is the case for most financials, the exaggerate inversion in the yield curve over the past few months has lowered expectations for future interest margins and subsequent profitability. Unfortunately for investors, TSC’s results have succumbed to this macro environment as its net interest spread has contracted ~35bps since June of 2018. However, this compares to a contraction of ~110bps between the 10-year and 3-month Treasury spread. Therefore, TSC’s impact to the dramatic inversion is relatively limited versus other financials. With the assumption that the U.S. economy continues expanding and the yield curve starts to steepen (via cuts in the Fed Funds Rate and/or long-term yields expanding), TSC investors should benefit from continued improvement in its bottom-line.

TSC is a branchless financial institution with three business segments: Private Banking, Commercial Banking, and Investment Management. Its private banking segment operates nationally and underwrites loans that are collateralized by marketable securities. Its commercial banking segment underwrites loans within the mid-Atlantic region for middle-market businesses and real estate ventures. Its investment management business revolves around the Chartwell investment strategies that are marketed to retail and institutional investors nationwide. Please review TSC’s IR presentation for further detail.

As discussed in the previous research report, the market’s valuation of TSC seems to focus on interest rate spreads and not earnings growth. At the beginning of 2019, management guided for loan and deposit growth of 15-25%. Jim Getz, CEO of TSC, recent commented on the 2Q19 earnings call: “Driving this strong asset growth was record organic loan growth within our strategic lines of business, as total balances grew to $5.7 billion at June 30, 2019, an increase of some 24% compared to one year prior and nearly 25% annualized from March 31st. As a reminder, one of our 2019 goals is to deliver double-digit organic loan growth at a rate of 15% to 25%. And we're clearly executing on this while continuing to strengthen our market position and client relationships.” This growth is clearly reflected in TSC’s income statement:

[source: S&P Capital IQ]

Even though TSC markets itself as interest-rate neutral, changes in interest-rate spreads will ultimately impact TSC and it would be naïve to assume otherwise. Below is a chart of TSC’s spreads over the past several quarters compared to changes in the yield curve:

[source: S&P Capital IQ, Federal Reserve Bank of St. Louis]

As shown above, TSC’s net interest income will be impacted by a contraction (and current inversion) of the yield curve. However, its impact relative to most financials seems relatively minor and should hopefully be temporary. For example, as of its recent filing on June 30

, the average yield on its deposits stood at 2.49% (vs. 2.41% as of December 31

). However, this should adjust downwards throughout 3Q19 as the June cut in the Fed Funds rate is fully reflected (the Effective Fed Funds Rate was 2.40% as of December 31

vs. 2.13% as of August 16

).

Though the yield curve will minimally affect TSC’s bottom-line, it should not be the primary focus. Instead, investors should focus on management’s growth ambitions with its balance sheet, as this will significantly impact earnings at a greater scale than movements in the yield curve.

Within the 2Q19 earnings release, TSC recorded a substantial jump in cash equivalents and subsequent rise in shareholder equity. The likely purpose for the increase in cash is for an upcoming acquisition in the 2

half of the year. Furthermore, regulatory capital ratios strengthened over the past six months as highlighted below:

[source: company financials]

TSC reported a recent weakening in the bank efficiency ratio: 55.2% as of June 30

vs. 53.1% as of December 31

, 2018 and 50.5% as of June 30

, 2018. Though operating margins contracted a bit, they remain in the mid-50s which is one of management’s goals for 2019. Therefore, investors should not expect further contraction in operating margins, nor much of an expansion either.

TSC’s underwriting team continues to provide the company with high quality assets. Per the 2Q19 earnings conference call, “And at $5.7 billion loan portfolio, we reported just $2.2 million in non-performing loans at June 30th, 2019. A mere 4 basis points of total loans and an improvement from 14 basis points at the linked quarter end and 5 basis points one year ago. By comparison, the median $5 billion to $10 billion asset Bank reported an NPL to loan ratio of 58 basis points based on the most recent quarter data. Our non-performing assets of $5.2 million made up just 8 basis points of total assets of $6.8 billion at quarter end, improved from 16 basis points at March 31st and 11 basis points at June 30th, 2018. The same peer group reported NPAs to assets of 45 basis points based on most recent quarter data.”

Chartwell’s investment management fees are flat Y-o-Y; however, flows are a bit concerning. Conservative investors should lower expectations of future bottom-line contributions from this segment:

[source: TSC 2Q19 10-Q]

On the flipside, management reiterated its goal of $15b of AUM in Chartwell by the end of 2019 (~50% increase). This will most likely come from an acquisition, as organic growth of 50% over the next six months is irrational. Hopefully such an acquisition will be accretive to investors, especially in the long-term.

On July 15

, 2019, the board of directors approved an additional share repurchase program of $10mm. Combined with the $1.5mm remaining authorized on its current program, management has the ability to repurchase $11.5mm worth of shares. Investors should not get too excited, though, as this only represents approximately 2% of TSC’s market cap. Furthermore, management seems more focused on increasing shareholder value via accretive acquisitions or further growth in its balance sheet.

[source: S&P Capital IQ]

As highlighted above, TSC’s valuation has contracted over the past few months as the yield curve also contracted, and ultimately inverted. However, the market assigns an illogical multiple to TSC as it seems to completely disregard the potential growth in net interest income regardless of the interest-rate environment. Assuming consistent earnings growth of 15% over the intermediate future, TSC’s fwd P/E ratio should trade closer to 15x. Based on a current fwd P/E ratio of 11x, this intrinsic value calculation would equate to ~35% upside.

Since TSC’s investment proposition is through earnings growth via organic loan growth, its performance will be highly correlated to the economy. Any struggles in growing the loan portfolio as management expects will have drastic consequences on its stock price, at least in the near-term. Furthermore, a deterioration in the economy will likely affect the credit quality of its loans, thereby increasing loan losses for the company.

Like its banking peers, TSC is subject to intensive regulation that is ever dynamic.

The banking industry is highly competitive, and TSC’s strategy in significantly increasing its loan portfolio can be stifled by other banking institutions.

As of 6/30/19, TSC was categorized as well capitalized based on its regulatory capital ratios. Any deterioration in said ratios will increase the cost of equity and negatively affect its stock price.

As highlighted throughout this report, the market seems focused on the yield curve and its likely effect on TSC’s profits. However, unlike most other financial companies, TSC’s bottom-line is more interest-rate neutral. Therefore, investors should stay confident in management’s ability to continue growing earnings through organic growth of its loan portfolio, and potentially through accretive acquisitions. In the long-term, TSC’s stock price should rerate based on its growth profile and not the macroeconomic environment.

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:

The information presented is based upon sources and data believed to be accurate and reliable.