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How to evaluate the opportunity is a question with no easy answer, but it is a relevant question to ask when it comes to Parline Bancorp (BY). This Chicago-based commercial lender has an attractive market opportunity lending to small and medium-sized businesses in the nation’s third-largest metropolitan area, not to mention taking share in what is still a highly fragmented market. Additionally, a fragmented market creates acquisition value for Byline, as well as an opportunity for M&A growth within the market.

So the question is how much credit to give to the growth potential of M&A and/or how much M&A support to incorporate here. On their own, if Byline achieves my primary earnings growth targets, the stock isn’t that attractive today, but I’d be surprised to see this bank again in a few years and not see meaningful mergers and acquisitions to grow the Bank. or a bank acquisition.

A solid small commercial lender

Byline’s Bread and Butter lends to more than 10,000 Chicago-area businesses with annual sales of approximately $10-50 million.

Unlike many lenders of this size, Byline isn’t particularly leveraged for commercial real estate loans (about 37% of the current loan portfolio), and likely at least part of that stems from the fact that bad CRE loans over a decade ago were instrumental in the bank being recapitalized and essentially reborn as Byline.

Instead, core commercial and industrial loans make up a solid 35% of the loan book, and the bank also has a growing leasing business that accounts for just under 10% of total loans. Byline is also a very active SBA lender, one of the 10 most active in the nation, and the leading lender in its footprint in Illinois and Wisconsin. The sale of SBA loans contributes significantly to the bank’s non-interest income (two-thirds of Q4’21 non-interest income), although about 15% of the bank’s loan portfolio is of retained SBA loans.

Since the recapitalization, Byline has generated a higher net interest margin than its peers, a byproduct of the lending markets it targets, and lower than average funding costs. The bank’s efficiency ratio is not outstanding, and bad debts as a percentage of bank-owned loans and real estate are somewhat higher than average (part of the “cost” of loan yields above the average).

Short-term loan and rate opportunities

The paycheck protection program loan trickle will put pressure on reported loan growth numbers in 2022, but Byline ended the quarter with adjusted loan growth of around 6% quarter-on-quarter. other, including growth in C&I and CRE loans. Byline’s commercial line usage is already higher than most banks (over 53%) but demand for loans is growing in its markets and I expect mid-single digit loan growth in high over the next two years.

Byline is fairly intermediate in terms of rate sensitivity, with the bank estimating a 5% change in net interest income on a 100 basis point change in rates. The bank’s loan-to-deposit ratio is a bit high at 85%, and although nearly 60% of the bank’s loan portfolio is variable/floating rate, existing rate floors mean it will take around one or two rate hikes for Byline to really benefit. from higher rates.

On a more positive note, while Byline’s historical deposit beta has been relatively high compared to its peers (almost 40% in the last cycle), there has been significant progress in the deposit base since then. , the bank seeing non-interest bearing deposits. from 28% at the start of the last tightening cycle to 42% in the fourth quarter of 2021.

M&A – Buy Until You’re Bought?

More than one small bank CEO has commented that in banking you are a buyer until you are bought. Given the nature of the Chicago market, I don’t think Byline will miss any targets – there are over 15 banks in the Chicago area with $1-2 billion in assets and no significant operations outside of Chicago, and there are also several credible target banks if management wanted to gain its way into Milwaukee.

With a roughly 1% share in the Chicago metro area and an established presence in SBA lending, Byline should also be attractive to a bank looking to break into the Chicago market, or looking to build on a small initial position in the market, in particular given cross-selling opportunities to this market for small and medium-sized commercial loans.

Perspectives

Between PPP trickle-down and more normalized loan sales opportunities, I don’t expect 2022 to be Byline’s best year in terms of pre-provision growth potential, but I do expect acceleration to a double-digit growth in 2023. Management is also laying the foundations for better operating leverage, by pursuing a branch reduction program (six additional closures) which will see the bank go from 87 branches at the end of 2014 to 38 branches mid- 2022.

I expect growth in loan demand, higher rates and equity gains to help fuel above-average earnings growth, with Byline delivering normalized core earnings growth of around 7 % long-term. I think the actual number will likely be higher, as I expect management to seek acquisition opportunities, but I don’t see Byline as a bank where growth through acquisition is a core strategy. With a CET1 ratio of 11.4%, the bank is arguably overcapitalized as is, reducing short-term returns, but giving the bank room to pursue mergers and acquisitions.

Discounting this revenue base, I get a forward-looking high single-digit annualized total return, and I generally insist on double-digit returns for a bank of this size. Likewise, neither the P/TBV nor the ROTCE-based P/E (13x ’23 EPS, with a higher P/E to reflect scarcity value) suggests that stocks are significantly undervalued today.

The essential

I believe it’s more likely than not that Byline will make another acquisition at some point in the next year or two, and that likely means my current earnings expectations are too low. I also believe that there is also an M&A safety net here – if the valuation were to get too low, I would expect a buyer to move in. As it stands, while I quite like the Byline story, I don’t see enough benefit today to make the case for choosing this bank over other options in the small banking arena.