Markets & Finance

BancorpSouth: A Solid Banking Play


S&P says the regional bank's credit quality is near the top of the industry and ranks its shares a strong buy

From Standard & Poor's Equity ResearchWe consider BancorpSouth (BXS; recent price, $17) to be one of the strongest midcap financial institutions that we cover, based on historical, current, and expected trends in lending profits, credit quality, and fee-income growth. We view the stock's valuation as compelling, and our recommendation is 5 STARS (strong buy).

We believe this southeastern regional bank's credit quality is near the top of the industry, and we think it will remain relatively high, because the company operates in an attractive service territory, in our view, and has not engaged in high-risk lending practices or held similarly risky securities.

BancorpSouth has consistently maintained the highest levels of credit quality that we have seen in our coverage universe. Nonperforming loans accounted for 0.42% of total loans at the end of March, up from 0.32% at yearend and from 0.28% at the end of March 2007. This rate of increase was lower than those of most peers, which we think is because BancorpSouth has avoided boom-bust lending practices.

At the end of the first quarter, the bank's reserve for future loan losses was 1.29% of total loans, a level higher than that of its peers, by our estimates, and 3.1 times the level of its nonperforming loans. In our view, BancorpSouth is a conservative lender, having avoided subprime mortgage lending and adjustable-rate mortgages. Additional loan-loss provisioning may be required in 2008, according to our analysis, due to industrywide declines in credit quality, and we estimate that the company may take a loan-loss provision of up to $41 million this year, compared with $22.7 million in 2007.

Company Profile

Headquartered in Tupelo, Miss., BancorpSouth delivers banking and insurance brokerage services through 268 offices. Of those, 111, or about 41%, are in Mississippi, 53 are in Arkansas, and 34 are in Tennessee. The remaining 70 offices are in Alabama, Louisiana, Texas, Missouri, and Florida.

Through its wholly owned BancorpSouth Bank, the company has grown by acquiring other banks and insurance companies, buying assets from federal regulators, and opening new offices. The bank provides a range of financial services to individuals and small to midsize businesses. Its subsidiaries engage in investment brokerage services, consumer lending, credit life insurance sales, and sales of other insurance products. The bank's trust department offers a variety of services, including personal trust and estate services, certain employee benefit plans, including individual retirement accounts, and limited corporate trust functions.

Banking operations consist of lending and deposit gathering as well as other banking-related products and services, including investment and trust services. BancorpSouth's target market includes small to midsize businesses, entrepreneurs, professionals, and affluent individuals. Its investment and trust business includes investment management and advisory services, brokerage, portfolio management, securities trading, asset management, trust and investment services for businesses and individuals, estate and financial planning, and custodial operations.

BancorpSouth pursues both commercial and consumer lending. It grants commercial loans that are generally secured and are based on an appraisal of the borrower's ability to generate sufficient cash flow to support its debt obligations and other cash-related expenses. In residential consumer lending, the bank originates fixed- and adjustable-rate residential mortgages secured by owner-occupied properties in its markets. Loan originators operate from its traditional bank offices as well as from storefront locations.

At the end of March, the $9.2 billion loan portfolio totaled 70% of BancorpSouth's $13.2 billion in assets. Total loans comprised one-to-four-family mortgage loans (27%), other real estate mortgage loans (50%), commercial and agricultural loans (13%), and consumer and installment credit lines (5%), with the remaining 5% in lease financing and other loans. Lending growth in the most recent quarter was 2.3% on an annualized basis and 5.6% for the 12-month period ended Mar. 31.

BancorpSouth also held securities totaling $2.5 billion, or 19% of assets, on Mar. 31, with $1.5 billion hold-to-maturity securities and $972 million available-for-sale securities. Gains and losses on these investments, recorded in the income statement, have been minimal in all the quarters we have examined, looking back two years.

Deposits of $10.1 billion at Dec. 31, 2007, were apportioned as follows: noninterest-bearing demand deposits, 17%; interest-bearing demand deposits, 35%; savings, 7%; and other, 41%.

Low-Cost Deposits

BancorpSouth's deposit-to-loan ratio of nearly 111% at Mar. 31 was much higher than peer and industry averages, and we think that this high ratio will help support its net interest margin (NIM) in 2008 and beyond, as the bank has the option of letting higher-cost deposits "run off," an option that most peers do not have.

BancorpSouth has retained a significant amount of lower-cost core deposits, due to a high degree of loyalty among customers. Low-cost core deposits and noninterest-bearing deposits are usually built up over a long period from a bank's corporate banking relationships. The advantage of low-cost core deposits is that they help the NIM. This, in turn, has led to BancorpSouth's ability to generate a NIM that we estimate is higher than those of peers: It was 3.79% in the first quarter of 2008, up from 3.66% in the first quarter of 2007.

In 2007, noninterest income accounted for 35.4% of BancorpSouth's revenues. Since gains and losses on securities were quite small in 2007, we expect fee-income growth in 2008 to be based on increases in recurring fees, such as insurance commissions, service charges, and debit-card and credit-card fees.

Growth Through Acquisitions

In December 2004, the company acquired Premier Bancorp, in Brentwood, Tenn., with total assets of about $160 million. Also in December 2004, BancorpSouth acquired Business Holding Corp. of Baton Rouge, La., adding another $170 million of assets. In December 2005, it purchased American State Bank Corp., which had $358 million in assets and was headquartered in Jonesboro, Ark. In March 2007, the company acquired Signature Bank of Springfield, Mo., which had about $850 million in assets and $600 million in deposits at the end of 2006. In addition, BancorpSouth recently acquired three insurance-related businesses.

Company and Industry Outlook

We have a positive view of the economic growth potential of BancorpSouth's service territory, which is centered in northern Mississippi, eastern Arkansas, and southern Tennessee.

We expect net income to rise 1.5% this year, reflecting higher loan-loss provisioning, and increase 6.7% in 2009. Assuming a 32% effective tax rate, we see earnings per share of $1.71 this year and $1.83 in 2009.

Due to BancorpSouth's ability to attract and retain low-cost deposits, its net interest margin expanded to 3.79% in this year's first quarter, up from 3.64% in the first quarter a year earlier. We project a 2008 NIM of 3.72%, up slightly from 3.68% in 2007. We expect net interest income to rise 3.3% in 2008 and 2.6% in 2009.

We estimate BancorpSouth's noninterest income (including acquisitions) to climb 17% this year, to $270 million, or 38% of revenue. We expect fee income to contribute to total revenue growth, which we anticipate will be 8% in 2008.

We project an efficiency ratio (noninterest expense as a percent of total revenues) of 64.9% in 2008 and 66.8% in 2009, mainly due to increases in compensation and incentive pay in insurance brokerage. The 2007 efficiency ratio was 65.4%. We are not concerned, however, about these projected increases in noninterest expenses, as we have seen that the efficiency ratio is often related to the amount of fee-income-generating services offered by a bank. BancorpSouth is adding additional fee income through growth in insurance brokerage services. We think the relationship of BancorpSouth's efficiency ratio to its percentage of revenues derived from fee income is in line with industry averages.

Earnings-per-share growth has averaged about 6.5% during the past three years, and we see growth of about 4.9% annually over the next three years.

Valuation

BancorpSouth shares are trading at about 9.9 times our forward-four-quarters EPS estimate of $1.71. However, we think the stock should have a higher multiple due to what see as BancorpSouth's excellent credit quality. Our 12-month target price of $22 is based on a multiple of 12.9 times our forward four quarters EPS estimate, a premium to regional banking peers. Factoring in the company's dividend of 22¢ per quarter, we see total return potential of about 35% from current levels.

Corporate Governance

In our view, BancorpSouth rates highly on a number of corporate governance measures, compared with other banks we follow. The majority of the board of directors is outside directors, and the compensation, nominating, and audit committees are made up entirely of outside directors. In addition, BancorpSouth does not have a dual-class capital structure. All directors with more than one year of service own stock, and the company's option plans appear to be reasonable in terms of the size of grants and the performance goals.

We think there are a few negatives related to takeover defenses. For instance, the company has a poison pill, which is an automatic issue of shares, or placing of shares and options, that may be deployed to repel an uninvited takeover bid. Moreover, the board of directors is classified, which means it cannot be replaced all at once by an acquirer. Furthermore, the board may amend the bylaws without shareholder approval. These defenses against uninvited takeovers may limit any increase in the share price that would likely occur in the event of a takeover—a possible negative for shareholders.

Investment Risks

The primary risk we see to our recommendation and target price is the possibility of a severe, housing-related economic downturn, which could lead to a decline in the growth rate of the loan portfolio and increase the level of nonperforming assets. Additional risks are competition in the insurance brokerage business, another credit crunch, increases in noninterest expenses, and a decline in lending yields stemming from possible future Federal Reserve interest rate cuts.


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