It looks to us as if Wintrust Financial’s acquisition of AIG’s life insurance premium business, which closed in July, is shaping up to be a much better deal than we (and the rest of Wall Street) first realized.
In particular, the accretion of the discounted loans acquired in the deal will be heavily front-loaded, which means the deal should deliver an early, substantial earnings pop. The company will use those extra earnings, we believe, to clean up some problem assets, in order to set up for a good 2010. While the Street appears reasonably close on what Wintrust will likely earn in 2010, it’s still short by about 40 cents per share—largely because of the outsized early accretion.
Premium Finance Deal Accretion is Front Loaded: Recall that under purchase accounting, loans and securities purchased at a discount (or premium, for that matter) are marked to market, with any discount or premium amortized over the life of the loan. Underlevel-yield accounting, the accretion benefit on the loans acquired from AIG will be front-loaded, and fully decline after 6 years (average life of the loans is 5-7 years). The accretion is so front-loaded, in fact, that the deal is ending up being more of a capital raise than an acquisition. The discount on the loans will accrete into income, and will boost their yield from LIBOR+190 to roughly LIBOR+850. The end result will still be roughly $6.00 per share in discount coming back into income over the next six years.
Here are our estimates for the EPS impact over the next six years:
Deal Will Allow Wintrust to “Clean Up” the Balance Sheet: The true bottom line impact of the transaction is going to depend on how much cleanup the company plans to do. The magnitude of the premium finance accretion, pretax, is substantial compared to various credit items. For example, the quarterly premium finance income is enough to allow the company to essentially cover its entire provision expense, assuming credit remains relatively stable for the next few quarters. Take a look at quarterly discount accretion as a percent of several key credit metrics:
We suspect the company is working on aggressively working down its non-performers via sales. This will likely result in higher net chargeoffs going forward--which the new-found premium finance accretion will help cover.
If the Deal is So Great, Why No Other Bidders? Of course, AIG said there were multiple bidders. All sellers say that. But Wintrust probably got such a good deal because a) the process started in early 2009 when everyone was still running scared; b) it had funding lined up, and c) it knows the business, and not many players are in that business.
The Street Appears To Be a Bit Light On the Deal’s Impact: It’s tough to tell where the Street is coming out on the deal’s accounting; however, consensus net interest income estimates look a bit light. The consensus estimate for NII in 2010 is $375 million. That’s roughly $15 million (40 cents per share, after tax) short of second-quarter annualized net interest income ($290 million) plus the $100 million in discount accretion on the premium finance receivables the company should generate in 2010. It’s not a huge difference, but not immaterial either.
Capital/Outlook: On the capital front, perhaps the best move for the company would be for it to bet on itself. Wintrust can probably avoid raising capital here, since it should be able to clean up the balance sheet using the premium finance deal accretion, get much better core earnings by 2010, and raise capital at that time, if it has to. Nor does it likely make sense for the company to raise common under $35 or $40 to pay back TARP. It’s reasonable to expect the market will pay up for the stock once the balance sheet is cleansed and investors realize the earnings power. (We have normalized earnings power in the $3.50 range.)
From an operating standpoint, the company has not had significant credit problems. While there’s no reason to believe the company is yet seeing substantial improvement in the problem loans it does have, neither is it likely that the flow of new problems getting worse. The company hasn’t given any indication that anything has surprised it so far this quarter.
(We have a position in Wintrust)
What do you think? Let me know!