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Webster Financial ‘avoided the mistakes of US bank failures’

David Rogers
The Australian
Nov 17, 2023
Azora Capital founder Ravi Chopra. Picture: Renee Nowytarger

The US financial sector is not without its problems but Ravi Chopra backs Webster Financial Corporation as his stock pick for the 2023 Sohn Hearts & Minds Investment Leaders Conference.

The chief executive and founder of US financial services hedge fund Azora Capital, did make a ton of cash for his clients by short selling each of the four US regional banks that failed in March.

In fact the hedge fund had its most profitable month on record.

But Webster Financial didn’t make the same mistakes as its peers, according to Mr Chopra.

Most US banks were sucked into buying low-interest rate, long-duration, fixed-rate assets at record lows, after the Federal Reserve slashed interest rates to record lows at the start of the Covid-19 pandemic.

That exposed them to a serious amount of interest rate risk which was triggered in 2022 when the Fed unleashed its most aggressive interest rate tightening since the 1970s.

But unlike the vast majority of its peers, Webster Financial has best-in-class capital and profitability.

It is also expected to trade on six times earnings per share for the next year and, most importantly, it has what Mr Chopra considers to be an “undervalued and underappreciated asset”.

Webster’s HSA Bank is the fourth largest provider of “health” savings accounts in the US.

While healthcare is notoriously expensive in the US, and one way that Americans offset that is by contributing — tax-free — towards their health savings accounts for medical expenses.

Because of contributions from monthly paychecks, HSA Bank’s business is “highly atypical, recurring, and grows in all environments”, including 2022 and 2023, when the rest of the banking industry saw its core deposits fall by over 20 per cent, Mr Chopra said.

Most of its peers bought 1.5 per cent yielding on paper, with 15-year maturities, at the lowest point of the Fed funds rate in the history of the United States, he recalled.

“None of them had any credit risk, but they sure had a whole lot of interest rate risk,” he said.

“Of course, that was in time for the Fed to raise rates 525 basis points in a straight line, which had two important impacts.

“One was that all those bonds were now $US7.3bn underwater, which for context is 16 per cent of bank capital, which is pretty similar to how credit losses were during the GFC.

“The second impact was that with higher interest rates, deposits started leaving the banking system and depositors started seeking higher yielding alternatives.”

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Because US deposits above $US250,000 are uninsured, the failure of Silicon Valley Bank awakened uninsured depositors to the realisation that they were effectively unsecured lenders to banks, and not even getting paid to do so, causing deposit flight.

The other aspect of Webster’s business is that its deposits are “highly transactional.”

“So irrespective of the interest rate environment, HSA Bank pays a fixed 50 basis points on that cash,” Mr Chopra explained.

“So while we’ve raised the Fed funds rate to almost 5.5 per cent, the value of those deposits and therefore the value of that business has never been greater.”

He sees this an opportune time for Webster to monetise the strength of HSA Bank, either through a joint venture or an outright sale in business.

“Currently there’s a pure-play, publicly traded player in the HSA business which trades at 30 times earnings, due to all the great characteristics we just talked about.

“If we can cut that in half and use 15 times on HSA Bank and nine times on the rest of core Webster, which is a 20 per cent discount to its historical multiple, we get 60 per cent upside to stock price.

“So in summary, we believe that Webster Financial Corporation has a unique path to value creation for the monetisation picture, relative to the US banking industry that faces many, many challenges.”

This article was originally posted by The Australian here.

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