People's United Stays on Sidelines

We are reiterating our Neutral recommendation on People's United Financial Inc. (PBCT">PBCT) based on the company’s better-than-expected third-quarter 2011 earnings. The earnings of the company also compared favorably with that of the prior quarter and prior-year quarter.

In October, People's United reported its third-quarter 2011 operating earnings per share of 19 cents, beating the Zacks Consensus Estimate by 2 cents. Earnings also compared favorably with 17 cents per share reported in the prior quarter and 8 cents in the prior-year quarter.

The modest improvement in results was driven by higher net interest income, enhanced revenue and lower nonperforming assets and loans, partly offset by higher non-interest expenses.

Despite an asset sensitive balance sheet, People’s United Bank continues to pose a modest capital position, with capital ratios exceeding each of the regulatory requirements. Its tangible capital ratio and total risk-based capital ratio were 11.8% and 16.6%, respectively, as of September 30, 2011, far exceeding the regulatory minimum requirements of 1.5% and 8%, respectively.

In 2010, People’s United completed the acquisitions of Smithtown Bancorp Inc. and LSB Corporation. These acquisitions, which would extend the company’s presence in New England and New York State, will be accretive to the company’s 2011 earnings. Further, People’s United’s acquisition of Danvers Bancorp Inc. in 2011 marks a platform of growth for the company.

People United’s net interest margin (NIM) has been growing steadily. Despite a lingering period of low interest rates and pricing pressure in the market, the company expects the net interest margin to remain above 4% in the upcoming quarters. As of September 30, 2011, NIM increased to 4.13% from 3.64% in the prior-year period, supported primarily by low-cost funding, good loan mix and strong capital levels.

In July 2011, the company adopted certain cost saving initiatives, including the elimination of selected positions primarily within corporate functions, non-core lending businesses and the former Bank of Smithtown. These will likely lead to an annual cost savings of about $23 million, beginning in 2012.

On the flip side, People’s United’s banking business is heavily regulated by the federal and state governments. Bank regulations and changes in state and federal tax laws could hurt the business anytime in future. In July, the Dodd-Frank Act implemented significant changes in the financial regulatory backdrop, which would impact all financial institutions including People’s United. The company expects the Act’s interchange fee provisions to shrink the interchange fee revenue considerably, beginning in the fourth quarter of 2011.

Moreover, the current market volatility and limited credit availability could continue to adversely affect the U.S. banking industry and the global economies in the foreseeable future, which will affect People’s United as well.

Overall, People's United is trying to overcome the challenging economic environment through opportunistic acquisitions and cost reduction initiatives. The announcement of the acquisitions and positive earnings reflect its strong capital and liquidity position. Going forward, growth in loans and deposits are expected to keep the financials bright. However, the recent regulatory issues and market volatility might act as headwinds.

People's United currently retains its Zacks #3 Rank, which translates to a short-term ‘Hold’ rating. However, People’s United’s closest competitor - Hudson City Bancorp Inc. (HCBK">HCBK) retains a Zacks #2 Rank, which implies a short-term ‘Buy’ rating.

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