Chemical Financial About To Double In Size With An Unexpected Merger Of Equals

I’ve been bullish on Chemical Financial (CHFC) for a little while now, as I liked the prospects for this community banking-oriented financial company to gain deposit share in Michigan and surrounding states as larger banks looked elsewhere for growth. Although I thought M&A was certainly going to be a part of the company’s future, I was surprised to see the merger of equals with TCF Financial (TCF) announced in tandem with fourth quarter earnings.

TCF has never been my favorite bank, but I like this combination, and particularly as there will be a lot of Chemical Financial executives still in positions of authority in the combined company. I believe this is a good blending of relative strengths, and it may well be a blueprint of deals to come in the Northeast and Midwest as larger banks no longer seem so interested in sizable whole bank acquisitions in those areas. Modeling the new combined entity takes a little more guesswork than I’d like, but I believe this combination is undervalued today and well worth consideration.

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Chemical Financial About To Double In Size With An Unexpected Merger Of Equals

Chemical Financial Beaten Up As Investors Flee From Banks

With concerns about a slowing economy, lackluster loan growth, peaking credit quality and rate leverage, and diminishing operating cost leverage, I can understand why investors have moved on from the bank sector in pursuit of greener pastures. In doing so, though, they sold down several banks beyond a point of valuation that I would regard as fair, and Chemical Financial (CHFC) is one such bank.

Although Chemical Financial is not a perfect bank, and Michigan is not a perfect banking market, I believe this growing mid-cap is likely to maintain above-average pre-provision profit growth unless the economy and rates deteriorate sharply over the next two or three years.

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Chemical Financial Beaten Up As Investors Flee From Banks

Chemical Financial Seeing Decent Growth, But There's Still Work To Do

Michigan’s Chemical Financial (CHFC) has been doing alright. The shares had basically been tracking the regional bank indices on a year-to-date basis, but still outperforming on a full-year basis, and second quarter results should have investors feeling reasonably good about the near-term growth prospects. In addition to decent loan growth, Chemical Financial announced that it won the banking business of the city of Detroit, a relationship that should bring in around $500 million of lower-cost deposits that the bank can use.

I’m a little concerned about the jump in provisions, but Chemical Financial’s credit is still healthy on balance. I’m also a little concerned about the company’s fairly weak spread leverage – while Chemical’s cumulative deposit beta remains low, so too is the cumulative loan beta. There still appears to be some upside on the basis of high single-digit earnings growth and a high-teens ROTCE, and Chemical Financial does have the option to use further M&A to drive more growth.

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Chemical Financial Seeing Decent Growth, But There's Still Work To Do

Chemical Financial Investing For Future Growth

Chemical Financial's (CHFC) performance has been somewhat mixed since my last write-up on the company (in mid-September 2017). Although the company has reported some healthy quarters relative to expectations and the banking sector, in general, has benefited from the tax bill passed in 2017, investors have been surprised by the company's willingness to increase spending to build the business. With that, the shares are up close to 20%, which isn't bad, but isn't quite as strong as regional banks in general and other Michigan banks like Comerica (CMA) and Independent Bank (IBCP), though better than Mercantile (MBWM) and Flagstar (FBC).

Although Chemical Financial isn't exceptionally cheap, I believe there is still worthwhile upside here for long-term investors. Management's efforts to hire more commercial bankers should benefit loan growth in 2H'18 and beyond, and I believe the company is making investments to support a larger banking franchise long term (including additional M&A). I'd like to see more progress on improving the deposit mix, but that's not something any bank can fix in just a couple of quarters.

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Chemical Financial Investing For Future Growth

Chemical Financial Offers Some Value And A Proven Growth Model

Today, Chemical Financial (NASDAQ:CHFC) is still digesting the transformative acquisition of Talmer, but this top-10 Michigan bank (and the largest bank headquartered in Michigan) is likely not done with its one-two punch of organic community banking growth and growth through acquisition. Although there has been some turbulence since the deal and the company is still looking at a few quarters where results will be impacted by strategic shifts, the company is on a trajectory for low double-digit earnings growth and should trade above $50 a share.

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Chemical Financial Offers Some Value And A Proven Growth Model