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Analyst Forum

What’s Ahead?

May 1st, 2012 |

Peyton Green is a senior research analyst covering banks and thrifts at Sterne Agee & Leach in Nashville, Tennessee. He talks about why he thinks bank stock valuations will improve this year, and predicts which banks and thrifts will do better than most.

Stock valuations for banks have been improving. M&A pricing has improved slightly.  What do you expect for this year?

Six months ago, we were more bullish on bank stocks because valuations were lower than they had been a year before and more of the companies had positive catalysts in play. We thought the market offered a good opportunity to buy at a good valuation. Fast forward to today and the market has recognized a lot of the value for those catalysts. In September and October and August, when the market was falling apart because of European markets, we realized the world doesn’t all come to an end. Banks ultimately are a voting machine for the local economy. What you’ve seen year-to-date in the movement in bank stocks is the result of better economic moves on the U.S. front, rather than what’s going on in the rest of the world. I don’t know that there are many more people buying bank stocks than a year ago, but there are less people selling them. The average investor has been underweight on bank stocks for the better part of three out of the last five years. Not many of the companies have much growth. A lot of the movement in bank stocks last year was because of credit losses coming down. The best stocks that we’ve seen over the past two years have had good growth prospects.

What about this year?

I think the valuations will do surprisingly better than people expect. Everybody was worried to death about the economy getting worse but it’s gotten a little better. The other wild card that could develop is live bank M&A [not FDIC-assisted deals]. Live bank M&A is slowly starting to pick up. We’ve seen more action in the past year in economies that were less affected by the economy, for example, Louisiana and Texas, the Northeast and the MidAtlantic. Over the course of the next year, we should see that broaden out into other geographies. M&A always causes investor activity in the sector to pick up. That doesn’t mean [bank stocks are] going to go straight up. I think the sector, like the market as a whole, is due for a bit of a pull back.

Forward Looking Statement: What are your favorite stocks?

We think the barbell approach works, where you buy quality banks that benefit from an uneven playing field created by the recession. Also, we like banks that are coming out of the recession and have more improving credit leverage. We like UMB Financial Corporation in Kansas City, Missouri. It is more of a financial services company with non-bank financial services, such as asset management, wealth management and securities processing [back office operations for mutual funds and hedge funds, etc.] that make up 28 percent of the revenue base. Those businesses have been growing at a double-digit rate the last couple of years. Loans for the bank are up 6 percent to 8 percent per year and deposits have grown 10 to 15 percent per year and charge-offs have been in the 50 basis point range.

Signature Bank in New York has been able to take market share because it competes with all the too-big-to-fail banks. Once things settle down, it will be a great opportunity to pull market share and hire banking teams.

On the credit leverage side, we like MB Financial, Inc. in Chicago. The company has provided for loan losses of about 12.9 percent since the end of 2007 and charged off about 11.6 percent of its loan book, so it has been a very difficult cycle. But [recently], it was able to redeem TARP Preferred [Troubled Asset Relief Program stock] without any kind of common raise or debt offering. We think results will improve significantly this year. We would expect the Chicago metropolitan area to improve this year to provide economic opportunities.

One that will be a stock to own during the next couple of years, maybe not the next couple of quarters, is TCF Financial Corporation in Wayzata, Minnesota. We feel like the stock is really in its fourth bad year. We just think things will start improving this year. They went about a balance sheet restructuring where they sold a good portion of their bond portfolio and got rid of high cost offerings and it’s going to benefit earnings by about 30 cents per share going forward. They had a lot of [nonsufficient funds] fees and debit card interchange fees so they got hit on both ends [by new regulations limiting those fees]. They had 40 percent of their loan portfolio in residential mortgages in Michigan, Minnesota and Illinois. Those three states have been more adversely affected from a credit perspective than other states in the Midwest. We think this is a year where real estate values will start to stabilize and incomes start to increase a little and the bank will start to get some relief in 2013.

One of the best live bank M&A opportunities recently was executed by Hancock Holding Co. It bought Whitney Holding Corp., in June of last year. It was an $8-billion asset bank buying a $12-billion asset bank at the bottom of the cycle. We think this will be very good for Hancock shareholders and Whitney’s shareholders.  We think they’ll make $3.15 per share in 2013 and the street is predicting $2.90 per share. They have more opportunity for cost saving and their growth profile is going to start to pick up over the balance of the year.

We’ve had record high deposits in banks and low interest rates. Do you see that as a problem for the banks you cover?

There has been a ton of cash pumped into the system and that cash has found its way onto bank balance sheets, in part because people are less enamored of the money market funds. There is talk about regulating that industry. There also is simply the cyclical component where companies and consumers are deleveraging. We would expect those deposits to move out eventually. This year, as you see a pick-up in loan growth, you’d expect commercial depositors to use their depository liquidity first and then borrow money, but you simply never know. It is something we worry about in the longer run. If there was a shock in interest rates, we would worry about it and expect a behavior change.

Stock Retrospective

Scott Siefers, managing director at Sandler O’Neill + Partners, follows up on his prediction that Wells Fargo & Co, PNC Financial Services and U.S. Bancorp would all perform well, despite the economic environment. 

“The one thing that has changed is the economy appears to be on slightly more solid footing than a few months ago,’’ he says. “Those are still the best names, but the group as a whole has performed better as a result of the economic improvement. The names that have done really well have been high-risk names, such as Bank of America. PNC and U.S. Bancorp did well last year, so they’re starting off in a better position so the relief rally isn’t going to affect them.”

“The jobs side of the economy is gaining a little traction. I can’t say I feel great about real estate. We’re plotting along on the bottom but at least some of the macroeconomic indicators are improving with a bit more traction. Where I can’t say I feel great is the [interest] rate side of the equation. As long as rates stay down, the tougher it is going to be for banks.”

pgreen

Peyton Green is a senior research analyst covering banks and thrifts at Sterne Agee & Leach in Nashville, Tennessee.

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