Brett Rabatin is senior research analyst for Birmingham, Alabama-based Sterne Agee & Leach, one of the largest privately owned investment banks in the country. He covers Texas and Western banks with an average market capitalization of $2 billion to $3 billion. He talked to Bank Director magazine in late September about the impact of low interest rates and the finalization of Basel III capital rules, saying that banks are staying cautious with their capital plans.
A shortened version of this interview appeared in the fourth quarter issue of Bank Director magazine.
A year ago June, you were interviewed on Fox News and picked favorite bank stocks Texas Capital Bancshares, East West Bancorp and Western Alliance Bancorp. What do you think of them now?
I wouldn’t call Texas Capital a big outperformer but it has gone up some. East West and WAL [Western Alliance Bancorp] have been two of the highest performing banks in the regional bank space. WAL’s stock is up 73 percent year-to-date, compared to 24 percent for the KRE, the S&P regional bank index. The 2013 estimates [the average earnings estimates for analysts who cover the stock] have gone up 43 percent year-to-date. The median increase for banks in the index was 3 percent.
Why is WAL doing so well?
In the bank space, you have to have a reason for relative outperformance. In combination with a relatively attractive valuation, my contention has been that its [earnings] estimates were light. Forty percent of the franchise is in Las Vegas. It is the largest independent bank that has survived in Vegas. Three years ago, I was one of the people who thought Vegas was a black hole and nothing was going to escape. But housing is better and credit is better, and combined with that and their growth in Phoenix and Southern California, I would like that stock to outperform.
The thing that is really challenging today is borrowers can get five or six banks to lend them money and make them compete for loans. If you don’t want to deal with one of the large banks, you’re probably talking to WAL in Vegas. WAL is not going to get a really limited [interest] rate. They have what I would consider a non-commoditized lending bent. It keeps their margin from compressing as much as peers.
How will continued low interest rates impact the banks you follow?
Now we’ve got Bernanke saying, ‘it’s QE [quantitative easing] forever baby.’ He didn’t really say that, but that’s what I felt like. Investors are looking for higher rates to boost margins and that’s not happening. Loan growth is challenging. Credit leverage for most has played out. The back half of this year doesn’t look positive for earnings leverage unless something changes with the economy or the interest rate outlook. We are hoping things improve in 2014 or 2015.
We need an economy that isn’t built on Fed juice, as it were. And we don’t have that. There is too much uncertainty in Washington, and this creates questions for companies, which makes it hard for companies to say they want to expand.
I think the Federal Reserve wants rates to go up gradually, like maybe 10 basis points a quarter or something like that. And the Fed may not raise the fed funds rate until 2016. I think that’s unfortunate if you are a bank investor. The banks need rates to go up to make more money. Every incremental dollar on the balance sheet is at a lower rate than previously and every loan most likely has a lower profit margin than what you currently have on the balance sheet. The balance sheet also reprices over time. Loans mature. Customers come in and say, I have a 5 percent loan and I’d like it to be 3 or 4 percent. You have to acquiesce or you lose that customer. I don’t mean to be Dr. Gloom because there are some positives to bolster investor hopes. We continue to see M&A budding. I have seen a couple deals in my space.
Basel III has been finalized. There was a thought that once that happened, banks would make decisions about their capital plan and increase their dividends. What do you think?
I think there is still some hesitancy at the bigger banks in terms of using excess capital. I think that will change over the next year. The smaller banks are hesitant as well to fully lever to the new benchmarks. Maybe the regulators won’t like you if you do that. I think everyone is keeping a little dry powder. Clearly, we’re not going back to 2007, which is a good thing. It’s a process, not an event.
We’re not all going to see lots of higher dividends and a rush to invest all this excess capital?
For a lot of institutions, if it’s a pervasive problem because they’re a solid bank generating a good return on equity and assets, and if they can’t grow fast, I think higher dividends are in their future. I’ve had a few banks increase dividends, but they’re going to increase it a penny or two. If you’re a bank CEO, you don’t want to run your company like a utility. You don’t want to pay out all of your earnings or a substantial portion to shareholders as dividends. What that means is you’re not growing that fast and you’re not using the capital you have. I think every bank CEO will tell you they want to grow.