Analyst Forum Interview: Brian Gardner

The Brown-Vitter bill proposes to break up the big banks. There is a proposal to bring back the Glass-Steagall Act, which separated commercial banks from investment banks. With lots of pending legislation and new, as yet-unwritten rules coming out of the Dodd-Frank Act, Bank Director magazine decided to talk to Brian Gardner to get a sense of how much of this legislation is really going to pass and when to expect finalization of some of the new banking rules. Gardner is senior vice president of research in Washington, D.C., for Keefe, Bruyette & Woods, a division of Stifel Financial, and he spoke to Bank Director magazine at the end of June, shortly before publication of the final Basel III rules.

A shortened version of this interview appeared in the third quarter issue of Bank Director magazine.

What is the mood now in Washington?

There is little chance the Brown-Vitter bill will pass. There are a number of senior Democrats who have been critical of big banks that are not supporting it. Legislation has two purposes: To pass and change policy, or to move legislators in a certain direction. The timing and reaction to the bill coincided with an overall movement in regulatory circles questioning how successful Dodd-Frank was in ending too-big-to-fail and what else needs to be done. I think you see an environment in Washington which is more favorable to smaller banks and less favorable to large banks. That is not to say Washington or the regulators have turned into a bunch of small bank advocates. I hear from bank managements regularly on the problems and challenges they have of dealing with regulators. I don’t take issue with any of that. My observation is a relative one. Certainly compared to larger banks, the rules are being geared toward smaller banks in a more favorable light. 

What’s the evidence of that? 

In Dodd-Frank, the Collins amendment eliminated hybrid forms of capita called TRUPS [trust preferred securities] from being included in Tier 1 capital, but grandfathered banks under $15 billion in assets. Community banks had a lot of problems with the original Basel proposal that changed risk weightings for mortgages. Aside from requiring banks to hold more capital for mortgages, just the complexity of the added calculations for capital was tougher for smaller banks. I think regulators will drop that from the proposal, so at least on the margin, it will be more favorable to smaller banks. [Editor’s Note: Gardner was right. After he spoke to Bank Director magazine at the end of June, the Federal Reserve Board came out with a revised final Basel III rule that dropped the controversial risk weightings for mortgages. The revised final Basel rule also grandfathers TRUPS for banks below $15 billion in assets.]

What, in your view, is the banking regulation that is going to have the largest impact on banking?

Finalization [of these different rules] would have the biggest impact right now. As for Basel, banks are already gearing up to make sure they can deploy capital effectively. At least they can get some clarity, finally. Sometimes, it’s not whether it’s a bad rule or a good rule, it’s just a matter of knowing the rule. On the Volker [Rule], we’ve been waiting for two years now and it is supposed to be done by year-end. But these are deadlines that have been missed regularly. The big banks were already spinning off their proprietary trading desks well before the Volker rule [was written to ban big banks from proprietary trading]. I’m not convinced the Volker rule will have the impact that people think it will, because I think it’s largely been implemented already by larger banks. I don’t expect to get a lot of clarity on risk retention and QRM [qualified residential mortgages] over the next couple of months. The debate over [the future of] Fannie Mae and Freddie Mac will go on for years. That debate is getting started right now.

How are investors seeing the banking industry right now? 

Clients I talk to are more predisposed to the smaller banks because of regulatory issues. It is but one factor. The rules that tend to be more pro-consumer, such as the Credit Card Act a few years ago, create barriers to entry and make competition less likely. The larger credit card companies are consolidating their hold on the industry. From an investor standpoint, regulation is not always a negative [for all companies]. It can also be a positive and I think that’s the case in the credit card space. In the end, though, I think it’s monetary policy rather than regulatory policy that is driving the view of banking right now.

Originally published on August 5, 2013.

Analyst Forum Interview: Collyn Gilbert

Gilbert_4-22.pngCollyn Gilbert, a managing director at Keefe, Bruyette & Woods, first talked to Bank Director magazine at the launch of Analyst Forum two years ago when she was with Stifel Nicolaus. Stifel purchased KBW in February and she moved over to KBW, which is focused on the financial sector. She still covers small to mid-sized bank stocks and revisited in March what she said then.

We talked to you in the first quarter of 2011 for our first Analyst Forum interview. You said at the time that there was a great opportunity to own a basket of potential sellers, and that you expected considerable amounts of M&A in 2012 and beyond. How do you feel about that now?

I do think M&A is going to be a key component of the industry. Why did it not take place starting in 2012? I think what we missed was the unwillingness of management teams to pull the trigger.  In 2012, you still had good earnings growth for the sector but as we look to 2013 and 2014, earnings growth is going to slow considerably. That could be the catalyst we need to facilitate M&A. It’s a real struggle to grow earnings, especially for the small and mid-sized community banks that may be more real estate dependent and dependent on net interest margins. There is, finally, some degree of capital clarity and what the future looks like for growth. I think we’ve definitely seen a pickup in M&A. In our universe of small and mid-tier banks, we have had 11 acquisitions close in the last 12 months. It’s there. It’s not the big names like the Fifth Thirds and the BB&Ts. The median asset size for sellers has been in the couple hundred million dollar range.

What have those deals looked like?

Because they are so small, some of these [sellers] were trading at tangible book value. [Their stocks] are illiquid in nature. It allowed buyers to get decent pricing on them. You actually have seen these deals accrete book value for the buyers. We have not seen the premium M&A, where banks trading at 1.5 tangible book sell for 1.7 to 2 times tangible book. There is still a lot of bottom feeding. There are banks still challenged and management teams that are fatigued. There is no need to acquire deposits right now because there are a lot of deposits and not much growth in lending. If interest rates rise, that will be a factor to help M&A.

When we talked last, you predicted the banks that would do well would do so because of declines in non-performing assets and reserve levels and net interest margin improvement.

That was true. Now, looking at 2013, we’ve sort of exhausted that. There are some situations where banks are carrying higher-cost funding, which they can re-price lower, but materially lower deposit costs in 2013, I don’t think it’s going to happen. Margins are going to continue to come under pressure this year. I hope we start to see the trough by the end of the year but that’s tough to say.

You will see fewer banks that are able to improve their margins?

It’s virtually impossible. If they are getting better margins, how are they doing that? Are they getting riskier assets? You kind of have to wonder. Are they going farther out on the interest rate curve? You have to be a little bit cautious. {Editor’s note: The latest issue of Bank Director magazine has a story on this topic.}

Two years ago, we had a high level of capital in the industry. It’s still high. Do you see banks using this effectively?

The industry is sufficiently capitalized at this point. The small and midsized banks still follow the trends at the larger banks and keep an eye on what the regulators are saying at the larger bank level. I think that you’ve seen some [regulatory] relief there, and you’ll see more banks move to deploy capital, either in buybacks or increasing dividends. 

We talked two years ago about efficiency. What do you see banks doing with their efficiency levels now and is that a focus for investors or not?

It should be a focus [for investors]. With margins under pressure and growth being limited, these banks really need to think about their efficiency level. The past couple of years they have been cutting some of the fat. Now, we’re in a position where banks have to take a hard look at the expense level and the biggest part of that is the branch network. The one thing I don’t hear enough of from the banks I follow is: How are you rationalizing your branch networks? With consumer behavior evolving at a very rapid clip, if you’re not addressing that, you’re going to be taken to the woodshed. I’m kind of surprised banks aren’t talking about it. Banks have been so wedded to bricks and mortar through so many different cycles and technology has not been the hallmark for the banking industry at the mid-tier level. It’s going to take some time to kick in. [Waterbury, Connecticut-based] Webster Financial Corp., which we follow, is doing a good job shrinking the branch network and [expanding] mobile banking and responding to changing consumer behavior. They said they would reduce investment in branch infrastructure by 20 percent. The theme is starting to trickle down from the bigger banks. The smaller banks, their behavior lags the bigger banks by nine to 12 months.

What should small and medium sized banks do to make themselves more attractive to investors?

You have to be a lot more efficient and look at what the expense structure is. At the same time M&A needs to be an important part. No bank wants to sell. No CEO or board wants to give up their position and their compensation, or whatever the case may be. If putting two institutions together allows you to cut costs and improve returns, that is certainly beneficial to the shareholder.

Analyst Notes

From recent analyst reports:

Analysts at Keefe, Bruyette & Woods report strong commercial and industrial lending:

Excluding consolidation, loan growth has been more measured at 7.1 [percent] annualized, but still solidly ahead of last quarter’s pace. 

For the quarter, C&I remains the largest source of growth for banks, now up 13.4 [percent] in total, modestly above last quarter’s 11.7 [percent] pace. Consumer lending continued to expand at a solid pace, which we believe may have been aided by increased spending through the holiday season. For the quarter, consumer balances grew 9.9 [percent] across all banks, led by credit cards.

Real estate lending edged higher, benefiting from increased residential mortgage and CRE volumes.  For the quarter, CRE [commercial real estate] grew 3.8 [percent] over 3Q12 levels. While modest, the growth does reflect the first quarter of positive CRE growth at large banks since the end of 2008, suggesting that these banks may have turned the corner on CRE lending after running off these portfolios for nearly four years.

Analysts at Raymond James & Associates predict consolidation over the next five to 10 years, rather than a large wave of acquisitions:

With many of the mega and large regional banks more focused on capital repatriation to more normalized levels (stress test results due in March), meeting Basel III capital standards (countercyclical + SIFI buffers), and improving their valuations, we believe M&A activity in 2013 to again remain largely relegated to smaller deals for banks with assets of $1 billion or less. Indeed, we note that of the 788 announced acquisitions from 2009 through 2012, 705 (89 percent) were for banks with less than $1 billion in assets. With the view that greater scale is needed in the new banking paradigm to combat the costs and time associated with implementing new rules associated with Dodd-Frank, we see more management teams/boards of smaller banks “throwing in the towel” in coming months and years. To this end, we note of the 7,181 FDIC-insured institutions as of 9/30/12, 6,522 (91 percent) had assets under $1 billion, which in our view will continue to be where the majority of deals come from in the nearer-term. Still, we wouldn’t rule out a handful of larger deals similar to what we saw in 2012 (like M&T’s acquisition of Hudson City or FirstMerit’s acquisition of Citizens Republic).

In our view, we see meaningful industry consolidation over the next 5-10 years rather than a large wave that occurs over just a few given our belief that banks are sold and not bought. Using this logic, coupled with an improving (albeit slowly) economy, modestly better asset quality, and shades of loan growth, we believe an M&A target’s view of franchise value will remain above that of potential acquirers. Put another way, we expect the disconnect between buyers’ and sellers’ expectations to remain wide but slowly move closer to equilibrium over time.

SNL Financial reports few conversions of mutuals:

Only 13 conversion deals were completed during 2012, significantly down compared to 20 deals in 2011 and 24 deals in 2010. Seven of the 13 deals were standard conversions and six were second-stage conversions.  As for standard deals, one theory maintains that mutuals specializing in single-family mortgages without too much of a capital cushion will need to look for equity infusions, possibly in the form of a conversion, so as to diversify revenue and minimize interest rate risk. That theory has not panned out so far, but if credit quality worsens, some companies may opt to go public. Excluding the publicly traded [mutual holding companies], pending conversions and pending mergers, 149 mutual thrifts have more than $100 million in total assets, hold at least two-thirds of their loans in single-family mortgages and carry less than 15 [percent] tangible equity to tangible assets.

Buying into trouble? Experts give their advice on FDIC acquisitions

Buying a failed bank can be a brutal experience. There may be opportunity to grow your bank, but there also is risk and hard work to do in a short amount of time. Plus, all that work can feel like a waste, if you lose the bid to buy. As the final post in a series on FDIC-assisted bank acquisitions, we’ve summarized advice for those considering such a deal from the final session of Bank Director’s May 2nd conference in Chicago:


Walt Moeling, partner in law firm Bryan Cave, says that bankers looking to do transactions “really need to focus on strategic planning in the big picture sense.”  Are you large enough to handle the acquisitions you want to do? If you double in size, how many people on your team have ever worked at a bank that size? “You can see banks struggling with the staffing issue two years out,’’ Moeling says. He also tells bankers to communicate regularly, or start networks, with other bankers who have done FDIC-assisted deals. If you run into a problem, they might have advice. Also, remember that communication isn’t great between all the different regulatory agencies. Don’t assume your regulator knows what the FDIC knows, and vice versa.

Jeffrey Brand, principal and an investment banker at Keefe, Bruyette & Woods, says figure out what the costs of bidding for a bank will be, emotionally and financially, and develop a team with clear responsibilities. “It’s a very intense, two-week period,’’ he says. “You get very invested in the process. You might not win (the bid), and you need to be prepared if the wind comes out of the bag.”

Rick Bennett, a partner at accounting firm PricewaterhouseCoopers, tells bankers that FDIC-assisted deals continue to be highly accretive to bank balance sheets. The more acquisitions a bank makes, the easier the process becomes. But some bankers underestimate the amount of people and resources needed to acquire failed banks. “Ask yourself, if I am successful, what does that mean for me from a resource perspective as well?” he says.

Where My Deals At?

Last summer, Keefe Bruyette & Wood’s released an interesting bank takeover list. It had the usual suspects — potential buyers and potential sellers — and a “surprising” third: potential buyers who could become sellers. I thought back to this report while watching a handful of videos from our annual Acquire or Be Acquired conference over the weekend. With so much discussion at AOBA centering on FDIC-assisted transactions (which we will explore in greater detail in Chicago this May), this survey came back to me as it focused on so-called open-bank consolidation, comprising potential deals that wouldn’t involve a shutdown by the FDIC first.

Quite a few presented their views on non-distressed bank mergers at our 17th annual M&A conference —  forecasting a huge wave of bank M&A driven by aging management, the need to cut expenses and boost earnings, heightened regulatory costs and more. Of course, FDIC-assisted bank transactions continue to attract strategic acquirers, and the bidding process remains competitive. So “escaping” this particular discussion at our event proved nearly impossible. Indeed, for any healthy bank, considering this type of deal as a growth strategy bears real consideration.  

Case-in-point, this short video of Ben Plotkin, Vice Chairman of Stifel Nicolaus & Co.and long-time Bank Director supporter. We asked Ben to provide his thoughts on the impact of FDIC-assisted deals on M&A activity when we were together at AOBA; take a look:

A random fact that might interest only me…

As we celebrate President’s Day today, February 22, did you know today’s federal holiday celebrates George Washington’s birthday? In fact, this is the first federal holiday to honor an American citizen — celebrated on Washington’s actual birthday in 1796 (the last full year of his presidency).

Do you need $1 billion in assets to survive?

Community bankers at Bank Director’s Acquire or Be Acquired Conference this week in Scottsdale are hearing over and over again: you need to have more than $1 billion in assets to survive.

But is that true? And what about those community bankers who think they will survive just fine, thank you, despite the increased costs of government regulation and an earnings environment where big banks seem to have all the advantages.

Bill Hickey, co-head of investment banking at Sandler O’Neill & Partners, caused some consternation Monday morning when he told a crowd of nearly 300 bankers that they needed at least $1 billion to survive, explaining that the costs of regulation following Dodd-Frank’s passage is going to make it tough to make a profit as a small community bank.

A small bank will have to add employees to handle all the compliance issues and added paperwork for everything from Dodd-Frank to existing legislation such as the Bank Secrecy Act, he said later.

Alan Walters, the president of First Commercial Bank, a $275-million asset institution in Jackson, Mississippi, said organizations such as his will survive if they have a good niche.

He said speakers at the conference throwing around the $1 billion minimum are “way off the mark.” His bank will survive by providing a personal touch in competition with bigger banks such as Wells Fargo and Regions Bank, he said. People like it if their bankers know them by name, he said.

Where his bank has trouble competing with the big banks is providing loans at the $15 million range and above, but he said he focuses on small businesses and professionals such as doctors and lawyers with the funding they need to operate their offices.

Many banks are not expected to survive the next few years, in part because of increased regulation but also because many banks want to improve efficiency in the face of increased costs and low margins.

John Duffy, the chairman and CEO of investment bank Keefe, Bruyette & Woods, predicted that there will be 5,000 banks by the end of the decade, about 3,000 fewer than now.

Several bankers also said they thought regulators want the nation to have fewer banks. Former Comptroller of the Currency John Dugan, who also spoke at the conference Monday, said he never heard regulators say they want fewer banks in all his five year tenure at the OCC, which ended last year.

John Freechack, an attorney who advises financial institutions for Barack Ferrazzano, provided some reassurance to small, community bankers.

He said people have been predicting the demise of community banks for 20 or 30 years. In particular, the cost of new technology in banking was supposed to have put many of them out of business by now.

“From a board’s perspective, you need to make a determination of whether or not you’re going to be able to survive,’’ he said.  But he added after the session: “This is a very resilient industry.”

That would be good news for a lot of community bankers. About 90 percent of all the banks in this country have less than $1 billion in assets, according to James McAlpin, a partner in law firm Bryan Cave LLP.

Will 2011 be the year for bank stocks?

The bad news seems endless. Unemployment remains high. Bad real estate loans continue to hurt banks. Increased government regulation and caps on fees will hurt bank income in the future. And yet, so many bank analysts are so bullish on bank stocks in 2011.


Profitability is returning or will return this year to many mid-sized or small banks, several analysts say.

Stronger banks will be able to buy weaker rivals and grow market share. Even the investors of struggling banks stand to gain after years of misery. Their banks will get bought out at premiums compared to the disappointing prices of the last two years. 

Here is a review of what bank analysts are saying about the outlook for bank stocks in 2011 and their favorite picks:

mmosby.jpgMarty Mosby, a bank analyst at Guggenheim Partners in Memphis,
 says he thinks all of the 15 large-cap banks he covers will be profitable by the middle of this year and he projects a 30 percent stock market gain on average for his group, which includes Winston-Salem, North Carolina-based BB&T Corp., Atlanta-based SunTrust Banks, and San Francisco-based Wells Fargo & Co. 

“We believe 2011 will be the year of the recovery,’’ he says. “We will finally see banks return to the norm.”

Some banks will be better off than others in the new normal, of course.  Banks such as Wells Fargo & Co., Pittsburgh-based PNC Financial Services Group and New York-based BNY Mellon have revenue potential and strong capital, he says, which means they could buy other banks or increase dividends, always a plus for the many dividend-starved investors out there. PNC Financial Services Group reported today record profits of $3.4 billion for 2010.

Jim Sinegal, associate director of equity research at Chicago-based
Morningstar, Incexpects his top picks such as New York-based JPMorgan Chase & Co. and Wells Fargo to return 25 to 30 percent gains for investors. He hedges that a bit by saying it may happen in the next year—or two.

“We don’t see any surprises ahead that could derail something,’’ he says. “We’ll see a slow and steady improvement. Credit is slowly and steadily improving. A lot of banks already are benefiting from that. The worst loans on their balance sheets have already been charged off.” 

He even likes Charlotte, North Carolina-based Bank of America, even though other analysts are just too worried about an ongoing investigation into the bank’s foreclosure processes to recommend the stock. 

“We think the best values can be found in recovering banks,’’ he explains. “We think the stock is cheap.”

Bank of America was trading at $14.37 per share Thursday midday on the New York Stock Exchange.

jharralson.jpgJefferson Harralson, managing director in Atlanta for Keefe, Bruyette & Woods, says smaller banks might have a more difficult time seeing stock market gains this year than big banks. They could be hit hard by new regulations that limit fee income. New restrictions on debit card fees charged to merchants could limit that source of income by as much as 75 to 80 percent, he says. 

Plus, many small and even regional banks have not paid back the government for the Troubled Asset Relief Program money, which could weigh on stock prices this year as well. Investors worried the bank will be forced to raise more capital to pay back TARP won’t be eager to buy those banks.

kitzsimmons.jpgKevin Fitzsimmons, managing director at Sandler O’Neill & Partners in New York, says 36 percent of the group’s bank stocks have a buy rating, compared to 26 percent in January of last year. 

He also thinks there will be more risk in small bank stocks this year, because the heavy weight of regulation will move to smaller banks, as in rolling downhill, as regulators begin forcing those banks to recognize their problem loans.

“This is not going to be smooth going (for all banks),’’ he says. “(The market) will be selective.”

The good news is all that new regulatory pressure on small banks could lead more banks to sell out—for a premium this time.

Sinegal said recent acquisitions have netted prices at two times tangible book value for the acquiring bank, as opposed to no premium or 1.5 times book value during the last year.

“There is more optimism that the worst is behind us,’’ Fitzsimmons says. “There has been optimism that some banks will be able to go out and acquire more banks and the acquired banks can be bought at some sort of premium.”