Blog

Please see FIG Partner's Director of Research Christopher Marinac's article on insider ownership at community banks published on July 26 on bankdirector.com

One of the basic rules that always seems to resonate with investors is knowing which bank executives and directors like to “eat their own cooking.”  Long before Warren Buffett starting preaching about it in his annual shareholder letters (http://www.berkshirehathaway.com), inside ownership by senior management and directors has been a standard that is very characteristic of high performing banking organizations.  Based on my 20 years’ experience as an equities analyst, those companies that post better intermediate- and long-term earnings performance (and also seem to be must faster to adapt to changes in the industry) are those where the CEO and directors are large direct shareholders.

After the 2008 financial crisis and Great Recession diminished many banks’ stock values, how much “skin-in-the-game” do public community banks still maintain? Along with one of my FIG Partners research colleagues, I reviewed the proxy filings for 35 community bank stocks to test my theory that actual dollars of ownership vary widely among public financial institutions. Only four banks in our sample size exceeded $10 billion in total assets; the remainder range in size from $9.9 billion to just over $400 million.  The majority of the work was done by hand as I read individual proxies filed in Spring 2011, and I made a real effort to read all of the footnotes to ensure actual shares owned were separated from  options that had been granted but not yet exercised.  I have no philosophical issue against options, but when keeping score on “home cooking” only the shares that are actually held should matter. 

Please click here for the rest of the article

Discussion and concern abounds on the Street whether the United States’ debt obligations receive a rating downgrade from the major agencies and an actual default occurs on U.S.-guaranteed debt.  The rating agencies have their own skeletons in the closet from 2004 to 2009 that certainly contributed to the financial crisis and ongoing “Great Recession”.  So, we have little doubt that the reformed bond raters will rise to rescue the capital markets from another calamity.

Bank investors should care most about the ratio of tangible capital to underlying risk assets, or the Tier 1 Common equity.  Thus, what happens to Tier 1 Common ratios IF U.S. Treasuries and other guaranteed government bonds changed from a 0% risk-weight to 20% thanks to a ratings change?

We think investors need to be well aware of this issue, which is why we dug into the math.  There are 984 bank holding companies(BHCs), among both private and public concerns, and we computed a median Tier 1 Common ratio of 10.67% at 3-31-11.

If the combined US Treasuries and State/Govt. issues dropped from a 0% risk-weight to 20%, the median capital ratio would drop to 10.34%.  The capital deterioration seems benign.  In our recent Weekly Musings industry note (see Pages 3 & 4), we show an example portfolio composition with the highlighted areas in yellow.  For those BHCs with a large change in capital ratio, the companies had heavy capital above 15.0%.

In fact, we found only 5 banks whose Tier 1 Common dropped below the 7.0% threshold being established by the Basel III international capital standards.  Each of these banks had a minor adjustment and were only modestly above 7.0% Tier 1 Common—this is hardly a needle-mover in our book.

For investors in banks stocks, a few key items to remember:

(1) The FDIC and Federal Reserve hold guidelines for how banks determine risk-weightings on securities, loans, and other assets disclosed on quarterly call report filings.  If the FDIC and Fed do not alter the 0% risk-weights, perhaps this is a non-event.

(2) Many banks have long shifted into RMBS and other securities that already carry a 20% risk-weighting and are generally less exposed to pure U.S. government issues than in the past.

(3) Perhaps a greater risk to consider is a militant interpretation from bank auditors that an actual default on US Govt. debt should trigger a shift in risk-weighting despite inaction by regulatory agencies.  Such an auditor could refuse to endorse quarterly financial statements.  In this regard, the opinion of the accounting firms and their policy committees could be among the most important trend to watch.

$1.5 Trillion … please remember this figure and/or commit it to memory.

Most bankers we talk with suggest that commercial real estate lending remains one of the best areas to find strong spreads and fees and therefore drive incremental NIM-Net Interest Margin.  Of course, to many of these same bankers the only thing “real” in commercial real estate is the pain inflicted from regulatory examiners when too much CRE is on the books relative to underlying Tier 1 and Total Risk-Based Capital.  Therefore, most banks do not anticipate adding more CRE to their books given today’s environment.  But, is this a mistake?  Should banks dive into C&I-Commercial & Industrial loans which can carry weak structure and low spreads to their cost of funds, all in the name of loan portfolio diversity?

Our understanding of the current regulatory rules is that banks are permitted to lend up to 100% of Tier 1 Capital into a single loan type and that CRE lending continues to be judged as two separate buckets:  Owner Occupied and Non Owner Occupied.  Therefore, we found it very interesting to calculate among public Bank Holding Companies (BHCs) how much excess real estate loans could be made if we simply went up to a combined 200% of Tier 1 Capital for total Owner-Occupied and Non Owner-Occupied.  Guess how many loans could be made today if the 468 public BHCs simply had CRE loans at their maximum level?  The Answer (if you haven't blurted it out already)  = $1.5 Trillion.  See our handy table on Page 4 of our  Weekly Musings for more details.

The Wall Street Journal highlights the large competition for certain commercial loans by banks nationwide and underscores recent analysis from FIG Partners on declines in loan spreads during 1Q-2011.  Leverage loan yields are down significantly and the WSJ report highlights the pressure on banks to deploy cash into new loans (especially larger C&I credits), despite potentially lower spreads that may not compensate for underlying risk. 

See the WSJ article for more details and FIG Partners' Weekly Musings industry report from June 13th reveals our Spread Monitor from 1Q-2011.

Musings_6-13-11_Spread_Monitor_Updated.pdf

Through conversations with several bank CEOs, CFOs, directors, and investors (both institutional and private), we have concluded that one of the more important challenges to announcing an M&A transaction is the fear among Buyers that Goodwill and Intangibles created are large enough to cause a negative reaction to their stock price.  In fact, there is evidence that when banks report large increases in Intangibles within their quarterly EPS releases, stocks prices tend to underperform in the following 7 to 30 days. 

In our Weekly Musings industry note today, we examined public bank and thrift stocks from Mid-2009 through 1Q-2011 and found 48 examples of large quarter-over-quarter increases in combined Goodwill and Other Intangibles (i.e., this often is just core deposit intangibles attributed to deposits acquired either in an FDIC-assisted or regular-way transaction).  Stock trading data was examined from the day before a quarterly earnings release in order to establish the last trade before news occurred and extended to 30 calendar days afterwards.  Matching price data was generated for the BIX-S&P Bank Index, so we could judge whether each stock beat or underperformed the sector index.

Within 2 weeks after reporting quarterly EPS, which included a large goodwill change, 72% of the stocks underperformed the bank stock sector by 2.5% on average.  Even 30 days later, over half of these stocks still underperformed the sector index but by a reduced average of 0.9%.  Perhaps more interesting, is the individual company presentation in our Musings report.  To be sure, not every company experiences the same share price underperformance relative to the BIX-in 4Q-2009 many examples were still positive.  And, we observe in a few cases where the change in goodwill was moderate that the relationship is somewhat weaker.  Examples would be FNFG-First Niagara Financial in 2Q-2010 as well as SCBT-SCBT Financial in 1Q-2010.

Separately, we illustrate the experience of PACW-PacWest Bancorp, which surprised the equity market with its 3Q-2010 earnings release that included a large sequential quarter change in goodwill/intangibles that contributed to nearly a 9% reduction in tangible book value per share.  In our analysis, this is one of the best cases of a near-term negative reaction on a stock despite the company announcing a very accretive EPS transaction from an acquisition (i.e., this case was an FDIC transaction for failed assets that carried zero asset discount but the ultimate cash flow and EPS recognition was strong).  Our research suggest that the equity market took a temporary hiatus on buying PACW shares thanks to the goodwill jump and tangible book per share haircut.  As our charts show, the stock has since rebounded, but we think the pain of the investors' reaction lingers and likely influences management's decision on future deals.

It is important to note that declines in quarter-over-quarter tangible book per share usually correspond to the short-term stock underperformance we discuss above ... but not always.  We observed a few cases where absolute goodwill/intangibles were at least 30% to 40% but the change in shares outstanding and total common equity were great enough to permit tangible book to be flat or even report a gain.  FFBC-First Financial Bancorp (OH) and CSBC-CitizensSouth Banking (NC) are two examples from our analysis who seemingly bucked the trend.  This was largely due to common stock sales that were accretive to book value.

FIG Partners has launched an updated website at www.figpartners.com.

As part of our renovation, we now have our Research and Analysis on the Banking industry available to our clients via the FIG Research Portal which is a password-protected means of reading our daily insight and commentary on individual bank stocks and the industry.

Clients and those interested in joining our client list are encouraged to visit http://www.figpartners.com/request-portal-access.html

Questions on the website? Please contact Brett Villaume at This e-mail address is being protected from spambots. You need JavaScript enabled to view it

On June 7th WTBA announced the termination of its Memorandum of Understanding (MOU) with the Iowa Division of Banking and the FDIC. The lifting of this MOU is significant as it is among the fastest we have seen in today's regulatory environment (i.e., 13 months).  The capital mandates of the MOU required WTBA's bank unit to maintain a minimum Tier 1 Leverage and Risk Based Capital ratio of 8% and 12%, respectively. These ratios exceeded the minimums by 80bps and 330bps, respectively, at the time of issuance.

The short duration of the MOU stems from the significant progress WTBA has made on both the capital and credit front. NPAs declined over 50% or nearly $30mm since year end 2009 to 3% of loans and OREO, well below peer. Net charge offs accounted for ~25% of this reduction. The Classified ratio is down to ~35%, well below levels concerning to regulators. Our sense from speaking to other institutions is that a ratio below 40% (all else equal) is representative of a 2 rated bank. A ratio between 40-70% signals a 3 rating and above 70% a 4 rating. Over this same period, reserve coverage of NPLs soared to 223% from 76% given the reduction in nonaccruals. OREO represents nearly 70% of nonperforming assets.

Capital levels benefitted notably from balance sheet shrinkage. Specifically, assets and deposits declined over $250mm, or 17% and 22%, respectively, in 2010. The majority of this shrinkage (~$175mm plus) came at the hands of strategic, non core deposits that were funded by short term securities. WTBA had a ~15% investment in a bank like company focused on internet deposit gathering and agreed to put these deposits on their books until the portfolio got to large, at which time they would be transferred to another institution. This transfer occurred July 30, 2010. This shrinkage along with reduced credit costs boosted the bank's Tier 1 Leverage and Risk Based ratios to 11.9% and 18.2%, respectively. The Tier 1 Common and Tangible Common Equity ratios at the Parent are 12.3% and 8.95%, respectively. 

WTBA shares have increased ~35% since touching a low last August (~$5.50 per share/~85% of TBV) and currently trade at ~112% of Tangible Book Value. We expect the company to finalize its redemption plans for TARP in the short term and would not be surprised to see a capital raise announced given the recent lift in share price as redemption of the preferred is a priority for the Board of Directors. The company has filed a shelf registration statement. Absent a capital raise, WTBA appears to have plenty of excess capital at the bank level which could be up streamed to repay TARP, depending on regulatory approval. Excess capital above a 9% Tier 1 Leverage ratio is ~$38mm.  Participation in the Small Business Lending Fund remains a possibility as the company completed an application.

The Association of American Railroads released its latest survey of national economic conditions as of May, "Rail Time Indicators", which contains U.S. and Canadian Freight Rail Traffic data, as well as other economic data points that can be used to judge the current health of the economy.  May's intermodal traffic rose 8.5% over May 2010's level. In fact, this was the second highest May ever, second only to May 2006 which only eclipsed last month by approximately one intermodal train a week! The AAR reckons that the reasons behind the strong growth in intermodal transport is due to a blend of things; from strength in international trade, higher gas prices and truck driver shortages. However, carload traffic was not as bright, rising only 0.5% since May 2010, flat over April, though still up 16.4% over May 2009.  Much of the decline and the divergence from intermodal can be traced to falling commodity shipments, which saw only 8 of the 20 categories record gains over May 2010, the lowest number since November 2009. Further, rail freight cars in storage, which measures cars not used in the last 60 days, showed an increase of 0.2% from May to June 2011 to 18.4% of the North American fleet and is consistent with a small decrease in demand.  This is still a long way from the 31.9% recession peak, but it is also a long way from the normal 2-3% estimate when the rail industry was at its “healthiest.” Other economic data include a review of the most recent GDP growth, Industrial Production, Employment, Consumer Confidence, Housing Starts, etc., all contained in this one useful report. 

We must also remind our readers of the statistics for the 10 major ports in the U.S. and how they compare year over year. Container Traffic (how activity is measured and known as “TEUs”), increased in every port but Charleston, which saw a decrease of 2% over last April. Charleston’s loss is most likely Savannah’s gain, as the competing port has been one of the fastest growing ports in the nation, with an increase of 9% over the same period.  However, the largest increase belongs to Portland, with 28% growth since the same time last year. Regional Combinations (CLICK HERE  for chart) show that the West Coast (So Cal) is still showing improved growth, with a YoY change of 6%, though the Southeast is not far behind with 5% and is expected to continue with the expansion of the Panama Canal in 2014.

Daniel Tarullo is a governor on the Federal Reserve Board who has stirred up the pot again on required capital levels for the largest banking companies, in particular the "SIFIs" or systemically important financial institutions.  His speech on Friday last week suggested that perhaps these banks should have 10% to 14% in Tier 1 (much of which should of course be common).  This compares to the previously announced Basel III standards of a 7.0% Tier 1 Common ratio (excluding TARP, all other preferred, and OCI or other comprehensive income which factors unrealized securities gains, after-taxes) and probably 8.0% on full Tier 1 leverage ratio.

Our concern is not with the largest banks but rather what de facto standard is applied to routine regional and community banks that are less than $30 Billion in size and especially sub-$10 Billion.  Our experience has been that when new standards are established for a small focused group of banks that investors tend to apply this higher capital threshold to all institutions.  Whether you call this the "Law of Unintended Consequences" or simply the reality that investors tend to make new rules a "one-size-fits-all" standard, we take Mr. Tarullo's suggestions to heart that perhaps normal community banks need to be considering Tier 1 Common levels well in excess of 7.0% and that 9%+ capital levels (excluding all TARP, SBLF, and OCI) could be reality.

Once again, this leads to our repetitive conclusion that more M&A is necessary and additional capital must be considered for those banks who wish to survive as independent this period in their operating history.  For a list of Tier 1 Common ratios for the public bank holding companies (BHCs), please contact us or your FIG Partners sales representative.