M And A Activity May Catalyze Upside in Regional Banking - Tom Mitchell - Miller Tabak And Co., LLC

February 13, 2012

67 WALL STREET, New York - February 13, 2012 - The Wall Street Transcript has just published its Southeast & Midwestern Banks Report offering a timely review of the sector to serious investors and industry executives. This Southeast & Midwestern Banks Report contains expert industry commentary through in-depth interviews with public company CEOs, Equity Analysts and Money Managers. The full issue is available by calling (212) 952-7433 or via The Wall Street Transcript Online.

Topics covered: Consolidation in Regional Banking - Growth in U.S. Midwest - Regulatory Outlook Gains Clarity

Companies include: BBCN Bancorp (BBCN); Bank of America (BAC); Cathay (CATY) and many more.

In the following brief excerpt from the Southeast & Midwestern Banks Report, interviewees discuss the outlook for the sector and for investors.

Tom Mitchell, Senior Analyst at Miller Tabak + Co., LLC, began in the industry as a Research Analyst with NYSE firm Mabon, Nugent & Co. in 1973, for which he covered consumer and commercial finance companies, credit card companies, and large multi-industry companies encompassing major insurance and financial subsidiaries. In 1990, Mr. Mitchell branched out to set up an independent money management shop, Thomas Mitchell Management Co., Inc., and has managed individual and institutional accounts for the past 16 years. He rejoined the sell side at Miller Tabak in July 2006, with primary coverage responsibility for banks, REITs and other financial stocks.

TWST: Is this a regional issue or is it a specific bank issue in regards to the banks you mentioned that still haven't cleaned up their act?

Mr. Mitchell: It's isolated cases. When I say not cleaned up their act, they probably are a lot cleaner than they were a year ago anyway. We have something we call the deadweight ratio, which is just a quick ratio of nonperforming assets to earning assets. That ratio for our coverage universe has gone down considerably in the last year, but there's still some banks that are out there that are between 2.5% and 3%. That ratio is - the assets that aren't earning anything are essentially still 2.5% to 3% compared to the assets that are earning. So that's a lot lower than it was at the peak of the problems, but it's a lot more than it should be. The better banks are under 1.5%.

TWST: Is there work to be done?

Mr. Mitchell: So I'd say that, broadly speaking, the whole industry still has work to do. The other part of the problem about that ratio and the reason we like it is because after a recession, generally, the industry has shown the ability to grow new earning assets, increase their loan portfolios, and to a certain extent, diminish the impact of legacy problem loans by extending new credit to good, new creditworthy borrowers.

For whatever reason, that has not happened in the aftermath of the Great Recession. Instead, the total amount of bank loans outstanding is roughly flat now for the last three years. So the ability to render the problem loans proportionately less of your total business hasn't been there. Another way to look at it is that not only are problem loans sticky, but they remain a large part of the total business compared to what they have been in the past, coming out of recession periods.

TWST: Is that because the demand for loans isn't there or the banks being tougher in terms of granting them?

Mr. Mitchell: I think that, broadly speaking, banks have tightened their lending standards so much that they've really altered the way that they do business with customers. Whether it's reducing credit lines, whether it's discouraging usage of credit lines, there is a certain lack of demand on the commercial side, but it's very plain vanilla, very high-quality credits. It's not a lack of Main Street demand. I like to say that everybody wants to lend a lot of money to Microsoft (MSFT) because Microsoft doesn't need it. To a certain extent, that encapsulates the general attitude I think that I hear from bankers.

On the third-quarter conference calls, all over the country, bankers were saying, "Yes, we want to do more C&I lending, and we really want to do it with the good credits." By the way, everybody else wants those credits too, so the spreads are coming down. But with maybe a couple of exceptions, we didn't hear anybody even mention anything else that they were interested in doing. I think it's an interesting window on the mentality of banks regarding credit risk that the staff of the Federal Reserve in their white paper, I think it was a little over a week ago, came out and said that terms, conditions and standards for lending on residential mortgages have now overshot on tightening how loose they got between the early 2000s and 2007.

TWST: So they've come full circle?

Mr. Mitchell: They've done more. It's like they've gone more than full circle. So lending standards in that area are tighter than they've been in a long, long time. There's a lot of anecdotal evidence that your real, best customers are not using as much of their credit lines as banks would like to see them do. We hear from a lot of banks that they have more customers but no more loans outstanding. Almost everybody will point to the fact that there are parts of their business where they're growing. But in recession after recession, 1974-1975, 1982-1983, 1991-1992, you go back to those recessionary periods, and banks were still running off bad old business, but they were increasing their total outstandings after those recessions. That has not happened in the period so far, in the period after this last recession.

TWST: What's it going to take to get that going?

Mr. Mitchell: My rule of thumb is that if we can just find a way - and it may take some policy action by the federal government or it may not - I think that if we found a way to get a floor under housing so that people could be confident of two things. One is that the value of what represents for most Americans their largest investment is not going to continue to decline indefinitely, one. And then two, that it is easier to refinance mortgages. Right now, there's an enormous amount of consumer spending stimulus that's locked up in mortgages that can't be refinanced at current rates.

It's wonderful to have rates under 4.25%, but there are plenty of people with equity in their homes, who are still employed, who have 6% or higher mortgages out there, but who can't refinance for one reason or another. So I think that presents a problem that actually is sort of symptomatic for the whole industry, although as a specific problem, it's not that big a part of banks' portfolios, but it goes to the ability of people to manage their finances in an optimizing way.

We're talking about - I'm not telling about people who want to use their homes as ATMs - I'm talking about refinancing outstanding balances dollar for dollar. I believe there are many people who want to refinance the exact same balance and reduce their monthly payments by 15% or 20%, and they can't do it even though everything you look at says, "Oh, if you look at the table it says, yes you should be able to do that."

TWST: In this kind of changed world, where are the banks going to find growth if they're not going to lend?

Mr. Mitchell: One possibility is that one or two of them will start, and the others will follow. I can't suggest that that's not a possibility because it seems like bankers - it may be true in every industry, but bankers more than participants in other industries - seem to be most comfortable when they're doing what other banks are doing, and not doing anything very different. I like to say that bankers are herd animals, and to some extent, I think that's true.

But I think that the other side of it is that there are opportunities, and I think there will be more opportunities to generate earnings and franchise value growth through acquisitions. I would expect it would be, at some point, maybe as early as this spring, when the industry will enter a new round of very active consolidation. One of the things that everybody has to do right now is tighten their belt. There's nothing like an intelligently structured consolidation to reduce the expense ratios of the combined entities. At the margin, that reduces the expense ratio of the whole industry. I think there will be a lot of more of that kind of activity.

TWST: What names are at the top of your list?

Mr. Mitchell: We particularly - we think that the whole Midwestern area is interesting, partly because, although it has changed, the automobile industry has come back, and is now improving. It's more a directional factor than an absolute factor, but we think that's good for the whole area. We think that Fifth Third (FITB), Huntington (HBAN), FirstMerit (FMER) - all of those happen to be Ohio-based banks - are very interesting at this time, each for somewhat different reasons. But we think that the Midwest generally is more interesting now than it was a year ago, and a whole lot more interesting than it was in 2007.

TWST: Is that a motivating factor that's going to get investors to step up here and play with these names?

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