In Q4 Of 2011, Banks That Held Large Position In Agency MBS Had To Accelerate Premium Amortization Faster Than Anticipated, Says Analyst At Sterne Agee; Find Out What This Means For Their Net Interest Margin In This Exclusive Interview

Wall Street Transcript

67 WALL STREET, New York - March 12, 2012 - The Wall Street Transcript has just published its Pacific and Southwest Banks Report offering a timely review of the sector to serious investors and industry executives. This Pacific and Southwest 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: Interest Rates and Loan-Growth Strategies - West Coast Banking Consolidation - Regulatory Compliance Costs - Pockets of Growth in Western Banking

Companies include: BBCN Bancorp (BBCN); Central Pacific Financial (CPF); First Republic (FRC) and many more.

In the following brief excerpt from the Pacific and Southwest Banks Report , interviewees discuss the outlook for the sector and for investors.

BRETT RABATIN comes to Sterne Agee & Leach, Inc., from FTNN Midwest Securities Corp., where he was a sell-side Equity Research Analyst for eight years. He covered small- and mid-cap banks located predominately in the West and Texas. He was the number one stock picker in The Wall Street Journal's Best on The Street survey for Banks and Thrifts in 2002, was recognized as number two overall in 2004 in Forbes and StarMine, and was the number two overall earnings estimator in 2004 within the bank/thrift sector. Mr. Rabatin has a BBA in finance from the University of Memphis. He is a Member of the CFA Institute and CFA Society of Nashville.

TWST: What are the investment themes in that space right now?

Mr. Rabatin: For 2012, it's obviously a year of a difficult revenue growth, given the low interest rate environment. So what investors are focused on are the institutions that can clearly grow via strong good loan growth, and then also banks that still have leverage to improving profitability from credit-quality trends improving. Those would be the two main things. Generally speaking, they are also looking at banks trying to keep their profitability level at solid levels until things change from an interest-rate perspective.

TWST: Are banks doing anything to try to make up for the low interest rates and the loss of revenue?

Mr. Rabatin: The Southwest and Texas is an economy that's growing faster than most of the economies in the country, so it's an area where there is some pretty good C&I loan growth in particular, and so the institutions are clearly earning out more success than the average area of the country in growing their loan portfolio, which is maybe a critical thing in 2012 for offsetting obvious margin pressures.

TWST: What about specific names? Who specifically do you like in your space right now and what sets them apart from others?

Mr. Rabatin: One of my favorite names has been Silicon Valley Bank (SIVB). They are a bank that's very unique. They are focused on the technology space, and in general their client set is the strongest part of the economy. So they are really growing rapidly, they are very core funded, and so it would be much better for them if interest rates are higher, but they are growing so rapidly that, in general, their prospects for EPS growth in the next two years are very strong, and that's a name that I think is going to trade for much higher valuation than your average bank in this kind of environment.

TWST: Have the mortgage portfolios changed dramatically over the last couple of years for the banks?

Mr. Rabatin: There have been a lot of changes in both the loan portfolio and the securities portfolio. What we saw in 3Q and 4Q was banks looking for loan growth. The mortgage platform really started to either bring some of those mortgages on to their balance sheet, or they really started to try and grow those mortgage portfolios as a way to bolster their loan-growth trends. East West (EWBC) would be an example there, they've really had strong loan growth in their mortgage portfolio over the past two quarters.The other thing that's been happening is the prepay speeds have increased and were very high in the fourth quarter. So generally speaking, 10- and 15-year agency pass-through securities, which account for a large proportion of banks' securities portfolios, were bought at a premium to par, and what's happened is that faster agency MBS prepay speeds have resulted in some institutions having to amortize that premium faster than they originally anticipated. So in the fourth quarter especially, we saw a lot of banks that hold large positions in agency MBS in their portfolios having to accelerate premium amortization in those particular securities books which put pressure on those banks' net interest margin.

TWST: Is this a good place for investors to be looking at?

Mr. Rabatin: Generally speaking, banks were very low valued in terms of their typical valuation metrics heading into 2012, and it was a sector that wasn't getting much attention; however, the sector has risen noticeably, especially through January. What hasn't happened is the estimates have not moved up, and in fact, estimates for 2012 and 2013 in general have moved down slightly, so the valuations have improved considerably. And what the market is telling us is that we are going to see the economy improve and that estimate revisions to the upside are going to be the result as the economy does continue to strengthen. The question from here is, does the economy really improve or is this another hearsay like the spring of 2010 when we thought the economy was getting better and it stalled? From our perspective, I generally think that the sector doesn't have a lot of upside in the near term from a valuation-expansion perspective, but if the economy does improve, then these things do have some additional upside.

TWST: What are some things you will be watching over the next year or so as you make decisions about the sector?

Mr. Rabatin: There are a lot of issues in the bank sector. We talked about regulatory issues; we will always keep a close eye on that. It is very much a macro-driven topic right now. What we are looking for is to see if loan growth does accelerate for the bank group, one of the things that I worry about is that banks in their need for loan growth are being more aggressive in their pricing. So from my perspective, one of the things that would tell me that loan growth really is going to accelerate would be banks are not having to compete as aggressively on rate and terms, and I'm not really hearing that yet. I'm still hearing that it's very competitive particularly on C&I loans, and so you worry that banks are being too aggressive for the loan growth. So maybe there is a recent economic upswing and data is not going to fall. We are very keen on loan growth, very keen on regulatory issues, and then very keen on what happens with credit quality from here.

The Wall Street Transcript is a unique service for investors and industry researchers - providing fresh commentary and insight through verbatim interviews with CEOs and research analysts. This Pacific and Southwest Banks Report is available by calling (212) 952-7433 or via The Wall Street Transcript Online.

The Wall Street Transcript does not endorse the views of any interviewees nor does it make stock recommendations.

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