Regional Banks
INITIATION
Not All Banks Are Created Equal—Initiating
Coverage of the US Regional Banks
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We initiate coverage of the Regional Banking Industry, with an initial
strategic focus on the (1) Southeast, (2) Midwest, and (3) Mid-Atlantic
regions of the United States. Our coverage of 13 banks include:
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Outperform: BOH, CMA, FHN
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Neutral: FULT, KEY, MTB, RF, STI, TCB, VLY
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Underperform: BBT, SNV, ZION
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Regional bank stock prices should correct from here, with only a few
names making new lows. Additionally, elevated stock price volatility has us
focused on relative investment strategies. The three drivers of our
expectation for a near-term correction include (1) an acceleration in credit
costs in 2Q09, (2) a dilution from current capital raises and expectation of
future raises, and (3) the increased risk of government ownership of certain
banks following weaker core earning results in 2Q and 3Q. Even though we
believe some banks may build capital levels organically over the next year
(BOH, TCB, VLY), we also believe consensus estimates are too high,
especially for 2010, stemming from lower credit cost expectations.
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Regional Bank stocks typically outperform before unemployment
turns. Bank stock prices have historically rebounded before both
delinquencies (two-quarter lead) and unemployment (six-quarter lead). With
our base-case assumption for peak unemployment in 2H10, we believe the
2Q09 rally was partially warranted based on historical stock price
performance. However, that real estate price declines led the contraction in
economic growth (which has historically lagged) leads us to believe that the
current credit deterioration cycle will be extended, implying higher credit
costs and capital declines.
Continued…
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Credit: Residential construction will likely continue to drive losses in 2Q09, while we
expect commercial mortgage and commercial & industrial lending to the retail industry
to face higher losses over the next few quarters. Our expectations are supported by
conversations with chief credit officers over the last month, and could have a greater
impact on MTB and ZION, owing to their higher concentrations in retail commercial
loans. Within the commercial book, we also expect losses to rise in the shared national
credit (SNC) lines, while some of the larger SNC underwriters like CMA and KEY have
disagreed with our conclusions. Alternatively, one trend that could offset the natural
deterioration in credit quality is the need for banks to produce higher pre-provision
earnings and capital builds following the requirements of the Supervisory Capital
Assessment Program. This could shift credit costs into 2011 and 2012, in the same
period that regulators might look to increase industry reserve levels.
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Core Earnings Power: Net interest margins may positively surprise investors in 2009
as banks look to reduce their excess liquidity, deposits re-price lower, and as common
equity raises do not increase the cost of funds (assuming cash can be deployed into
assets yielding +3%). Additionally, asset yields initially declined faster than deposit
costs; however, we look for this spread to increase in 2009 as deposits play catch-up
and irrational competition moderates.
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Our Issues with the Supervisory Capital Assessment Program: We believe (1) preprovision
earnings and (2) commercial real estate loss assumptions in the
government’s stress test are too low; however, the bigger inconsistency is the lack of
credit given to banks that have proactively reduced problem credits. While FHN did not
participate in the stress test, we believe the company is the most conservative in loss
recognition, and applying loss assumptions to December 31 loan values may not be an
effective exercise.
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What would make us more positive on the industry: Lower valuations are always
helpful, while we would like to see a continuation in the deceleration for leading
economic indicators and most real estate indexes (prices, sales, inventory).
Additionally, a moderation in early-stage delinquencies, especially among early-cycle
loan classes like construction and residential mortgage, could help improve our
industry outlook.