U.S. Mid-Cap Banks
Look for 2Q09 Results to Drive a Rally; Inflow of NPAs
Should Slow, NIM Upside; CMA & CYN Top Picks
U.S. Mid-Cap Banks
Steven Alexopoulos, CFAAC
(1-212) 622-6041
steven.a.alexopoulos@jpmchase.com
Preeti S Dixit
(1-212) 622-9864
preeti.s.dixit@jpmchase.com
J.P. Morgan Securities Inc.
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• We Expect to See a Rally for Most on 2Q Results. Although we expect credit
deterioration to worsen in the second quarter (and 8 of 21 banks covered to report
losses), we look for the rate of growth in NPAs to slow compared with 1Q09, tied to
NPAs reaching a very high 1.81% of assets in 1Q09 on strong 32% sequential
growth posted in 1Q and also helped by banks seeming to have incrementally better
success in selling NPAs during the second quarter. We also look for positive NIM
surprises with several of the more asset sensitive banks benefiting from the lagged
effect of deposit repricing in the second quarter. Finally, we expect fee revenue
growth to be strong in the quarter, supported by mortgage banking, capital markets
and seasonally higher service charge revenues. On the negative side, banks will be
hit with a one-time FDIC assessment fee, reserves will likely be built further as
banks prepare for the peak of the credit cycle, and although deposit growth seemed
to remain healthy in the quarter, loan demand seemed to be very weak again across
categories. Overall, we expect the positives to outweigh the negatives, and we expect
a rally driven primarily by slowing growth of NPAs and upside NIM surprises.
• With TCE Bolstered and Economic Free Fall Abating, We Would Selectively
Add to Regional Bank Sector Exposure. Since we now have 6 Overweights, 10
Neutrals, and 5 Underweights across our coverage, we are feeling marginally more
bullish. With the industry raising a remarkable $60.4 billion in 2009 YTD, equity
recapitalization risk has been greatly reduced. On the credit side, although it feels to
us that we are only entering the 4th inning of the credit cycle, which implies stillsignificant
risk in the bank sector, with signs that the worst of the pressure on the
economy may have abated we believe this sets up the banks to continue working
toward the credit cycle peak and for the market to eventually start pricing in a
recovery, which historically occurs about a year prior to the peak in credit. We
recommend focusing long positions on banks (1) that have leverage to businesses
boosting very low inventory levels in 2H09, such as CYN, CMA and PVTB; (2) that
are using market disruption as an opportunity to take market share, such as FMER,
CFR and PBCT; while (3) we remain cautious on higher-risk banks that have yet to
fully reduce recapitalization risk, such as MI, WTNY, SNV and ZION.
• Trading Ideas Heading into 2Q09: CMA & CYN Top Long Picks; PVTB, CFR
& BXS also Good Longs; Cautious on Long WTNY & SNV and on Short MTB.
At CMA, we look for loan losses to come in at a much lower rate than implied by
the discount valuation. At CYN, while the Street is looking for loss rates to escalate,
we look for the company to beat the quarter by holding NCO/provision rates flattish,
demonstrating that the shoe dropped on credit in CA in 1Q09. At PVTB, we look for
the company to post its second quarter of profitability, beating consensus calling for
a loss. We look for losses to remain flattish at CFR, leading to an upside surprise vs
consensus and for strong mortgage results at BXS to drive an upside surprise vs
consensus. We would be cautious on long positions on WTNY and SNV, as each
was just downgraded to junk status by S&P, and are cautious on shorting MTB,
which feels crowded, and credit pressure on CRE at the bank is likely less in 2Q09
than expected.