Regional Banking is Alive and Well

Consolidation is diminishing the ranks of banks across the country, but there is still plenty of room for regional banks to survive and thrive, according to Joseph Stieven, director of financial institutions research at Stifel, Nicolaus & Co., a brokerage and investment banking firm based in St. Louis. Stieven, who mainly covers regional banks in the $20 billion and below asset class, addressed the ability of regional banks to compete against larger superregional and national banksu00e2u20ac”in part by sticking to their niche.

Bank Director: How do you think regional banks can compete with larger regional or even superregional banks?

Joseph Stieven: The truth of the matter is that a lot of our companies are taking dramatic market share from these superregionals and mega-regionals, and from the national firms. While the Bank of Americas might acquire market share, they end up losing a good percentage of it once they try to consolidate operations. And that business ends up, typically, flowing to local and regional banks.

Is that, in part, because they are focusing more sharply on niches?

No. I think it is due, in part, because they employ a slash-and-burn mentality that ends up causing customer dislocation many times.

Who is using this slash-and-burn mentality?

Most major acquirers have used it to some extent. They try to rationalize these deals by expense cuts, and expense cuts always cause people to be moved out the door. Banking is still a relationship business, and when people walk out the door, when employees leave, a lot of times those relationships leave.

Can you name some banks that this has helped?

There is a good example here in St. Louis. The two largest banks in St. Louis now are Bank of America and U.S. Bancorp. Both did not operate here five years ago. Basically, NationsBank acquired Boatman`s [Bancshares] then merged with BankAmerica to gain their presence. Then Mercantile [Bank] was acquired by Firstar, which then merged with U.S. Bancorp. If you look at the market share of these companies from the time that the acquisition was announced to today`s, it is down materially. Some people believe that that is business they wanted run offu00e2u20ac”and I`m sure some of it isu00e2u20ac”but I am sure a bigger percentage is not.

They are still breaking out enough of the market share numbers?

You can get some of the data, some of the call reports, from the regulators, but it`s not perfect. You can`t get everything you want. We have a bank here in St. Louis, the holding company is Mississippi Valley Bancshares, its subsidiary is the Southwest Bank of St. Louis. That`s the bank that is always first to drop the prime rate in the United States. The company, since 1995, has reported some of the strongest earnings per share growth rates in the industry. Their loan growth has been averaging close to 20% a year. And I guarantee you that St. Louis isn`t growing 20% a year. So where are they getting the business from? They are getting it from people leaving the mega-bank because they get fed up with having their loan officer changed every other year and things like that.

So the business gets picked up at the regional level?

Sure. We look for banks that can grow their business internally. The one thing I would like to remind directors of is this: Acquired market share growth does not translate into shareholder value; while a very high percentage of internal market-share growth translates into true shareholder value.

Why is that?

If you acquire somebody, you have to pay for all your market share. But if you grow internally, have you paid three times book or four times book for it? Of course not. The thing about acquisition market-share growth is that it`s easy. It`s fun. It`s sexy. You get big. And CEOs can justify higher pay when they get bigger. But shareholders only care about growth that enhances earnings per share. There have been studies that have found that the majority of mergers, not just bank mergers, are not beneficial in the long run. But every time there is an acquisition, the company gets bigger and the CEO says, “I deserve more pay because I`ve got a bigger company.”

Looking also at the regional banks, do they have a problem battling these large institutions that offer just about anything you can think of? Citigroup, for example, offers insurance and credit cards, loans, almost everything. Is that a problem for regional banks?

No. I don`t think so. They are going after different markets. Citi is interested in making loans to people at $50 million to $100 million a chunk. A lot of these regional banks are interested in making $1 million loans.

Is it best, if you are a regional, to look at a couple of niches, at what you do best?

There is no doubt. If you look at the highest performing regional banks, you will typically find they have certain niches that they are very good at.

Can you name a few and their niches?

Mississippi Valley Bancshares here in St. Louis is simply a commercial middle-market lender. They don`t do anything on the retail side except take deposits. They might make a mortgage loan if they get lost. Sterling Bancshares in Houston is a very strong, small business lender. Their average loan is well under a million dollars. 1st Source [Bank] in South Bend [Indiana] has several niche businesses that they actually take on a nationwide basis. One is used private aircraft lending. They also do financing of fleets for rental agencies and heavy equipment financing. Very specialized.

How did they get into that business?

The family, and the largest shareholder, was from The Associates in Dallas, which is an asset-based lender.

Are these banks also some of the ones that you are bullish on?

We love Fifth Third as a company. They are a fabulous company. But when the stock is valued at 30 times earnings … you know, I love to drive a Rolls-Royce … but you have to look at valuations too. If a stock is already highly valued, it might not necessarily be one we`re pushing right now because you`ve got to look at the valuations.

It`s a difficult market, but what are some of the banks you are bullish on right now?

Actually, the bank stocks have been acting pretty well. We actually think the smaller regionals look exceptionally attractive right now, and here are a couple reasons. Number one: typically, the smaller regionals are growing much faster internally. Number two: typically, at the smaller regionals, management owns a lot more stock, therefore, they think like stockholders. They are not looking to get a 70 million dollar gift after they have had bad earnings, as some big banks have done. We really think some of the mega-regionals are playing from a defensive position. As I`ve already said, stockholders get rewarded for internal growth, not acquired growth. Suppose I said to you, “I`m going to compensate you on internal growth, and I`m going to give you market share. You choose what market you want to be in.” Let`s say you choose New York, and you are being compensated on market share growth, but it`s got to be internal growth. Do you want to start with 35% market share or 3% market share? You`re going to choose 3% because that`s where you are going to grow much faster. From 35%, it`s darn hard to grow. So we think the mega-regionals are working from a very defensive position.

In other words, it is difficult to grow from a cost-cutting basis?

We are not a believer in banking as a cost-cutting business. It is a revenue growth business. Revenue growth has got to be the key driver, and expense cuts are not the way to go. You have to live tight expense controls every day. But you have to grow your revenues. What are some of the other regionals you are bullish on? We have got a lot of super, little niche banks out there whose returns and asset quality have been exceptionally strong and stable, even as this market has been very volatile. Two that have done an excellent job in niches are Republic Bank (RBNC) in [Lansing,] Michigan and Irwin Financial (IRWN) in Indiana.

What are some of the central issues that bank directors should be aware of at this point in time? What should they have on their radar screen?

I think the biggest key is for directors to understand how shareholder value is derived. Value is derived by stockholders. As a board member you have to live in a per share world. Stockholders don`t lay claim to net income; they lay claim to their proportionate interest. If a company grows its net income 50%, but if shares outstanding grow 50%, you are no better off. I would remind board members that they have to live in a per share world.