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Citigroup: Cleaned Up but Falling Behind Mara Der Hovanesian, BusinessWeek 10-05 Citigroup investors aren't the only ones who are impatient with a stock that's going nowhere fast and a new investment strategy that has yet to pay off. "Get in line," quipped CEO Charles "Chuck" Prince, in an interview with BusinessWeek on Oct. 4. "It's not as good as I want it to be either." Prince has faced one crisis after another during his three-year reign, from run-ins with regulators on three continents to shareholder lawsuits over Enron and WorldCom. And the Federal Reserve tied his hands, forbidding all acquisitions until he cleaned house. That's all behind him now. But now Prince is facing his biggest crisis ever — one of confidence in his leadership and his ability to steer a trillion-dollar empire toward desperately needed new growth. Profits have fallen short of analysts' estimates in four out of the last five quarters, and the stock has been stagnant for about three years. Citi's U.S. consumer business, which has suffered after years of neglect, is behind much of the bank's woes. As some shareholders grumble that it may be time for him to go, the CEO acknowledges the discontent: "The concerns are perfectly legitimate," says Prince. "People are saying 'Do something!' They want to know how long is this guy going to take?" An ethics cop was exactly what Citigroup needed when Prince took over in 2003. Citigroup founder Sanford "Sandy" Weill's voracious drive to create a financial powerhouse through rapid-fire acquisitions was spectacularly successful. But the effort to build revenues at all costs created a cowboy culture lacking in controls. Prince, a corporate lawyer for most of his career, starting at U.S. Steel in the 1970s, clamped down hard on rogue behavior and worked closely with regulators to get Citi back in their good graces. With the ethics issues resolved, some people are wondering whether Prince's focus on rules and regulations is stifling the vitality of the company. "There are too many layers of bureaucracy, and he has a problem with generating momentum," says one former senior executive. As a global financial services company, Citicorp is unrivaled in reach, yet it has dropped to No. 3 from No. 1 in the credit-card business, and smaller retail banks are eating its lunch. In many cases, Citigroup lags behind in both revenue and profit percentage growth when measured against either retail bank rivals, such as Bank of America and JPMorgan Chase, or investment banks like Morgan Stanley or Goldman Sachs. Some crave the return of a rainmaker as leader. "Maybe it's time for a management change to get this horse running again," says Carl Salvato, portfolio manager of money management firm Great Companies. Investors such as Salvato will be happy to hear that Prince is dropping hints that he's revving up the deal engine again. He laments that for the past three years he had to stay out of the market and focus exclusively on making existing operations more profitable. "We're getting ourselves back on the playing field," he said, noting that most of the acquisitions will be in foreign markets. There's already chatter in London that he's eyeing Lloyds Bank or BNP Paribas. Prince insists he's not interested in a big U.S. retail bank or mortgage company unless it's at a fire-sale price. But deals alone aren't enough, and Prince concedes that. By all accounts, Citigroup is still a profit powerhouse. Earnings surged to $24.6 billion last year, a 37.7% jump since December, 2003, the year he took over. But almost half of the company's businesses are under pressure to find new sources of growth, and recent investments have yet to pay off. Moreover, despite $16.8 billion in stock buybacks and $14 billion in dividend payouts in the last 18 months, the stock has hovered at around $50 a share. Since Prince's appointment in October, 2003, shares are up just 8.6%, vs. 35% for the S&P 500 Financials Index. One of the biggest complaints by investors and analysts alike is that Citi's expenses are growing faster than its revenues. In Q2, revenues were up 9%, but expenses rose 15%. And only 2% of the cost increase was due to new investments, such as building up retail branches. Because the gap between expenses and revenues has been widening, shareholders. Citi's Prince says he got the message. In an internal memo sent to employees on July 22, he announced that he has asked business heads to evaluate every line item and squeeze out "business-as-usual" costs. But he's vehement about not cutting investments to shortchange the future. Revamping the consumer business is absorbing most of Prince's focus. Citi lags behind competitors in deposits by a mile (3% of the U.S. market, vs. 10% for BofA and 7% for JPMorgan). "If we don't grow consumer, the whole place has modest growth," he says. Prince is planning big branch expansions in locations where many customers of the company's Smith Barney brokerage business live, hoping to sell them bank products. In Boston, for instance, Citi is planning to build 30 branches next year as a service to 30,000 Smith Barney clients. If it's successful, Citi will roll out new branches in Philadelphia and a half-dozen other cities. If not, it's back to the drawing board, says Prince. One well-regarded financial analyst says Citi's retail expansion is misguided. Building the consumer bank from scratch is "controversial, late in the cycle, and in markets that are over-banked," says Merrill Lynch senior bank analyst Guy Moszkowski. "It's not convincing." For now, the board is backing Prince. Nevertheless, Wall Street analysts are frustrated by the lack of results. "They have made promises to investors . . that look very challenging for them to deliver," says bank analyst Joe Dickerson of Atlantic Equities, who recently cut his 06 earnings estimate. Michael Mayo of Prudential Equity Group downgraded the stock in July to neutral, partly because he thinks "Citigroup seems to lack a catalyst [for growth]." Prince's strongest critics think the best way to spur growth is to break up the financial behemoth. Prince is dead set against it, but money manager William Smith of SAM Advisors in New York proposes splitting the bank into three parts: retail, investment banking, and global operations. He figures a breakup could push the stock to $66 immediately, from $51 today, and to $90 in two years. All eyes will be on Citi's Q3 numbers to see if there has been any progress since the end of June. Prince also plans to address investors in a special conference call on Oct. 27 to explain the bank's investment strategy. In defense of his record, Prince says investments he made three years ago in Citi's capital markets business are now paying off nicely. In Q2-06, the investment banking arm earned $1.7 billion, up from $1.37 billion in Q2-05. The investment bank marked its 19th consecutive quarter as the No. 1 underwriter of combined debt and equity offerings. Prince's biggest challenge is to project himself as a leader with a vision. Meanwhile, talented people who are frustrated by the pace of growth are heading for the exits. A number of high-level executives, from advertising to investment banking, have left, taking underlings with them. Prince responds: "When you are making a lot of changes, you are by definition making someone unhappy." The bank says it has recruited many talented people to fill holes. Of course, not everyone is pessimistic about Citigroup's prospects under Prince. Steve Neimeth, a senior portfolio manager at AIG SunAmerica Asset Management, says the stock is a good buy. It has a 4% dividend yield and trades at roughly 11 times 2007 expected earnings, with an annual EPS growth rate of 8% to 10%. With help from a surge in the Dow 30 stocks, Citi hit a 52-week high of 51.03 on Oct. 4th. Neimeth likens the recent underperformance of Citi's shares to that of Merrill Lynch or Morgan Stanley when those firms were undergoing management upheavals: "You need to buy them when they are out of favor." Finding the Most-Attractive U.S. Banking Markets Jaime Black, CFA, CPA, MorningStar 10-04 The U.S. is awash in banks. At the end of 2005, the FDIC insured 8,832 banking institutions. With so many banks to choose from, we searched for a method to narrow the field to a subset with attractive home markets. While we would never recommend buying a stock simply because of its location, comparing banks by state makes a lot of sense, primarily because interstate banking is actually relatively new. Where are the attractive opportunities and what states should banks avoid? To find out, we compiled some statistics using information available from the FDIC. We are using 2005 numbers because 2006 data are not yet available. Where the Money Is Using the FDIC and census data, we have estimated the deposits per person for the 50 states plus DC. The 10 states with the highest deposits per person: South Dakota $54,550. District of Columbia $41,060. New York $36,114. Delaware $29,479. Utah $27,334. Massachusetts $26,416. New Jersey $25,448. Illinois $23,910. New Hampshire $22,554. Connecticut $21,961. Most of the states with high deposits come as no surprise. The East Coast states and the District of Columbia are also in the top 10 for wealth and per capita income. These are states with high costs of living and high wages, as well as a lot of competition. Citigroup, Bank of America, and Wachovia compete fiercely on the East Coast. These big guns also face competition from smaller niche players, like Hudson City [HCBK], for deposits and loans. Hudson City may have just a tiny slice of the pie, but its focus on high-value mortgages corresponds well with its affluent market. We we have no idea why South Dakota came out on top. But new bank entrants would be intimidated by Wells Fargo, which dominates South Dakota with more than 60% of the deposit market share. Utah has a growing economy and recently has seen its population growth rate increase. Utah's population is also the youngest in the United States, with a median age of only 27 years, giving banks years to grow along with their customers. Employment is growing at an annual rate of nearly 5%, almost 3 times the national average. These factors make it relatively attractive to new entrants and lucrative for the established banks. Zions has the largest market share of any branching bank, with Wells Fargo close on its tail. Where the Money Is Not If we want to know where the opportunities are, we also want to know where to avoid. The bottom 10 states in terms of deposits per person fit our expectations. Lowest Deposit Amount Per Person Alaska $9,732 New Mexico $10,340 Idaho $10,749 Oregon $11,758 Mississippi $12,020 Arizona $12,407 Louisiana $12,586 South Carolina $12,701 West Virginia $12,832 Minnesota $13,467 We note two trends. The states with the weakest economies, low amounts of skilled labor, and lowest per capita incomes appear on this list. The middle south states and northwestern states have small populations, with economies that were formerly dominated by industries like textiles (Mississippi and Louisiana) or agriculture (Idaho and Oregon). New Mexico and Arizona have rapidly growing economies. The populations of both states are also expanding rapidly. These two functions create opportunities for banks, but this opportunity is tempered by the fact that job growth in New Mexico and Arizona is coming mostly from low-paid, unskilled jobs. The states also tend to have large immigrant populations that are not major users of banking products, which could help explain the lower deposit per person ratio and their high people/branch ratio (which is featured a little further down). JP Morgan and Bank of America are the major banks in Arizona, combining to hold 45% of the deposit market, while Wells Fargo is the top in New Mexico, with 21.5% of its deposit market, followed by Bank of America's 16%. These large banks are best-positioned to take advantage of the underbanked and growing populations of these two states. Where the Customers Are We looked for the numbers on which states have the least amount of banking coverage. We wanted to find the areas that had less competition for individual customers. We were shocked to see that the best bang for the buck appears to be in some fast-growing, well-populated states. Most People per Branch California 5,433 Arizona 5,147 Alaska 4,934 Nevada 4,685 Rhode Island 4,527 Hawaii 4,479 Utah 4,070 New York 3,896 Texas 3,844 New Mexico 3,819 California banks have a lot less competition per customer than any other state. Bank of America holds a 20% market share in California, followed by Washington Mutual with 16%, and Wells Fargo with 12%. Even though almost 50% of the market is held by the top three banks, there is a lot of opportunity for niche players. California's population has increased by 6% over the past five years. Banks like WestAmerica [WABC] have carved out niches serving small businesses in the state, and Silicon Valley Bankshares [SIVB] caters to startups in its tech haven. There are some worries, including a cooling housing market and the fact that inventive financing (think option adjustable-rate mortgages) are extremely popular in this state of sky-high real estate prices. We would carefully check the credit history and exposure of any California bank before buying its stock. The big three banks have been around for several housing cycles, and they guard their balance sheets with vigilance. Texas has one branch for every 3,844 people. Every super-regional bank we know of either has or is building a presence in the state. Foreign bank BBBV is set to close on two Texas acquisitions in Q4. Texas' above-average population growth, the strong demand for oil, and an underserved population have made the state one of the two major destinations for banks looking for growth (the other being Florida). J.P. Morgan, Bank of America, and Wells have the top presence in the state, combining to be just under 50% of deposits. Cullen/Frost [CFR] is the only large Texas-based bank left in the market. Acquisition prices are big in Texas, with a median price of 3.9 times book over the past two years. There are still several smaller Texas banks left in the market that could get rolled up. Zions just completed its integration of Amegy, and the bank has already stated that it is open to new deals in the market. Where the Competition Is Now that we know where the opportunities appear to be, we also want to know where the crowded markets are. Fierce competition can result in banks paying up for deposits and aggressively pricing loans, which would reduce profitability in the long run. Least People per Branch North Dakota 1,505 South Dakota 1,681 Nebraska 1,708 Kansas 1,828 Iowa 1,885 Arkansas 2,027 Vermont 2,286 Kentucky 2,379 Wyoming 2,415 Wisconsin 2,417. The Midwest appears to be crowded. By combining tough competition with a slightly slower-growing economy and lower-than-average population growth, the Midwest appears to be the least-attractive region in the United States. Many Midwest states are dominated by rural areas. People are spread out, so a higher number of branches is needed to serve the same number of people than in an urban area. This will typically result in higher costs and a higher efficiency ratio. These markets also tend to favor smaller banks, and the community bank is a common feature in these states. Iowa is one of the most fragmented states in the U.S., in terms of banking, and the 432 banks operating in the state have only four branches on average. No bank in the state controls more than 10% of the market. Wells Fargo and US Bancorp are the largest in the state, they combine to hold only 15% of the market. With slow economic growth and a stagnant population, Iowa does not appear to be the most attractive market for banks. The story for the rest of the list is surprisingly similar: fragmented markets with unattractive economic outlooks and rural populations A Note on Florida Florida is one of the most popular places to be right now. As a result, we expected to see the state in the top 10 of our results. The common statistic that is cited is that 1,000 people move to Florida every day. The state has a bustling economy that comes from tourism, other service industries and manufacturing. We hear about new deposits flooding in from retirees moving south, and with all of these things going for it, it sounded like the land of opportunity. So why did Florida not show up in any of our lists? Well, the answer shows us that our calculations are just clues for where to find opportunities, not definitive proof. Florida holds about $19,600 in deposits per person, which is only slightly about the average in the U.S. The state has one branch per 3,440 people, again average. But we are looking at a static numbers. Florida will need 106 new branches per year and $7.1 billion in deposits annually just to maintain its current standing. With that amount of money coming in, the opportunity for banks is real. It's the same reason we believe Arizona. Arizona's population is expected to grow by 28% over the next 10 years. So which banks will benefit from Florida's growth? The top 10 banks in Florida control 84% of the market. It is a concentrated market full of large banks, with the average bank having 19 branches. Bank of America controls 20% of Florida's deposit market, and Wachovia trails slightly with 18% of the market. These companies have been gaining, not losing, market share and are in a position to greatly benefit from all the growth expected in Florida. Note: Wachovia and World Savings [a subsidiary of Golden West] would have $72.4 billion in Florida deposits and a 19.9% market share, compared with 19% for Bank of America [$69.2 billion in deposits].SunTrust Bank was No. 3 in Florida on the FDIC market share list, with 528 offices, $35.4 billion in deposits and 9.7% market share as of June 30. Washington Mutual was No. 4 with 248 offices, $12.2 billion in deposits and a 3.37% market share. AmSouth Bank was No. 5 with 246 offices, $10.1 billion in deposits and 2.8% market share. However, AmSouth is merging with Regions Financial later this year, giving the Birmingham.-based banks a combined 399 offices, $18.4 billion in deposits, and 5.1% market share. Throughout Florida, there were 5,310 banking offices and $363.4 billion in deposits on June 30, growing from 5,081 banking offices and $342.8 billion in deposits a year earlier. (Tampa Bay Business Journal 10-13) PNC Boosts Net Income Forecast Nick Godt, MarketWatch 9-08 The PNC Financial Services Group said Friday it expects to take a $200 million charge to adjust its portfolio in light of the Federal Reserve's decision to leave interest rates unchanged in August. But the actions, it said, should improve its interest income relative to current estimates by $50 million annually. The charge would stem from the likely sale of $6 billion of securities, half of which it intends to replace with other securities while the rest would be used to reduce wholesale funding, PNC said. It also expects to add approximately $3 billion worth of interest rate swaps. As a result, PNC management said it will reduce its securities portfolio credit spread and interest rate volatility exposures, while positionning itself to benefit from a potentially steeper yield curve. September Ratings Changes On 9-08 Bank of America downgraded Wachovia to neutral from buy. Analyst John McDonald said the downgrade was consistent with his firm's cautious view on bank stocks generally. In addition, "we believe shares of Wachovia could remain range bound as the overhang from the Golden West deal and Wachovia's increased exposure to mortgage banking will sustain the current valuation discount of 8% relative to the large cap bank group," he wrote. On 9-07 S&P analyst Mark Hebeka upgraded Wachovia to a strong buy from a buy, citing what he sees as a "compelling" valuation and the bank's "strong growth prospects and sound business strategy." "We believe its focus on customer service, core deposit gathering and de novo branch building should help mitigate a challenging industry environment, and view its relatively high amount of fee-based income and diverse business lines as competitive advantages," Hebeka wrote in a note. The analyst also said he expects strong revenue synergies from Wachovia's proposed acquisition of Golden West , which shareholders of both companies approved last week. On 9-08 Banc of America Sec Downgraded MTB from Buy to Neutral. On 9-11 UBS Downgraded BAC from Buy to Neutral. On 9-15 Bernstein Downgraded FITB from Market Perform to Underperform. Housing Chill Begins to Pinch Nation's Banks Robin Sidel, WSJ 9-01-06 The cooling housing market is starting to pinch the nation's banks, which are more exposed to real estate than ever -- and it comes at a time when some of their other key businesses already are being squeezed. Although real-estate downturns typically trigger concerns about rising delinquencies and defaults on existing mortgages, the more pressing worry in the industry right now is that a slowdown in demand for new loans will cut into earnings that have been exceptionally strong. That is significant because financial institutions already are grappling with several issues. They include a difficult interest-rate environment, competition for traditional banking customers, a saturated credit-card market and expectations that strong consumer-credit quality will soon show signs of weakening. "Any wiggle in the real-estate business has a significant impact on banking because that's where the growth has been coming from," says Richard Bove, an analyst at Punk, Ziegel & Co. The Commerce Department last week reported that sales of new single-family homes fell 4.3% in July to a seasonally adjusted annual rate of 1.1 million. The National Association of Realtors, meanwhile, said that existing-home sales fell in July to the lowest level since January 2004. Indeed, banks have begun to warn investors that the housing slowdown is starting to hurt their business. FirstFed Financial Corp., a Santa Monica, Calif., bank with a large mortgage business, said in a securities filing Monday that its mortgage originations were down 47% in July from year-earlier levels. The next day, First Horizon National Corp., a Memphis, Tenn., bank that sells home loans across the country, said it expects mortgage originations to fall by $1 billion in the third quarter due to a falloff in applications. And Punk Ziegel's Mr. Bove last week cut his rating on Salt Lake City-based Zions Bancorp to a "hold" from a "buy" due to views that the bank, which provides loans to home builders, will experience lower volumes as construction slows and land values decline. Banks have ridden the real-estate boom over the past five years by pitching traditional loans, newfangled mortgages and home-equity loans that can be used to pay off credit-card bills or fund a new plasma-screen television. While the banks reduce their exposure to these loans by selling some of them into secondary markets, real estate still amounts to a chunk of their assets. As a result, real estate, including mortgages, home-equity loans and commercial loans, represented a record 33.5% of the U.S. banking industry's $9.298 trillion in assets in July, according to the Federal Reserve. The numbers represent the highest level in the Fed's database going back to 1973. Although the nation's biggest banks have sprawling operations, their share of the mortgage market also has grown during the boom, whether through acquisitions or internal expansion. At J.P. Morgan Chase & Co., the nation's third-largest bank as measured by assets and market value, real estate represents about 13% of the bank's assets. That is a slight increase from 2003, when real estate was less than 10% of Bank One Corp.'s assets and about 11% of J.P. Morgan's assets. J.P. Morgan acquired Bank One in 2004. At Bank of America Corp., the nation's second-largest bank, behind Citigroup Inc., home-equity loans represented 5% of assets as of June 30, up from 4% at the end of 2001. "Five years ago, you would have said that mortgage risk was pretty [small] for the banking industry as a whole, and for the large banks in particular, but it is hard to say that today," says Frederick Cannon, an analyst at Keefe, Bruyette & Woods Inc., which specializes in the financial-services industry. So far, bank executives and Wall Street analysts are expressing little concern about the prospects for a big increase in mortgage delinquencies or defaults, particularly if unemployment stays low and the economy shows signs of strength despite high gasoline prices. They say that credit-scoring models are far more sophisticated today than they were in previous housing cycles. Delinquencies stood at 4.41% in the first three months of the year, up from 4.31% in the year-earlier period, according to data released by the Mortgage Bankers Association, a trade group, in June. Still, the mortgage market is filled with new types of loans that were far less prevalent -- or didn't exist at all -- in previous housing downturns. These products, such as interest-only loans or adjustable-rate mortgages in which the borrower can choose from multiple payment options, are viewed as more risky than traditional fixed-rate mortgages. The trade association says that fewer than 25% of all mortgages are adjustable-rate loans. "The oldest saw in banking is that bad loans are made in good times," Keefe's Mr. Cannon says. "We have never really faced a weakening housing market with the structure of the mortgage market as it is today." Regional Banks' Pinch Foreshadow National Woes Nick Godt, Dow Jones Newswires 9-14-06 Some big and medium-size regional banks are starting to report more problems stemming from a fast-falling housing market and slowing economy, likely foreshadowing what will become a nationwide phenomenon, analysts said. Over the past week alone, both Cincinnati, Ohio-based Fifth Third Bancorp (FITB) and Portland, Maine-based TD Banknorth (BNK) issued profit-warnings. NJ-based Commerce Bancorp (CBH) reiterated its view that profits and revenue will rise only modestly in Q3, after it was forced to guide lower in Q2. The three banks have cited a range of issues - from declining volumes of loans and deposits to rising loan losses and higher costs - that are likely to worsen with a slowing economy and affect a growing number of banks in various regions of the country. "If one or two banks tell you that things are going to be problem, you'd better believe that everyone is going to have a problem," said Punk Ziegel & Co analyst Richard Bove. Late on Monday, Fifth-Third said that bad debt and nonperforming assets would lead Q3 earnings to be "modestly lower" than in Q2. Elaborating on the outlook during a Lehman Brothers banking conference on Tuesday, chief executive Christopher Marshall said the losses were coming from its retail consumer business, but declined to elaborate on whether it was directly linked to the housing market. "There's not anyone thing in particular," Marshall said. "It's a general increase in stress on our consumer borrowers," adding that he didn't know if the phenomenon was impacting just the Midwest region or the whole country. David Daberko, chief executive of National City another Midwest bank, said last month that consumers were "getting stretched big time." The Midwest region, which has already been hit by the declining U.S. auto industry, is particularly vulnerable to the decline in wealth experienced by some homeowners as the housing market continues to fall. "The Midwest regional banks are more challenged by fact that the Midwest is growing less than the national economy," said Jim Callahan, banking analyst at MorningStar. This historically industrial region has fallen behind as manufacturing moved overseas while baby boomers have moved to richer parts of the country, such as the West and the Southeast, and taken their assets with them. This has heightened competition for dwindling loans and deposits volumes, Callahan said. But those pressures are not just felt in the Midwest. TD Banknorth, which has been trying to aggressively expand in the Mid-Atlantic region, warned Tuesday that Q3 earnings would be lower than analysts expected amid a "leveling off" of both commercial and consumer loans. "Competition for loans and deposits remains extremely competitive," TD Banknorth said. Higher marketing costs and the shift of consumers to higher-rate deposits are also hurting margins, it said. Similarly, Commerce Bancorp on Tuesday reiterated its previous outlook for flattish earnings in Q3. The bank has continued to grow its volume of deposits, but it has been paying more to offer higher-rate deposits. Interestingly, the three banks have played down their exposure to a fast-falling housing market, either pointing to their limited holdings of risky mortgages or noting that their geographic location was not among the previously hottest markets. But as the housing market stops fueling wealth and consumption and slows the economy as a whole, demand for loans is naturally shrinking across the board, while new deposits have to be "stolen" from the competition by paying higher rates. "The business of American banks is lending money against real estate values, whether via mortgages, home equity, commercial lending, and even other types of loans," said Bove. "Therefore as housing goes down, earnings are going to go down." Not surprisingly, Midwest banks such as Fifth Third, National City, US Bancorp (USB) , Comerica (CMA) and TCF (TCB) have tried to expand geographically to move into higher growth areas to the West or the Southeast. National City, for instance, said in July it would snatch two banks in Florida -- Fidelity Bankshares (FFFL) and Florida Harbor Bancshares (HARB) -- for $1 billion each. But even if growth hasn't started waning as fast as in the Midwest, a big chunk of the growth seen in Florida, California and throughout the whole country over the past five years has been directly and indirectly linked to real estate, Bove noted. And the bread and butter of regional banks has remained lending money to businesses and consumers, and taking in fees from deposits, mostly from their core region. "A fundamental risk with many banks is that they are exposed to their regional economies," said Morningstar's Callahan. Regional Banks Covet Investment Boutiques Amid M&A Boom Clint Riley, WSJ 9-12-06 After largely abandoning investment banking in the aftermath of the 2000 tech-stock bust, regional bankers again are looking for ways to sell customers advice on deals as the mergers boom continues. Following the lead of the industry's three big titans, two major commercial banks have bought small investment banks in the past year. Analysts see the start of a trend. Wells Fargo several weeks ago announced the purchase of Barrington Associates, a boutique investment bank in L.A. that specializes in advising midsize businesses with annual revenue of between $25 million to $1 billion. The deal's terms weren't disclosed; some bankers estimate the sale price of the 40-person shop at about $50 million. The Barrington deal follows a similar move last year by PNC Financial of Pittsburgh, which bought Harris Williams, a 110-person boutique investment bank in Richmond that is considered a leader in middle-market M&A advisory work. Profits at Harris Williams are up substantially since the acquisition closed in Q4-05, the bank says. These deals mirror strategies pursued by the industry's biggest players -- Citigroup, Bank of America and J.P. Morgan Chase. Over the past decade, each has expanded to become massive financial institutions that can offer big corporate clients broad lending capabilities and investment-banking services like stock underwriting and merger advice, while collecting their cash deposits. The regional banks aren't looking to compete with the big players on a global scale, but want to offer more services to existing customers and attract new ones that are often ignored by the financial giants. "What is happening is that the bundled-product model is coming more into the middle market," said Jim Lawson, a co-founder of Lincoln International, a Chicago midmarket investment bank with 100 bankers in the U.S. and Europe. "You will see more consolidation between M&A boutiques ... and financial institutions." Analysts say other commercial banks that could seek out similar arrangements include U.S. Bancorp, BB&T, Fifth Third, Capital One, Comerica, National City Corp., Regions Financial, SunTrust Banks and Zions Bancorp. Midtier investment banks like Jefferies Group and Piper Jaffray, both publicly traded, often are discussed as possible targets for regional banks. But bankers and analysts say smaller, independent middle-market advisory shops without costly trading, sales and research staffs are more likely to receive overtures from a large regional bank, especially if they have international offices and knowledge of multiple industries. Such firms include Lincoln International, Sagent Advisors, and Goldsmith Agio Helms. The recent deals won't transform Wells Fargo or PNC. But they fill a void that many regional banks are learning they must plug to service the increasingly sophisticated financial needs of their base of small and midsize businesses. Many of these mostly privately owned companies -- from a variety of industries, including aerospace and manufacturing -- find themselves seeking big chunks of capital to expand globally or advice on selling all or part of their operations to private-equity firms or other buyers, often overseas. Executives at Wells Fargo and PNC say they will provide their respective boutique investment banks with financial heft and more products to offer clients. Still, in a nod to the cultural divide between commercial bankers and investment bankers, both banks say they will allow the boutiques to maintain their current names and continue to operate much as they did before being acquired. Will such marriages work over the long haul? Commercial bankers have tried to buy instant investment-banking presence before, only to abandon those efforts when the mergers-and-acquisition market turned sour. Several regional banks shuttered once-iconic boutique investment banks after the technology-stock boom went bust in 2000, including FleetBoston's Robertson Stephens. That experience leaves many investment bankers and commercial bankers hesitant to hook up. In this environment, however, many midsize companies aren't satisfied with their longtime regional banks simply lending them money, bankers say. With private-equity firms buying up more midsize companies, traditional loans and lockboxes aren't enough. Company executives and their private-equity backers want access to derivative products, interest-rate swaps, M&A advisers with global reach and many wealth-management options. "You have to bank them like they are a big corporation," says William Demchak, PNC's vice chairman and head of institution banking. One upside of this approach, commercial bankers say: By selling more fee-based financial services, they can make a tidy profit they otherwise mightn't earn by lending out money in today's competitive and difficult interest-rate environment. Regional banks that fail to adapt risk losing clients to hedge funds, private-equity firms and larger Wall Street rivals with more financial offerings and services. September Ratings Changes On 9-08 Rochdale Securities Downgraded CYN from Buy to Hold. On 9-26 Boenning & Scattergood Initiated covereage of FNB at Market Perform. On 9-28 Piper Jaffray cut bank holding company Synovus Financial Corp (SNV) to market perform from outperform, saying residential construction growth, which provided good tailwind for the company over the pas year, could slow going forward, while cost of deposits should continue to increase given intense pricing competition. August Ratings Changes On 8-10 Stifel Nicolaus Initiated coverage of ONB at Hold. On 8-14 Rochdale Securities Downgraded NCC from Hold to Sell. On 8-17 Prudential Initiated coverage of WL at Neutral. On 8-17 Goldman Sachs Downgraded CMA from Neutral to Sell. On 8-18 AG Edwards Downgraded KEY from Hold to Sell. On 8-21 Credit Suisse Downgraded STT from Outperform to Neutral. On 8-24 Friedman Billings Downgraded TCB from Outperform to Market Perform. On 8-17 FirstMerit declared a quarterly cash dividend of $0.29 per share on the Corporation's Common Stock, up $0.01 from the current quarterly dividend of $0.28 per common share, payable September 18, 2006, to shareholders of record on August 28, 2006. On 8-29 Friedman Billings downgraded First Horizon [FHN] to underperform from market perform, after FHN said Tuesday that it expects mortgage banking earnings to be unfavorably impacted this quarter by two unrelated events. The further deterioration in the current mortgage environment is expected to reduce the company's pre-tax operating earnings by approximately $35 million as compared to the second quarter. The settlement of a class action lawsuit is anticipated to create an estimated $21 million pre-tax accrual. Analyst Gary Townsend cuts his $3.20 2006 EPS estimate to $2.80 and his $3.55 2007 EPS estimate to $3.00. Shares trade at 14.3 times and 13.4 times the analyst's revised 2006 and 2007 EPS estimates, at an unwarranted premium to the group. Home Page Factoids Previous Update |