37 Years Of Banking Industry Experience Sees No Investor Concerns For Financial Institutions Still Making Use Of TARP Capital
March 31, 2010 - The Wall Street Transcript has just published Pacific & Southwest Regional Banks Report offering a timely review of the Banking sector. This Special Report contains expert industry commentary through in-depth interviews with public company CEOs, Equity Analysts and Money Managers. Please find an excerpt below.
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Tom Mitchell, Senior Analyst at Miller Tabak, began in the industry as a Research Analyst with NYSE firm Mabon, Nugent & Co. in 1973, for which he covered consumer and commercial finance companies, credit card companies, and large multi-industry companies encompassing major insurance and financial subsidiaries. He also managed a firm account, investing in distressed situations, reorganizations and bankruptcies. In 1983 Mr. Mitchell joined New York investment management firm Weiss, Peck & Greer as one of five Portfolio Analysts, with primary coverage responsibility for the financial stock sector. As a General Partner of WPG from 1984 to 1990, he also initiated programs for WPG to invest in foreign stocks, and to use index futures and options for bona fide portfolio hedging. In 1990 Mr. Mitchell branched out to set up an independent money management shop, Thomas Mitchell Management Co., Inc., and has managed both individual and institutional accounts for the past 16 years. He rejoined the sell side at Miller Tabak in July 2006, with primary coverage responsibility for banks, REITs and other financial stocks.
TWST: Smaller banks have performed better than larger banks, and that trend continued recently as we heard about the latest regulatory news out of Washington. What's your perspective on smaller banks outperforming larger banks?
Mr. Mitchell: It sort of partly goes along with the idea that we're going to see consolidation. We've not turned the corner yet, but we're less worried about companies failing. So now let's start thinking about what they might be worth in a takeover. Wells Fargo, Bank of America (BAC) and JPMorgan (JPM) are not going to be taken over; or if they are, it's going to be the mother of all bailouts. So I think it's partly that that there is now sort of a tiering going on that if a company gets more profitable and they have the potential now to be a candidate to be taken over by a larger bank, I'm willing to pay more for that one.
Separately, I think that the issue of what we think of as the Volcker-Obama proposal, which is what you were referring to, I think that is really something that is ridiculous for investors to worry about. I'll tell you why I think it's ridiculous, even though obviously it has affected the stocks in the short run. The reason for this is if you just stop and think about it, proprietary trading is not something that's actually easy to make money at. Proprietary trading is not like having the franchise to collect the tolls on the New York State Thruway. Proprietary trading is extremely risky, and what is so interesting about people complaining about the possibility they might not be able to do proprietary trading is, gee whiz, a whole lot of them would have been better off and there would have been more of them still alive if proprietary trading had been prohibited for banks with FDIC insurance coverage as of, let's say, January 2007.
So why should anybody be complaining about losing the privilege to engage in proprietary trading? There are a very, very few banks that actually have the kind of franchise, a Goldman Sachs (GS)-type of franchise, that is worth enough to consider it a disadvantage not to be able to do proprietary trading. If you have a business that's good, for goodness sake, it's going to be worth just as much if it's in two companies as if it's in one company. There are no synergies between trading energy futures, and collecting deposits and making loans to businesses. It doesn't really work that way; it never has. This is sort of a highly technical business more and more focused on derivatives markets. Anybody who really makes money at it - and it's a relatively p/e business - is going to be able to either sell or spin off the business that does the proprietary trading, and the shareholders are not going to lose anything.
On the other hand, if you accept insurance from the FDIC on your deposits, then you can't do proprietary trading. Well, 99% of banks shouldn't be doing proprietary trading anyway, and the idea that you should be able to divide these things up into different parts makes perfect sense. Why not just have two companies? Morgan Stanley (MS) used to be part of JPMorgan, and American Express (AXP) used to be part of Wells Fargo, and all four have prospered as separate entities. JPMorgan is one of the few that that probably does have a real proprietary trading business that makes money in good times and bad. I don't see them having any problem ending up being worth whatever they are trading at, $40 a share, if they were to be divided into two companies.
TWST: Now that the big four banks are out of TARP, what are the ramifications for some of the smaller ones that still have TARP capital? Is that a concern?
Mr. Mitchell: It's not a concern at all. By the way, Citi (C) is not out from under it. They're basically still owned by the U.S. government and a Saudi prince. They are not fully independent at the moment. They're not majority owned by the U.S. government, but the government owns a whole lot of Citi. So they're not really out from under the government thumb. As to small banks and TARP, this is really interesting. The TARP preferred cost of capital to banks is 5%. Can anyone tell me how many of these banks that have been paying off their TARP money have raised alternate capital at less than 5%? I believe not one has done that. On a pure economic basis, it doesn't make sense to pay back the TARP. It's all in the question of how it affects your image and your ability, as you think of it, to be able to run the company the way you want to run it without any interference. I respect that. I'm not saying I don't respect that. I'm saying when you start to think about just truly the economic cost-benefit, 5% capital is a great deal. So holding on to 5% capital cannot be considered a bad economic decision.
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