Texas Capital Bancshares: A Sound Long-Term Transformation Plan, But Vulnerable In The Near Term

Writing about Texas Capital Bancshares (NASDAQ:TCBI) in February, I said that while I was bullish on the long-term strategic transformation plan put in place by the new CEO, I saw a “better than average” chance that the bank would underperform in the near term given the bank’s high deposit beta and willingness to invest opex into the transformation of the business. That’s largely played out this year as I expected, though I’m honestly a little surprised that the shares are only down a bit more than regional banking peers given the steeper pace of deposit cost growth.

I still see Texas Capital as a short-term/long-term puzzle I do like the CEO’s vision for what the bank should be – focused on commercial lending, with stronger investment banking, trading, and treasury options to drive fee income and stickier relationships – but it will take time to get there. In the meantime, I see elevated operating risk on higher deposit costs and weaker operating leverage. Investors unsure of their ability to time a turn in sentiment for banks may want to consider buying or holding the shares now, but there could be better entry points over the next year.

 

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Texas Capital Bancshares: A Sound Long-Term Transformation Plan, But Vulnerable In The Near Term

Texas Capital Bancshares: Love The Plan, But It Will Take Time

 

Wall Street being a notoriously impatient place, it's not so surprising that turnaround stories are so often overlooked in their early stages - usually, turnaround plans involve a lot of near-term pain and execution risk with no certainty on that outcome. When they work, though, the rewards can be substantial.

Writing about Texas Capital Bancshares (TCBI) back in July (ahead of the company's September strategic update), I was cautious on the near-term valuation and outlook, but still bullish and I thought that there were solid arguments for long-term investors to stay put. The shares subsequently spent some time below $60 and are pretty much where they were when I last wrote, underperforming the banking sector by a noticeable amount.

My feelings haven't changed. I think CEO Holmes has put a good plan in place, and while there is execution risk, I think that's outweighed by the opportunities this restructuring will unlock. Higher spending may well keep a lid on the share price for a while longer, but I think the long-term return potential makes this a name to consider if you believe management is pursuing the right plan for the business.

 

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Texas Capital Bancshares: Love The Plan, But It Will Take Time

Texas Capital Bancshares Making Smart Moves, But The Street Anticipates The Improvements

 

When I last wrote about Texas Capital Bancshares (TCBI), I wrote that while I was intrigued by the transformation potential at this Texas bank, I wasn't as comfortable with the valuation. The shares shot up about 50% shortly thereafter on Street enthusiasm for CEO Holmes' initial strategic moves, but have trailed off since then - ending up more or less flat with where they were when I last wrote, and underperforming the larger group of regional banks by about 10%.

I really like what I've been hearing from the company, and not just because it has largely matched the changes I outlined in that prior piece. I agree with the overall philosophy to reduce the bank's focus on more volatile businesses and instead prioritize growing its middle-market Texas commercial lending business, and I believe this move could generate long-term core earnings growth in the double-digits. The "but" is that a lot of that is already in the share price; I'm a big advocate of the idea that successful turnarounds can go much further than you initially think, but it's going to take time to turn around and reposition TCBI.

 

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Texas Capital Bancshares Making Smart Moves, But The Street Anticipates The Improvements

Texas Capital Bancshares Showing Progress On Credit

Now the real work begins.

Texas Capital Bancshares (TCBI) shares have done well over the past three months as investors have shifted toward a "risk on" position with the banking sector, and I also believe the hiring of former JPMorgan (JPM) executive Rob Holmes as the new CEO has brought a renewed optimism around the potential for the company to chart a new, more profitable course over the next decade.

When I last reviewed Texas Capital , I thought the stock offered upside on the potential of what the bank could/can become until better leadership, but that upside was tempered by above-average near-term volatility and operating risks. That's still basically my position, and while I do still see worthwhile long-term upside on its transformation potential, I'd like a better entry price to take on the risk that the path to that potential could be longer or rockier than the bulls think.

 

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Texas Capital Bancshares Showing Progress On Credit

Texas Capital's Upside Tied Largely To Self-Improvement

There's a lot not to like about Texas Capital Bancshares (TCBI) right now, and before the announcement of the new CEO, that was reflected in a weak relative performance track record over the last two years. Texas Capital has basically been an asset-sensitive spread lender that struggled to generate attractive efficiency ratios and ROA/ROE/ROTCE during the good times, and the company's strengths have largely been in lower-return businesses. On top of that, the bank has seen a noticeable talent drain over recent years, and the dissolution of the proposed merger with Independent Bank Group (IBTX) was yet another body-blow to sentiment.

Now, though, things are looking a little better for banks. Rates aren't likely to improve anytime soon, and loan demand and credit quality are likely to remain headwinds a little while longer, but it looks as though the bear-case scenarios are off the table with respect to credit losses. More specific to Texas Capital, there's a new CEO in place, and hiring the former head of JPMorgan's (JPM) Corporate Client Banking business has certainly helped sentiment.

Valuation and upside now really depend upon what this new CEO can achieve in terms of restructuring, repositioning, and just generally improving the bank. On an "is what it is" basis, I'd argue that Texas capital is now pretty fairly valued. On the basis of what it could become, though, I can see double-digit upside from here.

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Texas Capital's Upside Tied Largely To Self-Improvement

With A Much Different Risk/Reward Outlook, Independent And Texas Capital Call Off Their Merger

The COVID-19 outbreak has created some significant disruptions for the banking sector, with almost every bank building reserves in anticipation of higher loan losses from the ensuing recessions. Those disruptions have also led to the termination of the proposed merger of equals between Independent Bank (IBTX) and Texas Capital Bancshares (TCBI), with the two parties agreeing to go their separate ways without any termination fees or other commitments.

Looking ahead, I can see both banks as candidates to be involved in future M&A, though the challenges TCBI is currently facing (including the need to find a new CEO) lead me to believe they'd more likely be a seller than a buyer. While the current valuation on TCBI does look exceptionally pessimistic, I'd prefer IBTX at this point given the greater uncertainties in TCBI's business mix.

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With A Much Different Risk/Reward Outlook, Independent And Texas Capital Call Off Their Merger

Independent Bank And Texas Capital Bancshares Tying Up In A Curious MOE

Mergers of equals have suddenly become a lot more popular in the banking space, likely as an answer to several trends in the industry including significant growth headwinds in 2020 and meaningful economies of scale, particularly with respect to future IT spending and branch network costs. The latest announcement, the tie-up between Independent Bank Group (IBTX) and Texas Capital Bancshares (TCBI), is a curious one in many respects, but also one that makes quite a bit of sense.

Given the significant EPS accretion potential on relatively modest cost savings assumptions and loan marks, not to mention the diversification the deal will provide, I think Independent Bank shares are worth considering here, and likewise Texas Capital.

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Independent Bank And Texas Capital Bancshares Tying Up In A Curious MOE

Texas Capital's Strong Loan Growth And Spread Leverage Is A Potent Growth Cocktail

With some exceptions, bank stock investors have to choose between companies with strong leverage to higher rates (like M&T Bank (MTB) and Comerica (CMA)) and those with stronger loan growth. In many cases, “both” is not an option, which makes Texas Capital Bancshares (TCBI) a pretty exceptional growth story right now.

Deposit costs are rising and Texas Capital’s lending portfolio isn’t exactly low-risk, but I expect above-average growth from this lender to continue, particularly as it expands its national lending opportunities. Valuation is a difficult call; more traditional valuation approaches would say that these shares are quite expensive but traditional valuation approaches don’t necessarily fit a non-traditional growth story.

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Texas Capital's Strong Loan Growth And Spread Leverage Is A Potent Growth Cocktail

Knocked Back By Energy, Green Bancorp Looking To Rebuild The Growth Story Next Year

Energy lending has hamstrung many banks and Green Bancorp's (NASDAQ:GNBC) previously outsized exposure to the energy sector has come back to bite this small Texas lender. Management is moving fairly aggressively to exit its energy lending business and pivot toward lending growth opportunities in Dallas and Austin, but weakness in the Houston metro area remains a concern, as does this company's funding base.

I like Green Bancorp's portfolio banker lending model, and I think the underlying growth in major Texas metro areas like Dallas, Houston, and Austin can support above-average loan growth. That said, there's a lot of competition within Texas, and management needs to prove that it can carve out a durable differentiated lending franchise and expand its base of lower-cost deposits. The current valuation already assumes a lot of improvement (and long-term earnings growth in the range of 20%) and that doesn't leave much room for excitement from me.

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Knocked Back By Energy, Green Bancorp Looking To Rebuild The Growth Story Next Year

Southside Seems Priced Like A Better Bank Than It Appears To Be

Considering the size of the economy and the above-average population growth, it makes sense that both investors and other banks are interested in Texas-based banks. Although worries that weak oil/gas prices would undermine the entire state's economy pressured the shares of many Texas banks earlier this year, many have rebounded strongly and now sit at or near 52-week highs.

Southside Bancshares (NASDAQ:SBSI) is one such bank, and while I'm certainly interested in finding some good investment ideas in the Texas bank sector, I'm not convinced this one qualifies. In its favor, Southside could be an acquisition target for a bank looking to acquire a bigger presence in East Texas, and banks ranging from larger super-regionals like BB&T (NYSE:BBT) and U.S. Bancorp (NYSE:USB) to other Texas-based banks like Hilltop (NYSE:HTH) and Prosperity (NYSE:PB) are looking to build their deposit share in the state. Against that, though, is more leverage than I'd like, a heavily CRE-dependent loan book, and a valuation that already factors in some pretty solid growth expectations.

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Southside Seems Priced Like A Better Bank Than It Appears To Be

Can Prosperity Bancshares Build Value Outside Of M&A?

I thought Texas-based Prosperity Bancshares (NYSE:PB) looked like an interesting value back in late January of 2015, and the shares are up more than 10% since then but it has not been a smooth ride. Like other Texas banks, including Cullen/Frost (NYSE:CFR), Texas Capital (NASDAQ:TCBI), International Bancshares (NASDAQ:IBOC), and Green Bancorp (NASDAQ:GNBC), Prosperity shares had a rough time from late 2015 into early 2016 on worries that the steep decline in energy prices would undermine the bank's credit quality and loan growth in Texas and Oklahoma.

There are signs of weakness that shouldn't be ignored, including rising unemployment and shaky commercial real estate numbers in Houston, but Prosperity continues to have a strong credit quality profile, a good efficiency ratio, and a very disciplined overall approach. On the other hand, loan growth is weak and I have more doubts now about Prosperity's ability to grow outside of M&A. I believe that Prosperity can post mid-to-high single-digit earnings growth from here (equating to a low double-digit ROE down the road), but that no longer supports a compelling buy thesis.

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Can Prosperity Bancshares Build Value Outside Of M&A?

After A Post-Panic Rebound, It's Harder To Find Value In Texas Capital Bancshares

Quite a few banks with heavy Texas exposure took a beating in the market from the fall of 2015 through the spring of 2016, and Texas Capital Bancshares (NASDAQ:TCBI) took one of the heaviest beatings. But like Cullen/Frost (NYSE:CFR), Prosperity Bancshares (NYSE:PB), Comerica (NYSE:CMA), and BOK (NASDAQ:BOKF), Texas Capital has recouped a lot of that damage.

Texas Capital remains structured for significant growth, as loans continue to grow at a double-digit year-over-year clip, driving strong net interest income growth, while credit may be stabilizing. The question, then, is how much you want to pay for a very focused, growth-oriented Texas bank with ample room to expand. Banks like Bank of the Ozarks (NASDAQ:OZRK) underline some of the difficulties in valuing growth banks (they often, if not almost always, look expensive), and even mid-teens earnings growth isn't enough to generate a compelling fair value right now.

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After A Post-Panic Rebound, It's Harder To Find Value In Texas Capital Bancshares

Seeking Alpha: Energy's Fall Creates An Opportunity At Prosperity Bancshares

Wall Street may not be a zero-sum game at all times, but I think it happens often enough to say that bad news in one spot is usually good news somewhere else. I'm not remotely happy that oil's freefall has created a crater in the energy portion of my portfolio, but that drop has taken down the shares of many Texas banks, including Prosperity Bancshares (NYSE:PB).

While an ongoing energy rout would eventually damage Prosperity's loan growth and credit quality, direct energy lending is less than 10% of the loan book and Prosperity has exceptionally clean credit metrics. I would expect Prosperity to return to its M&A ways at some point this year and although not a screaming bargain by conventional metrics, the value in these shares is getting interesting.

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Energy's Fall Creates An Opportunity At Prosperity Bancshares

Seeking Alpha: Bank Of The Ozarks Continues To Execute

Even allowing for the fact that growth becomes more difficult as a company get bigger, if Bank of the Ozarks (NASDAQ:OZRK) continues to execute like this it is not going to be a small bank for long. This Arkansas-bank remains heavily weighted to real estate-based commercial lending, but continues to use disciplined underwriting to control risk while leveraging a very low-cost deposit base. The shares don't look cheap by most of the bank valuation metrics I like, but quality growth doesn't come cheap and I still see opportunities for outperformance and value-building acquisitions.

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Bank Of The Ozarks Continues To Execute

Seeking Alpha: Bank of the Ozarks Thriving; Consider Buying On Dips

There is no shortage of critics who will bitterly complain about how the Bush and Obama administrations have handled the near-meltdown of the U.S. banking system. One company that is not likely to complain at all is Arkansas's Bank of the Ozarks
(OZRK) as this company has feasted on FDIC-assisted acquisitions and continues to thrive by zigging where others zag. The question, though, is whether the potential returns are still worth the risk.

A Strong Close To The Year
Relative to larger banks like M&T Bank (MTB) or Wells Fargo (WFC), Bank of the Ozarks' earnings are relatively clean and simple. Although net earnings did slide about 7% from the third quarter, the bank nevertheless beat the average analyst guess by about two cents.

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Bank Of The Ozarks Thriving; Consider Buying On Dips

Investopedia: 2011 In Review - Regional Banks Are Suffering

The best that can be said about regional bank performance in 2011 is that the smaller regional banks did less poorly than their larger brethren this year. In fact, as measured by the Keefe, Bruyette & Woods Regional Banking Index, regional bank stocks are down more than 7% on a year-to-date basis and down about 2% on a rolling one-year basis. That's better than the larger cap KBW Bank Index (which is down almost 24% on a year-to-date basis), but still well short of matching the S&P 500 this year.

Is there really much surprise in the performance of these banks? Consumers are trying to repair their personal balance sheets, property values and unemployment remain stubbornly disappointing, and loan demand is a mess, as generally only poor credit risks seem to be actively seeking loans. Were it not for the concerted efforts of the Fed to keep rates low, many banks would be in tough shape. (For related reading on the Fed, see How The Federal Reserve Manages Money Supply.)

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Investopedia: Heavily Shorted Stocks Near Their Highs

Virtually every stock of any real size is going to have a certain amount of short interest. When a stock's short interest reaches double-digits, though, investors should pay a little attention. By and large, retail investors do not short stocks and neither do most mutual funds. Moreover, the rules and hassles of short selling combined with the theoretically unlimited loss potential often mean that short positions are not entered into lightly.

While some short positions are simply a byproduct of a fund manager's belief that a stock is simply overvalued, often it is a bet on the notion that there is something more fundamentally wrong with the basic business. Accordingly, it is interesting to see that there are a number of stocks with high short interests trading near their 52-week highs. Is this simply a product of a bull market that has gone on too long, or is there something worse lurking beneath the surface? (For more, see Stocks With Increasing Short Interest.)

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Investopedia: Comerica Gets Bigger, But "Better" Has To Wait

Comerica (NYSE:CMA) might be something of a microcosm and preview for regional banks this year. This Dallas-based bank not only reported better credit numbers for its fourth quarter, but stabilization in its loan activity and an acquisition of a smaller bank in a key target market. 

The Quarter That Was
Comerica's earnings were messy, but fairly typical for banks right now. Reported revenue did climb 5% and net interest income was stable, but core PTPP (pre-tax, pre-provision) earnings were down about 2% on a sequential basis. What's more, average earning assets were down 2% on a sequential basis. Consequently, while the company did report an impressive beat on the earnings line - reporting earnings of 53 cents versus a consensus estimate of 31 cents - virtually all of that upside was outside of its core earnings potential.

As that last sentence suggests, credit and provisioning was a major driver this quarter (as it is for virtually every U.S. bank right now). The company's fourth quarter provisions for loan losses were less than half of those in the third quarter and less than a quarter of what they were a year ago. As a result, the company's ratio of non-performing assets to total assets fell on a sequential basis. Said differently, the company charged off about $113 in bad loans this quarter, but only provisioned for $57 million of that, and that boosted the reported earnings (a "release" of loan loss reserves).

Getting Even Bigger in Texas
While Comerica's history is in Michigan, the company clearly sees Texas as its future. To that end, the company announced the acquisition of Sterling Bancshares (Nasdaq:SBIB). Comerica is offering up about 0.24 of its shares for each share of SBIB, giving the company a 29% premium (even after the stock had been moving up on merger chatter).


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Can PNC Get Regional Bank M&A Moving?

For a sector that is still dealing with remarkable turbulence and challenges to old business models, there have been remarkably few acquisitions in the regional bank industry. Sure, there have been plenty of distressed deals, where a bank has failed (or is about to) and an opportunistic suitor snaps up branches and deposits without having to pay much at all, but not much has happened in the way of strategic moves and not among the larger banks.   

If an acquisition rumor about PNC Financial (NYSE:PNC) is accurate, though, that may be about to change and perhaps 2011 will be a year where there is more activity in the industry. After all, banks like PNC, U.S. Bank (NYSE:USB), Spain's Santander (NYSE:STD) and Canada's Toronto-Dominion (NYSE:TD) could all look to put capital to use this way.

The Rumor 
The South Florida Business Journal recently ran a story suggesting that Pittsburgh's PNC is looking to expand its presence in Florida and is considering acquiring either Regions Financial (NYSE:RF) or BankAtlantic (NYSE:BBX) to do so. While this particular rumor is new and fresh, it is something of a reheated story. Regions and BankAtlantic were always thought to be prime acquisition targets during the boom years, and even during the worst of crunch as both banks were seen to be very much at risk from bad loans. While PNC has not generally been the buyer most frequently tied to Regions, the idea of PNC buying either of these banks makes sense.


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How About Santander & BB&T?

Ok, I know there is plenty of real news right now and I probably should not be spending my time on idle speculation. I also know rumors are a dime a dozen, and I really do not want to be involved in starting any myself. But I find myself wondering whether Spain's Santander (NYSE: STD) would think of having a go at BB&T (NYSE: BBT).

First, let me start by saying that I own BB&T, so I certainly have a personal financial interest in this notion.

I think it is pretty clear that Santander is not finished acquiring assets, and it is equally clear that they want to expand their U.S. operations. The company has been trying to find a way to reach a deal with Buffalo-based M&T Bank (NYSE: MTB), in part by acquiring Allied Irish Bank's (NYSE: AIB) stake in MTB. That said, MTB does not appear to want to sell out to Santander beyond AIB's stake. So we have an impasse there.

But what about BB&T? Although BB&T has large operations in Georgia (one of the sinkholes in the credit crisis) and a large commercial real estate portfolio, BBT has thus far done pretty well throughout the crisis and the bank has a well-earned reputation for both sound and conservative management. BBT management is also on record saying that they will need to make transformational M&A maneuvers in the coming years, and I do not believe the Colonial deal was what they meant.

BBT would give Santander access to a faster-growing area of the country (faster than the Mid-Atlantic), a large deposit base, and a profitable insurance business. The Southeast is also an area seeing significant Hispanic immigration and that might be synergistic for Santander given their operations in Mexico and Latin America.

It also does not hurt that BBT is undervalued right now and could be a cheaper "get" than MTB.

Of course, Santander has ample options - including simply standing pat and growing organically. If Santander wants to grow in the Southeast, Suntrust (NYSE: STI) is an option as well, and so to Regions Financial (NYSE: RF). And who knows? Maybe they go to Texas for Texas Capital Bancshares (Nasdaq: TCBI), or the western US for Zions (Nasdaq: ZION) or the upper midwest for TCF (NYSE: TCB). So on and so on - which is why I do not like speculating on these things; you can do it all day and get nowhere.

Still, I find the idea of a Santander-BBT link-up to be intriguing. I am a fan of both banks and have thought about purchasing Santander relatively recently. If I was not already over-exposed to finance, I probably would have by now. Nevertheless, time will tell ...

Disclosure - I own shares of BBT