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TCF Financial


is close to completing its transition away from heavy reliance on transaction fee income to high-margin specialty lending, according to BMO analyst Lana Chan.

Chan upgraded TCF to "Outperform," and raised her price target for the shares to $13, saying that key factors for the stock will be strong growth in specialty lending, credit quality improvement and "less risk on fees, as the hits from reg reform should be largely reflected in TCF's run rate even as the bank re-tools the deposit product offering, which includes free checking.

TCF Financial had $17.9 in total assets as of June 30. The Wayzata, Minn., bank was among the most reliant among larger institutions on checking account overdraft fees, before new rules requiring banks only to provide overdraft coverage for debit card and ATM transactions for customers who previously opted-in for the service were implemented in July 2010.

TCF was also among the hardest hit by the Durbin Amendment's limitation on interchange fees charged to merchants to process debit card purchases, which went into effect in October 2011.

During the first quarter, TCF underwent a major balance sheet restructuring, prepaying $3.6 billion in wholesale borrowings and selling $1.9 billion in mortgage-backed securities, as part of its strategy of moving away from longer-term residential and commercial real estate loans and MBS investments, to a focus on "originating high-yielding, low-risk, secured loans and leases funded by a low-cost, core deposit base," according to CEO William Cooper. The restructuring resulted in an after-tax charge of $293 million, or $1.85 a share, feeding a first-quarter net loss of $282.9 million, or $1.78 a share.

For the second-quarter, TCF reported net income available to common shareholders of $31.5 million, or 20 cents a share, increasing from $30.4 million, or 19 cents a share, during the second quarter of 2011.

Second-quarter net interest income increased 9% year-over-year, to $144.1 million, which together with $13.1 million in gains on securities, more than offset a 14% year-over-year decline in fees and other revenue to, to $99.8 million, mainly reflecting the Durbin rule's implementation during the fourth quarter of 2011.

The company's net interest margin -- the difference between the average yield on loans and investments and the average cost for deposits and wholesale borrowings -- expanded to a very strong 4.86%, from 4.14% the previous quarter, and 4.02% a year earlier, reflecting the reduced interest expense and more profitable loan mix. Cooper said in July that "with rates low and even lower, we'll probably see some reduction in that very high net interest margin... somewhere around 4.6%, 4.65%," which Chan said would be "still well above the small-cap bank group average of 3.80%."

TCF's shares closed at $10.44 Thursday, trading for 1.3 times tangible book value, according to Thomson Reuters Bank Insight, and for 10 times the consensus 2013 earnings estimate of $1.03, among analysts polled by Thomson Reuters. The consensus 2012 estimate is for a net loss of $1.19 a share.

Chan called TCF's valuation "attractive," as the shares have "lagged peers YTD, up only 1% vs. a 21% gain for the BIX (S&P Bank Index)," and have lagged over the past three years, because of "outsized exposure to the downturn in the housing market (with 58% of its loans in home equity at its peak in 1Q08)," the regulatory hits to fee income, and the restructuring.

As part of its transition, TCF is focusing on equipment leasing, inventory finance and auto lending, which together made up 32% of the company's total loans and leases as of June 30, increasing from 27% a year earlier. TCF grew these loans and leases 23% year over year, to $4.9 billion.

Chan said that the company's new lending focus was in "typically higher-yielding businesses, which could help mitigate margin pressure in a period of extended low interest rates." Despite having a national lending platform, "TCB is still only a very small player in these large market segments," the analyst said, as "auto lending is over a $600 billion market and both

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originated $6 billion in auto loans last quarter vs. TCB's $500 million of originations YTD."

BMO believes that "TCB can manage the growth of these national businesses while maintaining strong credit oversight," and that "growth in the specialty finance businesses will help offset downsizing in its consumer portfolio and rebuild fee income."

Interested in more on TCF Financial? See TheStreet Ratings' report card for this stock.


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Written by Philip van Doorn in Jupiter, Fla.

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Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.