Five Regional Banks With Dilution Potential

NEW YORK ( TheStreet) -- The troubled asset relief program (TARP) has meant many things to many banks.

For JPMorgan Chase ( JPM) and Goldman Sachs ( GS), TARP was a stigma to be dispensed with as quickly as possible. As soon as the government let them, they issued equity and paid back the U.S. Treasury.

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For Wells Fargo ( WFC), it was a nuisance that executives were determined not to let run its business. They did not want to dilute shareholders like Berkshire Hathaway ( BRK.A) by issuing new equity to pay it back, but they ended up doing so nonetheless. Berkshire Chairman Warren Buffett said the government forced Wells to issue the equity, an assertion that was never addressed either by Wells or government officials.

Bank of America ( BAC) needed the government funds more than executives there cared to admit, but they were only too happy to issue equity and pay it back at the first opportunity. Citigroup ( C) has done what it could to break free, but now it's waiting on the Treasury, which converted the remaining $25 billion of an initial $45 billion preferred equity stake into 7.7 billion common shares that it plans to sell off gradually.

For smaller banks, however -- and even large regionals -- the issue of when to repay TARP is not quite so fraught with politics. Eighty companies have paid back TARP so far out of 830 that have received a government bailout.

Some of these are not banks in the strictest sense, and there are still some large companies out there, like AIG ( AIG), Fannie Mae ( FNM) and Freddie Mac ( FRE)or GMAC, each of whose efforts to pay back the government is a story unto itself.

Our goal here is to look at five large traditional banks -- ones that used to be known as super regionals -- that have yet to pay back TARP, and to try to figure out when they might do so. It may give us a decent clue about how the more than 700 smaller banks that still hold TARP funds are likely to proceed.
TARP Redemptions and Net Income around time of redemption

When banks pay back TARP often has a lot to do with when they can consistently report a profit. An analysis by SNL Financial (see pop-up chart above) shows that of the 80 companies that have paid back TARP, 69 were profitable two quarters before doing so. Some of those turned in a loss in subsequent quarters either just prior to or shortly after paying back TARP. Only one, Manhattan Bancorp ( MNHN), showed a loss for all four quarters covered by SNL's analysis, which runs from two quarters before TARP recipients paid back the government through the first quarter following their payment.

In short, don't count on any bank paying back TARP until they show they have emerged from the crisis with at least one or two quarters of profitability. Beyond that, the big issue is whether or not they'll need to sell stock to shore up capital levels as part of clearing their bailout tabs. Here, then, are five of the largest TARP holdouts that tend not to command the national spotlight, and a look at their prospects for profitability, which ought to tell us a lot about when they are likely to pay back the Treasury and if they'll have to issue stock to do it.

1. SunTrust Banks ( STI):

Atlanta-based SunTrust is expected to break even in the first quarter of 2011 and turn a profit in the second quarter of next year, according to the consensus view of analysts polled by Thomson Reuters. Average analyst estimates tallied by SNL Financial project SunTrust will turn profitable in the second quarter next year.

SunTrust received $4.85 billion in preferred equity from the Treasury and has been saying for several months it wants to pay back the Treasury as quickly as regulators will permit. However, a report from CreditSights states that SunTrust may need to issue additional equity before it will be allowed to pay back TARP, something it would like to avoid doing.

2. Regions Financial Corp. ( RF):

Regions Financial, based in Birmingham, Ala., got a $3.5 billion preferred equity infusion from the Treasury. According to Thomson Reuters, Wall Street is currently expecting Regions to return to profitability in the second quarter of 2011, while SNL Financial has the company taking until the third quarter of next year to break into the black.

In a research report last month, Sandler O'Neill analyst Kevin Fitzsimmons cited "the prospect looming of a large capital raise for TARP repayment," as a reason for bearishness on the stock. Regions has been saying for more than a year that it wants to repay TARP as soon as regulators will allow it to do so.

The potential for dilution through further equity issuance is something investors need to be concerned about. A recent Credit Suisse report said rising interest rates could cause Regions' tangible common equity to dip below 6%, thought to be an unacceptably low level from a regulatory perspective.

3. Fifth Third Bancorp ( FITB):

Fifth Third was profitable in 2009 thanks to a big second quarter, though that was the only quarter last year in which Cincinnati-based lender was in the black. Analyst estimates tallied by both Thomson Reuters and SNL Financial are pretty bullish however, forecasting Fifth Third will be profitable in every one of the next six quarters.

Fifth Third CFO Daniel Poston said back in February that the bank will "most likely" pay back the $3.4 billion it received through TARP in the second half of 2010, according to Reuters, and executives declined to update that guidance during the first-quarter conference call held on April 22.

4. KeyCorp ( KEY)

KeyCorp is expected to break even in the first quarter of next year and turn profitable in the quarter after that, according to an analyst survey conducted by Thomson Reuters. For its part, SNL Financial's survey projects a profit for the Cleveland-based institution in the third quarter of 2011.

Executives at the company appear to support my thesis on TARP paybacks, recently telling analysts they want to see "sustainable" profitability before attempting to return the $2.5 billion they owe the government.

Kathleen Shanley, analyst at GimmeCredit wrote in a recent report that she expects KeyCorp to issue additional equity before paying back that investment, "judging by the precedent set by banks that have already repaid TARP funds."

5. M&T Bank Corp. ( MTB)

Bankers in Buffalo N.Y., where M&T Bank Corp. is headquartered, were apparently too chilly to get worked up into a lending frenzy during the crisis. The bank was profitable in every quarter last year, a trend analysts widely expect to continue.

Nonetheless, those conservative types at M&T have hung onto the $600 million in preferred equity they got from the Treasury in 2008. With tangible common equity at 5.43%, the bank would almost certainly need to issue more equity if it wanted to pay back TARP today. Shareholder Warren Buffett probably wouldn't like that too much, considering how steamed he seemed to be about Wells Fargo being "forced" to sell stock.

Another reason for M&T's caution may have to do with merger talks it's reportedly held with Spain's Banco Santander ( STD), according to The Financial Times .
Bank Stock Picks
Picking a Winner Among Tarp Holdouts

-- Written by Dan Freed in New York.

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