Regional Banks May Follow Cullen/Frost's Investor-Friendly Deal

NEW YORK ( TheStreet) -- A move by Cullen/Frost Bankers ( CFR) of San Antonio, Texas, could point the way for other banks to boost their returns on equity, enriching investors.

Cullen/Frost on Wednesday priced a $150 million perpetual preferred stock offering with a coupon of 5.375% and said it planned to use $144 million of the net proceeds to buy back roughly 4% of its common shares. The common shares closed at $61.25 Wednesday, trading for twice their tangible book value and for 15.2 times the consensus 2014 EPS estimate of $4.03, according to Thomson Reuters.

Those valuations are high. Of course, Cullen/Frost has been a steady performer, with operating returns on average assets (ROA) ranging between 1.12% and 0.123% over the past five years, according to Thomson Reuters Bank Insight. But there are other strong banks trading at lower multiples.

Wells Fargo ( WFC), for example, closed at $35.23, trading for 1.6 times tangible book value and 9.1 times the consensus 2014 EPS estimate of $3.89. Wells Fargo's ROA has ranged between 0.44% and 1.41% over the past five years, but the lowest return was in 2008, during the worst of the credit crisis. The ROA improved to 0.97% in 2009 and increased steadily to 1.44% last year.

Another example is U.S. Bancorp ( USB) of Minneapolis. The company has been the strongest and steadiest performer among the nation's largest banks, with ROA ranging from 0.82% to 1.62% over the past five years. The 0.82% return was in 2009 and the 1.62% return was for 2012. USB's shares closed at $33.93 Wednesday, trading for a high 2.7 times tangible book value, but a far more modest 10.3 times the consensus 2014 EPS estimate of $3.29.

It would seem that long-term investors are quite pleased with Cullen/Frost's predictable earnings.

So why would the company buy back common shares at such high valuations?

The Collins Amendment and the Federal Reserve


For starters, Cullen/Frost saw fit to issue non-cumulative perpetual preferred shares to lock in some relatively low-cost regulatory capital. Under the Federal Reserve's new capital rules proposed last June, about 1.5% of most banks' regulatory Tier 1 common equity ratios can be made up of non-cumulative perpetual preferred shares. KBW analyst Jefferson Harralson on Thursday said in a report that "CFR likes swapping out 12% cost of capital for sub-5.5% cost of capital."

Under the Collins Amendment of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, most trust preferred securities were excluded from banks' regulatory Tier 1 capital. The spirit of the Collins Amendment was to improve the "quality" of regulatory capital by excluding most trust-preferred shares and cumulative preferred shares, because these types of capital offered less flexibility to banks' management. If a bank decides to suspend dividend payments on cumulative preferred shares, the dividends accrue in arrears. If dividends on non-cumulative preferred shares are suspended, the company never has to pay the dividends to investors.

The Federal Reserve's proposed rules last June were considered a "capital-treatment event," allowing the banks in many instances to repurchase outstanding trust preferred shares at par value. This was very painful for some investors, since they not only lost very attractive income streams, but many took capital losses since they had paid significant market premiums for the trust preferred shares being redeemed.

Among the largest U.S. banks, JPMorgan Chase ( JPM) led the way with $9 billion in trust preferred share redemptions in early July, all at face value, with nearly $4.2 billion having coupons higher than 6.5%. Bank of America ( BAC) later in July redeemed $3.9 billion in trust preferred shares, all of which had coupons of 6% or higher, with $2.3 billion paying over 7.3%. Bank of America did pay a premium on the redemption of $1.8 billion of the trust preferred shares.

Many regional banks had no choice but to take similar actions, including BB&T ( BBT) of Winston-Salem, N.C., which redeemed $3.1 billion in trust preferred shares in July. Of that total, $350 million paid a fixed rate of 8.10%, while $575 million paid a fixed rate of 9.6%. BB&T issued $1.2 billion in non-cumulative preferred shares during the third quarter, with a coupon of 5.625%.

Boosting ROE


Harralson rates Cullen/Frost "underperform," with a price target of $54, even though he considers the company to be a "high-quality bank." The analyst said in a report on Jan. 31 that he saw "minimal near-term negative catalyst to send the stock materially lower," but that he also expected the shares to underperform the market because of their high valuation.

Harralson on Thursday said it was "surprising to us that CFR would repurchase at this level, with the stock at two times tangible book value and 15 times next year's earnings." He also estimated that the preferred issuance and common share repurchase will be "less than 1% accretive to 2014 EPS" and will increase the company's return on tangible common equity by about 50 basis points in 2014. Cullen/Frost reported a return on average equity of 10.03% for 2012.

When considering which other small-cap and mid-cap companies might consider issuing perpetual preferred shares in order to fund common-share buybacks and lower their cost of capital, Harralson wrote that "although we feel buying back stock at two times tangible book value is not always a good thing, we are generally favorable on this type of transaction, as it provides a meaningful boost to both return on tangible common equity and EPS."

Here are five possible candidates for similar transactions, which KBW's analysts say "have the size to issue non-cumulative preferred," shares, while also having high Tier 1 common equity ratios:
  • Bank of Hawaii (BOH) of Honolulu. The shares closed at $49.14 Wednesday, trading for 2.2 times tangible book value, and for 14.1 times the consensus 2014 EPS estimate of $3.47.

    KBW analyst Jacquelynne Chimera said in a report on Thursday that "we do not see BOH as likely for this transaction, although its non-common Tier 1 slug is not filled out as of yet." This means the company can still issue trust preferred shares and have them count toward Tier 1 common equity.

    Chimera also said Bank of Hawaii's capital level is "healthy" and that she expects the company to "continue paying out 75% to 100% of net income to shareholders." The bank pays a quarterly dividend of $0.45, for an attractive yield of 3.66%.
  • Bok Financial (BOKF) of Tulsa, Okla. The shares closed at $57.90 Wednesday, trading for 1.5 times tangible book value, and for 12.5 times the consensus 2014 EPS estimate of $4.62.

    KBW analyst Brady Gailey in a report Thursday called the company "another high-quality bank with significant Tier 1 common that could consider such an optimizing transaction," and added that "with its relatively cheaper-on-book stock price at 1.5 times, the deal would by 2% accretive to EPS."

    On the other hand, "BOKF is also sensitive to taking away float from its relatively thinly traded shares and has historically not been active repurchasing its stock at today's high $50 per share level," according to Gailey.
  • Commerce Bancshares (CBSH) of Kansas City, Mo. The stock closed at $38.77 Wednesday and traded for 1.7 times tangible book value, and for 13.2 times the consensus 2014 EPS estimate of $2.94.

    KBW analyst Christopher McGratty on Thursday wrote that a transaction similar to Cullen/Frost's "could look good on paper, but management prides itself on the transparency of its all-common capital base and has never had non-common capital."
  • Hancock Holding Co. (HBHC) of Gulfport, Miss. The shares on Wednesday closed at $31.61, trading for 1.6 times tangible book value, and for 12.1 times the consensus 2014 EPS estimate of $2.62.

    According to Harralson, the company "is perhaps the best positioned to execute a CFR-like transaction -- especially given the relative valuation of the shares." The analyst also thinks that Hancock could wait for an acquisition opportunity to issue preferred shares.
  • Signature Bank (SBNY) of New York. The bank's shares closed at $76.15 Wednesday, trading for 2.2 times tangible book value, and for 15.8 times the consensus 2014 EPS estimate of $4.82.

    McGratty wrote that "while Signature looks like a candidate on paper, SBNY is a growth company that has never paid a dividend, let alone repurchased shares."

-- Written by Philip van Doorn in Jupiter, Fla.

>Contact by Email.

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 TheStreet.com 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.

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