Big Changes at PrivateBancorp: One Bank Stock Worth a Look

Name a bank stock that's beating the S&P 500 this year. It's OK. I'll wait.

There are still a few, even after the double whammy of the Bear Stearns (BSC) and the Fannie Mae (FNM) / Freddie Mac (FRE) debacles.

For a notable exception, check out PrivateBancorp (PVTB). The small Chicago-based regional caters mostly to wealthy Midwesterners and managed to outperform its peers even as the spread of problems in housing crimped mortgage lending, credit markets, and basic banking activities of all stripes. Shares may have fallen 6 percent year to date, but that's better than a 12 percent loss in the S&P 500 and a whopping 22 percent drop in the KBW Bank index (KBE).

The reason behind some of that (relative) strength is this: During one of the worst downturns in banking history, PrivateBancorp decided to go on a massive hiring spree.

Last year, Bank of America (BAC) bought LaSalle but seemed more interested in its retail operations and less than interested in LaSalle's midsize corporate lenders.

The shakeup threw loose a small army of talent, and PrivateBancorp pounced, hiring more than 100 bankers since last November, including Larry Richman, a LaSalle veteran now installed as PrivateBancorp's new president and CEO.

"You had a mass exodus of highly skilled bankers who had strong relationships with middle-market companies," said Ben Crabtree, a Minneapolis-based analyst with Stifel Nicolaus.

The arrangement is nothing if not unique. It's essentially a team with experience managing a $75 billion bank jumping ship for a tiny institution (PrivateBancorp had $4.1 billion in loans in 2007). It's almost unheard of for such a small fish to swallow a bigger rival, especially when the entire banking sector is facing its worst year in decades.

Richman paints the jump as an opportunity to keep the long-standing LaSalle team together in a familiar locale.

"We'd worked together for between 15, 20, 25 years plus as a team. With the changes in the Chicago banking market, it created the opportunity to build an important local, commercial-relationship bank," he says. "It's an opportunity to do something special in a market that has provided us with an opportunity."

It also drastically changes the PrivateBancorp story for investors.

Basically, buying the stock is a bet that all the LaSalle folks will bring already solid business relationships along with them and push PrivateBancorp to the next level in terms of size. That is indeed happening at a rapid pace. As of 2006, the bank's total loans were $3.5 billion. As of the second quarter, they're $6.4 billion and are widely expected to head well north of $7 billion by year's end. About 75 percent of the new business came from the LaSalle bankers, the company said.

Richman doesn't put a number on year-end loan growth but says growth will be manageable because his bankers are able to court a huge base of existing clients.

"Growth in loans is coming from clients that are new to the bank but aren't new to our bankers," he said. The job—shift old business to a new company—also lets the firm be a bit pickier with the business it tries to transfer to the new bank.

Early results

So far this year, all those new bankers are earning their keep. In the second quarter, growth looked absolutely stunning. Loan growth exploded by 25 percent compared with the first quarter (not the year-ago quarter, where that sort of number would still look pretty good given tough times in the sector). Most loans were commercial and industrial, rather than for riskier commercial real estate or construction hit by the housing and credit crisis (the mix was $882 million, $217 million, and $83 million).

Shares jumped as much as 17 percent on July 29 when earnings were announced, despite the fact that paying for all the new talent continues to result in bigger losses (see conference call transcript). Quarterly results show that the bank's large-scale poaching comes at an uncertain price. Salary and benefit expenses in the quarter jumped to $31.8 million from $12.7 million. Basically, analysts are waiting to see if the new team can turn in good results. The bank had told investors its plan would mean some near-term pain (Richman calls 2008 an "investment year"), but analysts trimmed their estimates after a loss of 40 cents a share in the quarter missed Wall Street's expectation of a 24-cent loss.

Skeptics also look at the amount of capital needed to keep growth on track. So far, deposit growth has kept pace with lending, but the company has also handed out $310 million in equity during the second quarter. More capital-raising could be on the way. That's likely to be a bit dilutive for shareholders, but, to the bank's credit, investors should take heart that most other banks issuing equity right now are acting out of desperation as they struggle to keep enough capital on hand to fund huge losses and bad loans, not grow the business.

"The fact is, the stock has way outperformed the bank sector, even while its earnings have been significantly lower than almost any of us expected," Crabtree says. He rates the stock a "hold."

Crabtree says the stock is currently being valued more like a growth name and less like a bank. He writes:

"It's being traded by people who manage growth portfolios and want some kind of financial stock in their portfolio," he says.

Eventually, it's the uncertain performance of all that lending that will keep some analysts from declaring the ambitious reworking of the bank a success. There, analysts are split.

"Expenses, margins, and credit costs really pushed back the time frame for any sort of break-even for the LaSalle hirings," said Daniel Arnold, an analyst at Sandler O'Neill. He has a "sell" rating on the stock.

Others predict a more rapid rebound.

JPMorgan Chase analyst Steven Alexopoulos sees a loss of 75 cents this year, bouncing back to a $1.30-a-share profit in 2009.

Part of the split is a lack of clarity on loan quality. With the absolute size of the bank's loan growth soaring, it's tough to track what sort of trouble might have existed in older loans or predict how all the new loans generated by the LaSalle folks will do in the future. Loans, after all, don't go bad right away unless a banker is doing an awful job.

Net charge-offs for bad loans were $6 million in the quarter or 0.42 percent of average loans, higher than the bank's historical levels but well below its rivals.

Richman says he's taken an "active" view of any credit problems in the existing loans and says any losses are "manageable" because of the higher quality of the bank's wealthier client base.

Which brings up another point: Is it a good time to buy bank stocks at all?

To be clear: It's not. Calling the bottom of the credit and housing crisis is piling up a big body count on Wall Street among those willing to bet the worst is over. Analysts expect this stock to be volatile as long as troubled credit markets and the weak economy keep the entire banking sector on the ropes. "The one concern I have is the economy is weak right now. Is now the time to be rapidly growing your loan portfolio?" asks Oppenheimer analyst Terry McEvoy.

Disclosure: none

Comments

[22thoroughbred:]

It seems everyone assumes that if a bldg. has a teller window they will be insolvent in 90-180 days, not true. Yes, some will be and some should already should have been, but if able to do some digging it is possible to find bank stocks that not only will survive but will do wonderfully, beside PVTB, which I don't own, I bought EWBC, FED, CFP, CNB, NBG and HOME all on July 18-20 and have done amazingly well, and I didn't buy to trade, I bought and will continue to buy for 18 months from now, be patient and do the work.

2008 Aug 12 05:25 AM