In its third-quarter 2010 earnings report, Milwaukee-based Marshall & Ilsley Corp. reported a loss of $169.2 million. The loss was a significant improvement over the $248.4 million loss the bank holding company had in the same quarter one year earlier, but it was the bank’s eighth consecutive quarterly loss.
Many of the earlier losses at M&I Corp. and its largest subsidiary, M&I Bank, have been driven by loan losses related to the housing markets in Arizona and Florida. However, in the third quarter this year, one loan in the hospitality sector in the company’s commercial and industrial (C&I) sector drove the loss.
“Without this relationship, loan loss provision and net charge-offs were down substantially from the second quarter and the same period last year,” said Mark Furlong, M&I’s president, chief executive officer and chairman. “We will remain diligent in continuing to improve our credit profile, but our attention will increasingly shift toward a return to profitability and growth opportunities.”
Two days after M&I Corp. made its third quarter announcement, Standard & Poor’s Rating Services lowered its rating for the company to BB+/B from BBB-/A-3. The ratings agency also lowered its counterpart credit ratings on M&I Bank to BBB/A-3 from BBB/A-2. S&P’s outlooks on both entities remain “negative.”
In its announcement about the lowered ratings, S&P said it believes that net losses could continue at M&I for the next several quarters.
“We think the net reduction in nonperforming assets in recent quarters largely results from the high level of net charge-offs and aggressive loan sales activity, although we view favorably the significant decline in net inflows of nonaccrual loans,” the S&P report stated. “Furthermore, we see continued pressure on capital ratios given that we expect net losses to persist. The rating action also reflects, in part, our review of the bank’s recent financial performance, which has lagged our expectations and those of certain similarly rated large regional bank peers, in our assessment.”
Several Milwaukee-area banking analysts and many others who watch financial stocks agree. They say that pressure may be building on the bank’s board of directors and management.
“I’ve felt that for a long time with the management and board of directors. When will they be held responsible?” said George Reis, president of Two Rivers-based GVR Investment Management. “If (M&I) were truly an independent, publicly traded company, I don’t think this would be tolerated. In sports, when you keep losing, a head or heads have to roll. It’s one quarter after another.”
The bank’s management and its board of directors should be replaced, Reis said, because of the continued pattern of losses over the last two years.
“Where is the credibility of management and the directors to give us comfort that (the bank) is going to be turned around?” Reis said. “We talk about corporate governance. This lands right on the board of directors. And quite frankly, I’ve been saying for some time that management should have been replaced, or at least some of it should have been.”
During its announcement of its third quarter earnings, Dennis Kuester, chairman of the board of directors at M&I, announced his retirement from the chairman position. Kuester remains a member of the board.
Greg Smith, M&I’s chief financial officer and senior vice president, said the bank’s board and management have not taken the company’s losses lightly and believe the bank and its holding company are headed in the right direction.
“Whether it be myself, senior management or the board, we’re all focused on the (bank’s) turnaround and recovery,” Smith said. “In terms of this quarter, one relationship in the hospitality sector certainly crowded out a lot of other trends for the quarterly performance. Once you take that out, you can see our continued credit quality improvement. Even with that relationship, we saw our nonperforming loans improve for the fifth consecutive quarter, down 34 percent from their high water mark.”
Still languishing
M&I’s loan loss provision was its lowest since the third quarter of 2008, and its net charge-offs were the lowest since the first quarter of 2009, Smith said. The bank also has significantly reduced its construction and development portfolio. That now makes up 9 percent of its loans, compared to 23 percent at its peak.
The bank has not returned to profitability as quickly as it projected earlier this year, Smith said, but it believes it will do so next year.
“Our return to profitability has not been as quick as we hoped, but it has been largely driven from the weakness of the economic recovery as much as anything else,” he said. “If you go back to the beginning of 2010, we all thought we would have had a stronger economy (at this point), and that pushes our recovery into next year.”
M&I’s stock price remains depressed, compared with historic levels. Last week, it was trading in the $5.70 per share range. The stock traded in the $35 range in early 2008.
According to one analyst, the bank’s stock will likely face additional downward pressure in the near future, as it will likely be forced to raise capital to begin repaying its Troubled Asset Relief Program (TARP) loan. Interest rates on TARP loans increase to 9 percent when the loans become five years old.
Takeover target?
Because M&I’s stock is not likely to rise significantly, it could become an attractive acquisition target in the near future, several other analysts say.
“The banking sector is going to consolidate greatly in the next few years,” said Bill Fitzpatrick, an equity analyst with Milwaukee-based Optique Capital Management Inc. “Very few (institutions) will be immune to this. They (M&I) are a target, and so are all of their banking peers. They have a disgruntled shareholder base, a lot of value has taken a hit, they’ve got an excellent market position in Wisconsin – all aspects of a prime takeover target.”
In September, UBS analysts identified M&I among 39 companies as potential takeover targets. The analysts said a “plausible buyer” of M&I could be U.S. Bancorp, the Minneapolis-based parent company of U.S. Bank.
However, several factors will likely hold off potential suitors for M&I for at least six to nine months.
“Because they have such poor visibility, some legacy assets on their balance sheet and TARP, all of those will weigh on a borrower (or acquirer),” Fitzpatrick said. “They’ve got to wait until they return to profitability, where some assets may be sold off or paid off. They’ll get more for their stock then than they’ll get now. Any takeover is not likely in the next six months.”
David Krause, assistant professor of finance at Marquette University and director of its applied investment management program, said the pace of mergers and acquisitions is likely to grow in 2011 because of large cash reserves held by many companies and private equity firms.
However, uncertainty created by the Dodd-Frank financial reform bill will keep acquisitions within the financial sector to a minimum for the next six to nine months, as regulators begin crafting the actual rules within the regulation, Krause said.
“The regulations haven’t been written yet,” he said. “Now that we know who will be the chairs of the committees, in the next six to nine months we’ll know what aspects of the law will not be as strong, and which will be more strong. In this space, until the financial regulations are determined, there will not be a lot of consolidation. Give it nine months and then the banks will have some clarity.”
