2004 - Analyst Interview covering:
First State Bancorporation (FSNM)

Interview with:
Peyton N. Green, Senior Analyst, Financial Institutions Group
FTN Midwest Research Securities Corp.

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First State Bancorporation is looking to build a Colorado franchise that mirrors what they have done successfully in New Mexico

Regional Banks

Analyst Interview Covering:
First State Bancorporation (FSNM-Nasdaq)
9700 Jefferson N.E.
Albuquerque, NM 87109
Phone: 505-241-7500

Peyton N. Green
Senior Analyst
Financial Institutions Group
FTN Midwest Research Securities Corp.

Interview conducted by:
Lynn Fosse
Senior Editor

February 2004

Peyton N. Green

Mr. Green is a graduate of The University of the South where he received a B.S. in Natural Resources in 1993. Mr. Green began his career in the brokerage industry in 1993 and has been a research analyst since 1996. As an equity analyst he has focused on the banking industry since 1998.

Most recently, Mr. Green joined FTN Midwest Research’s Nashville, Tennessee office where he has been responsible for building the firm’s coverage of small and mid cap financial institutions since August 27, 2001. His current coverage universe includes 29 companies with market capitalizations of $100 million to $2.6 billion and is geographically focused in the Southeast and Midwest with some exposure in the Northeast. Previously, Mr. Green was responsible for bank and thrift and insurance research at an employee owned broker-dealer headquartered in Birmingham, Alabama. He has been routinely quoted in newspapers, business journals, and banking industry publications, both nationally and throughout the Southeast, about both general industry and specific company issues.

For his stock picking in 2002, Mr. Green was recognized as a Top 10 Stock Picker in the United States by NASDAQ-STARMINE 2002 Analyst Award Winner survey. Also, he was listed as a Top 5 analyst for Stock Picking Among Under-Covered Stocks in the NASDAQ-STARMINE survey. In May 2003, Mr. Green was listed as the third best among 97 analysts that covered Banks and S&Ls in The Wall Street Journal’s Best on the Street survey for his stock picks in 2002.

CEOCFOinterviews: Mr. Green, will you tell us a little about the companies you follow, how many and geographic areas?

Mr. Green: “I cover approximately twenty-nine companies; and usually twenty-five to thirty depending upon whether we have had some takeovers. These are primarily companies in the southeast and Midwest; that is the lion share of our coverage. I do have several companies in the northeastern part of the country.”

CEOCFOinterviews: Does this cover the financial services area?

Mr. Green: “Yes, it is primarily regional banks, and small and mid cap community banks.”

CEOCFOinterviews: How long have you been following First State Bancorporation and what attracted you to them initially?

Mr. Green: “What attracted me to First State Bancorporation, was the company’s relatively small position in New Mexico but also its emerging position. It is “the local bank” vs. several out-of-state banks that have consolidated the market over the nineties, through several mergers and acquisitions by each company. Typically, what we have seen in the past is that this usually provides an opportunity for someone to take market share and build their own franchise. What was exciting is that they had invested in building a franchise from a single branch in the Albuquerque area, into a footprint now that has about 15 branches today. So over the last decade they built a footprint that basically was non existent, into one that can now compete effectively.”

CEOCFOinterviews: What is it about First State that has allowed them to do that, and that will allow them to continue to do that in the New Mexico area?

Mr. Green: “I think that their focus is not all things to all people. First State is focused on banking small and commercial sized businesses and the owners of the businesses. That doesn’t mean that they can’t transact retail business but their primary focus is to serve the small and mid market business customer that might not get a high level of service and attention, or in many cases, just not a consistent treatment from the large super regional banks and regional banks that have their headquarters elsewhere. What allows them to be competitive is their high service aspect of how they treat their customers.”

CEOCFOinterviews: What do they know that other banks don’t know?

Mr. Green: “I think what they have is a consistency of people that call and deal with their customers instead of a revolving door that often happens in the super regional banks that have much more turn-over. They are New Mexico based and they are focused. They are the hometown bank, I guess is the way to say it.”

CEOCFOinterviews: First State has gone into Colorado and Utah. How has that played out and how do you see that for the future?

Mr. Green: “I think that is still a work in progress.   It is too early to call it a success and it is too early to call it a failure. I think they are basically in the middle where they are in the process of finishing their overhaul of the Colorado franchise and creating something that is much more like what they have created in New Mexico, which is the small business and mid market commercial focus. This has been very successful for them on a de novo (a state member bank that has been in operation for five years or less) basis in New Mexico. Essentially, they are doing that in Colorado even though they have the acquisition. When they bought the company, the infrastructure wasn’t what they were going to continue with; they were going to overhaul it and they were going to relocate the branches and hire commercial bankers. The good news is that if the opportunity is good in New Mexico, it is very good in Colorado because there are many more small businesses and mid market companies and fortunately for First State and others, it has been consolidated by the super regional banks. You have the same kind of competitive landscape that you have in New Mexico but probably with more opportunity, particularly in the Denver and also an area like Colorado Springs where the company has had very good success.”

CEOCFOinterviews: What do you see as their challenges in getting that done successfully and why do you feel they are up to the task?

Mr. Green: “We would characterize their challenges as simply getting the performance ratios (i.e., ROA and ROE) of their Colorado operations up to the level of the New Mexico operations. We would characterize their New Mexico operation as high performing, while the Colorado operation is a work in progress with understated profitability because of the overhaul and re-staffing effort that management has undertaken. The opportunity is for First Community to be a bank that is as profitable and can grow as fast as First State has in the New Mexico side of the footprint over the past five years; going forward, achievement of this would imply loan and deposit growth rates of 10-15%-plus depending on the economy. We would characterize the First Community acquisition as one that provides a long-term growth opportunity for FSNM—to duplicate the successful small business and middle market service oriented bank that has allowed the company to grow its Albuquerque NM deposit market share to 9.3% from approximately 1% over the past eight years. Success should enable First State to generate 13-15% earnings per share (EPS) growth over the long-term. We expect earnings growth will come from a combination of balance sheet growth that exceeds 10%, which is primarily loans and deposits, and some improvement in the overall return on average assets (ROA), which could approach 1.2% over the next 3-5 years compared to 1.0% in 2003. The New Mexico business is maturing and they have some refinement that they can do there but it is essentially firing on all cylinders; it is a matter of getting Colorado up to where New Mexico is. With the re-staffing mostly completed, we believe First State’s Colorado operation (First Community) will gain maturity over the next two years once the branch relocations are completed in 1Q04. Both markets should provide for solid balance sheet growth but the Colorado opportunity should be particularly strong over a longer time frame of 5-10 years, considering the company’s low market share of less than 1% in its CO markets, which hold about $46 billion in deposits, or approximately 5x the size of its Santa Fe and Albuquerque NM markets combined ($9.1 billion in total market deposits).”

CEOCFOinterviews: I know management is certainly key in this situation; will you tell us about your assessment of the management at First State?

Mr. Green: “Management is very key when you go in and undertake an acquisition like they have, and there are very few situations like this and it is a situation where for a large extent they said, “we don’t want the acquired bank’s culture, we want to create the culture that we know but what we need is an earnings stream to get through the twelve to twenty-four month period that we have to overhaul the company.” That is not as common; most management that you hear would say, “The management of an acquisition candidate is key, as is the footprint.” They went about it a different way and said “we can’t afford to buy a high quality franchises that gets us into the geography, all those acquisitions are too high priced for us.” They looked at the situation and decided that was the way to go instead of just de novoing into Denver, Colorado Springs or one of the other front-range towns. That is a bit of a different approach; they volunteered for a difficult job and I think that says a lot about their nature, that they are willing to work hard and they are committed to working hard, instead of just sitting back and saying “we did a good job in New Mexico” and then just continuing to operate that. I think they really are long-term focused and oriented on managing a company that can generate 13 to 15% earnings over time.”

CEOCFOinterviews: What do you see for the banking industry in general?

Mr. Green: “Right now, we have come off a very strong almost three-year period in terms of bank stock prices; just about every bank we cover has doubled over that time frame. The earnings growth has been very good; until recently, we had about 13-14% earnings growth. In 2002, it was about 8-9% in 2003, and 2004 will be a tough year because interest rates are still low. Our thoughts are that interest rates will stay low a little longer rather than go up, even though the economy is improving, and that causes some margin pressure. Certainly for somebody like First State that is asset sensitive, and it makes it more difficult because they don’t have as much opportunity to re-price their deposits in the low interest rate environment but they still have some assets that are re-pricing lower compared to a quarter ago or a year ago. What they need to get the numbers going, is a higher interest rate environment and that is true of a lot of the commercial banks that we cover.”

CEOCFOinterviews: What are you looking for from First State as they go forward and what should potential investors be looking at?

Mr. Green: “First Sate Bancorporation has posted loan and deposit growth in excess of 15% per year in New Mexico for the last one, two, five, and ten year periods, which is very strong. We are looking for the company to continue to mine market share from larger regionals in New Mexico, admitting that the growth rate is likely to slow over the next two to three years; the slowdown in the growth rate in New Mexico should be more than offset by the ramp up in growth of First Community in Colorado. Specifically, loan and deposit growth rates were 28% and 18%, respectively, in 2003, compared to loan growth of 22% and deposit growth of 23% in 2002. Loan and deposit balances jumped by 25% and 21%, respectively, in 4Q03 versus 3Q03 levels on an annualized basis. No matter how you slice it, FSNM has consistently grown its balance sheet by 150-200% of the average small cap bank that we cover.

Perhaps more impressive, First State has done a great job of improving the quality of their deposit base as noninterest bearing deposits represented 22.5% of total deposits at year-end 2003 compared to 17.5% a year ago. Noninterest bearing deposits are the hardest deposits for a bank to attract; for a commercially focused bank like First State, we believe that 37% growth in noninterest bearing deposits in 2003 (which followed 39% year-over-year growth in 2002) proves that the company is wresting away banking relationships from its competitors, not just transactions. We are glad to see banks that can generate 10-15% noninterest bearing deposit growth year-in and year-out, much less ones that generate 20%-plus growth. Such exceptional growth does not just demonstrate that they are getting core commercial relationships from other banks, but that they are hitting the ground, asking for the business, and getting it. We do not believe they would get the business if they weren’t doing a good job as full-service bankers. Going forward, the key for First State will be to show the same level of execution in Colorado that they have in New Mexico. The nature of the Colorado operation was that the deposit base was very CD oriented and very high-cost, relative to the core relationships that First State likes to get. First Community was retail oriented rather than commercially focused. This is why First Community had to be re-staffed. First State’s business model revolves around providing high quality service to commercial customers and getting their total banking (loan and deposit) relationship; time will tell if the lending/relationship officers that they have hired will deliver the whole relationship or transactions. Considering that the deposit side usually lags the loan side when a relationship moves over, it is really too early to tell how successful First Community will be. To date, only one of First Community’s branches has demonstrated initial success.

It makes sense that First Community’s Colorado Springs location is the first branch that has demonstrated some success as it was the first one to be totally re-staffed and relocated. Over the last year, the Colorado Springs location generated $8 million in noninterest bearing deposits (up from $0) and approximately $100 million in loans, which is very good considering they closed on the acquisition on October 1st of 2002 and completed the repositioning of this location in 2Q03. Management believes that they could be as successful in Denver once they get the remaining branches relocated, which should happen by the end of 1Q04. The key focus for investors in 2004 should be—are they growing noninterest bearing and low interest deposits in CO? They are still going to run-off some CDs, but it is about how much success they are having once they relocate the branches and once they have their commercial lending/relationship teams in place. That is the second half of 2004; the first half of 2004 is a transition period much like 2003 was.”

CEOCFOinterviews: It seems they know what they have to do and how to do it; it is just a matter of the time it takes to get it done!

Mr. Green: “I think that is exactly right; if there was a misjudgment on their part, it simply was that it would take longer than it did and they probably had to go through more of the employment base than they thought they would have to. They understood that they had to radically overhaul First Community and that wasn’t a surprise but it would take   18-24 months instead of 12-18 months. Over a three to five year period, that extra six months is not a big deal. Sometimes analysts like ourselves, are caught into this quarters results vs. next quarter and what is it going to look like three years from now.”

CEOCFOinterviews: Will you comment on the stock price valuation?

Mr. Green: “Currently FSNM is trading hands for 15.1x our 2004 earnings per share (EPS) estimate of $2.10. We are looking for EPS growth to accelerate in 4Q04, which is approximately six to nine months after the branch relocations are complete, and to continue into 2005. It is really a 2005 story, as our EPS estimate of $2.60 represents 24% year-over-year growth in 2005 vs. 7% year-over-year growth in 2004, assuming our estimates prove correct. Considering the slowdown we foresee in 2004 versus the 18% EPS jump experienced in 2003, the shares could tread water until investors see proof that the First Community overhaul/re-staffing process is complete and beginning to pay-off; however, once that happens, we think that earnings momentum should come back because balance sheet growth won’t be strong on just the New Mexico side but on the Colorado side, too. That should enable people take more of an optimistic view about the one to two year period instead of being concerned about the next one to two quarters.”

CEOCFOinterviews: In closing, can you tell us your current rating for First State?

Mr. Green: “We have a Buy rating on First State Bancorporation’s stock; we think the management will be successful in building the Colorado franchise that mirrors what they have done in New Mexico. It is not necessarily a mid year 2004 outlook; it is more of a long-term outlook. It is more of a three to five year call but we believe that is going to lead to earnings per share growth in the 13-15% range that is sustainable over a three to five year period, which is above average compared to the 10-11% that we normally see small caps generating.”

I, Peyton Green, certify that the views expressed in the research report(s) accurately reflect my personal views about the subject security. Further I certify that no part of my compensation was, is, or will be directly or indirectly related to the specific recommendations or views contained in the research report(s).

*FTN Midwest Research Securities Corp. (MWRE) makes a market in this security. Although this information has been obtained from sources which we believe to be reliable, we do not guarantee its accuracy, and it may be incomplete or condensed.  All herein listed securities subject to availability and change in price. FTN Financial Group and FTN Financial Capital Markets are divisions of First Tennessee Bank National Association. Equity research is provided by MWRE. FTN Financial Securities Corp. (FFSC) and FTN Financial Capital Assets Corporation are wholly owned subsidiaries of First Tennessee Bank National Association. MWRE is a member of the NASD and SIPC. FTN Financial Group, through First Tennessee Bank or its affiliates, offers investment products and services, including investment banking services.  Past performance is not indicative of future results. Changes in any assumptions may have a material effect on projected results. BUY: Improving fundamentals and identifiable catalysts in place expected to drive results ahead of expectations. TRADING BUY or SELL: Identifiable catalyst in next 90 days expected to move the stock; longer-term fundamentals not compelling (no L-T catalyst). NEUTRAL:  No catalysts to drive the stock higher or lower. SELL: Deteriorating fundamentals and identifiable catalysts in place expected to drive earnings below expectations. An affiliate of MWRE received investment banking related compensation from BARI, BKBK, BKUNA, CATY, CBC, CBKN, CCOW, CORS, CPF, EWBC, FINB, FLB, FLBK, FNB, GBBK, HBEK, IBCA, LION, NARA, OKSB, PBKS, PCBC, PHC, PNFP, PVTB, REBC, SBIB, SBKC, STSA, SWBT, TSFG, UBSI, WCBO, and WSBC in the previous 12 months.


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