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What's ailing Indiana's banks?: State-based bank stocks are trailing national peers as industry deals with tough period

May 14, 2007

Indiana bank stocks have taken a beating on Wall Street over the past year, lagging behind larger peers as the entire industry rides out an unfavorable environment.

Shares of Indiana's 16 publicly traded banks dropped an average of 3 percent from May 4, 2006, to May 4, 2007, according to research by Carmel-based banking consulting firm Renninger & Associates LLC.

Meanwhile, the nationwide SNL Financial bank index was up 4.4 percent. During the same period, the Dow Jones industrial average rose 16 percent.

Statewide, the worst losers were Fort Wayne-based Tower Financial Corp., which saw its stock plummet 22.7 percent; Indianapolis-based First Indiana Corp., which fell 17.5 percent; and Columbus-based Irwin Financial Corp., which dropped 11.8 percent.

Only one Indiana bank, Monroe Bancorp, saw its stock mirror the Dow's performance. The Bloomington-based bank's stock rose 15.2 percent.

Analysts and bankers say the slide can be blamed on a number of factors. A major culprit is a squeeze on interest-rate spreads, the difference between what it costs banks to borrow money and the rate they can charge customers who borrow from them.

The spreads traditionally are the breadand-butter of banks, particularly small ones that have fewer opportunities to branch into more diverse methods of making money.

Other issues conspiring against Indiana's banks are concerns about the subprime mortgage market, lower housing starts and alarming foreclosure numbers, along with the widely held view that the Midwest has limited potential for shortterm economic growth.

"There's less momentum in slowergrowth states," said Mike Renninger, principal of Renninger & Associates. "More vibrant markets are going to trade at higher multiples."

Indiana also is a crowded market with dozens of competitors, many of which have expanded aggressively in recent years. Local bankers are looking for ways to hold on until the banking environment takes a turn for the better.

"Good bankers will go back to the basics," said Bob Jones, president and CEO of Evansville-based Old National Bancorp, the largest bank headquartered in Indiana. "Good bankers will focus on credit quality and watch their costs. That's what gets you through difficult times like this."

Old National has seen its stock dip 9.7 percent over the last year. To cope, the bank is watching costs closely, refocusing associates on selling and serving clients and pulling back the reins on expansion in Indianapolis, a market Jones said has become "a little hyperkinetic."

In lean times, larger banks are able to lean more heavily on insurance, brokerage services, overseas lending and corporate banking services, said John Reed, a banking expert and executive vice president of Chicago-based investment firm David A. Noyes & Co.

For instance, shares of JP Morgan Chase & Co. were up 14 percent over the past year, and Bank of America Corp. was up about 3 percent. Even Midwest powerhouses such as Ohio-based National City Corp., which was down about 3 percent, and Fifth Third Bancorp, which was up about 3.5 percent, have been able to ride out the rough rate environment better than smaller banks. And Indiana is flush with smaller banks, thanks in large part to latearriving deregulation.

"[The larger banks] have been able to diversify quite well and are not nearly as affected by tight interest-rate margins," Reed said.

Long-term rates now are basically the same as short-term rates, or even inverted. That puts a crimp in the fundamental way banks make money-by borrowing at a lower rate than they lend.

The challenge was more pronounced during the first three months of 2007, Reed said, when listed banks in Indiana had a median stock price decline of 6.5 percent. The NASDAQ bank index, meanwhile, was down 4.5 percent.

Irwin Union Bank also is focusing on the fundamentals during what has been the longest span (12 to 18 months) with an inverted yield curve anyone can remember, said Brad Kime, the bank's president.

"It's just challenging from a marginmanagement perspective," he said. "Obviously, if we have narrower margins, it means less income growth, and less attractive of a stock price."

Kime expects the slide could lead to more consolidation in the industry. There are about 7,500 banks in the United States, down substantially from the 1980s, but there's still room for consoli- dation, he said.

If things don't improve, the slide could provide an opening for large out-of-state banks to swallow more of Indiana's financial institutions. As banks struggle, executives feel pressure from shareholders to show growth in other ways-including through mergers and acquisitions.

"When the potential seller's price is suffering, it does open the door to them being approached by an entity whose stock is not as punished," said Renninger, whose firm specializes in mergers and acquisitions.

The numbers make it easy for banks to stretch too far, said Old National's Jones.

"I've been in banking 27 years, and I've never seen an extended rate environment like we've had," he said.
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