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Despite concerns about the core lunch business, we believe that – for now – the company continues to execute so well in other day parts that we remain positive on all three durations (TRADE, TREND, TAIL).  Yesterday’s results were impressive but the stock’s reaction tells us how high expectations are for MCD.


There is so much to admire about McDonald’s top line performance, but there is just one issue that keeps nagging me and I keep thinking when it will become a bigger focus of the street attention.


I have been thinking about the core lunch business declining for a year now.  But the growth in breakfast, snacks and nontraditional day parts has overshadowed this issue.  At the company’s analyst meeting last November the issues around lunch were obvious but did not seem to cause much concern for analysts and investors.


On yesterday’s earnings call there were two questions that were asked that got at the issue and the company side-stepped the topics on both occasions.  The first question was on “building capacity” in the restaurants and the second was on traffic trends.  Don Thompson answer was telling on this issue, as he talked about the growth in nearly every day part but lunch.


In response to a questions on consumer movement Don Thompson said that there were a couple of things that the company focuses on.  “…One of which is day part analyses. So as we look at day parts like evenings and breakfast, do we see – are we seeing more momentum in some of those day parts, which typically starts to, if you correlate that with some of the unemployment numbers and some of the hired numbers, the new job numbers, it tends to help us a little bit. We see a little bit of movement. I mean, our evening day parts were pretty strong comp and breakfast has been a pretty strong comp for us.”


What about lunch?  After all, that is the core business.  To figure out the bear case on when MCD sales trends are going to slow, it’s important to keep in mind capacity constraints at breakfast and the afternoon and evenings.  Knowing that lunch is an issue, a breakdown of MCD comp performance is telling of how much the company is reliant on the non-traditional day part.


FY11 Comp = +4.8%

Price = +3.0%

Guest Count = +3.3%

Implied mix = -1.5%


Today’s traffic drivers are causing the decline in the mix of business, but that is more than offset by the growth in incremental traffic.  For the time being none of this matters, but it will.  The question is when?


Turning to yesterday’s results, when a company beats on EPS, margins, and prints global comps of 9.6% for December, the stock only goes down if expectations were very high.  For the time being, though, we remain positive on MCD.


The phrase, “expectations are the root of all heartache” comes to mind.  McDonald’s traded down yesterday despite producing a stellar 4Q.  EPS came in at $1.33 versus consensus $1.29, McOpCo restaurant margins came in at 18.7% versus 18.6%, and same-store sales easily exceeded expectations in December.  Please see below for the same-store sales and quadrant charts updated for today’s results.








MCD: WHEN WILL LUNCH MATTER? - mcd apmea dec



In terms of the top line in the U.S., which remains the company’s most important market, we believe that the company will continue to take market share from competitors.  The company is growing internationally and China, one focus of expansion, saw 4Q comps come in at +15.6% with double-digit traffic.  From an investment standpoint, the company’s 12 month yield of 2.57% and global diversification attracts the “flight-to-quality” investor.  That said, we do not believe that the fundamental story is over for McDonald’s.  


While it is impossible to know exactly what brought the stock down today, there are concerns around G&A, FX headwinds, and interest expense.  We believe that these factors are transient.  The increase in G&A is related largely to items particular to 2012, some of which will in fact help sales in during the year and beyond, and we expect strong top-line momentum to continue in early 2012.  Until we gain more clarity on real fundamental issues coming to the fore, we remain positive on MCD.



Howard Penney

Managing Director


Rory Green




Re-Shape The Debate

This note was originally published at 8am on January 20, 2012. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“I am trying to re-shape and improve my central position.”

-John Maynard Keynes


After getting publically steam-rolled for his failed government “stimulus” experiments of the late 1920s, that’s what Keynes finally admitted to Hayek in 1932. Keynes went on to tell Hayek that changing his views is “probably a better way to spend one’s time than in controversy.”


Classic. Can you imagine if Ben Bernanke and Larry Summers had it in them to change their central planning strategies as the facts have? Sadly, you probably can’t. That’s the anchor of Academic Dogma in our Ivy League towers that will take time to creatively destruct.


Keynes, of course, used willful blindness to alternative economic strategies like Hayek’s just as well as Bernanke and Geithner do: “Keynes admitted in a Treatise on Money that ‘in German, I can only clearly understand what I already know – so that new ideas are apt to be veiled from me by the difficulties of the language.” (Keynes Hayek, page 139).


It’s a good thing Albert Einstein was able to Re-Shape The Debate of his time in English…


Back to the Global Macro Grind


Solution - the 3 core factors our team focuses on from a Fundamental Macro Modeling perspective when we look at countries are:


Since our models have actually worked in calling the big Growth and Inflation turns for the last 4 years, we think it’s high-time to Re-Shape The Debate on how leaders (running countries, companies, or trading P&Ls) consider these 3 factors.


Rather than compounding Keynesian mistakes in forecasting Growth and Inflation by slapping random multiples on the economic growth that countries do or do note generate (with a 30-80% tracking error in their forecasts), this is what we do:

  1. Measure the Slope (accelerating or decelerating) of Growth and Inflation
  2. Apply Predictive Tracking Algorithms to all Growth and Inflation data we can find to generate an estimated range of outcomes
  3. Hammer out the reps each and every morning across all of Global Macro to adjust our models for any new Growth/Inflation data

Then, on a risk adjusted basis, we decide if there is:


A)     An acceleration in the existing slope (going from good to great is the same thing as going from bad to toxic)

B)      A deceleration in the existing slope (going from great to good is the same thing as going from toxic to bad)

C)      A centrally planned policy to attempt to arrest the gravitational force of the slope


Hopefully I didn’t lose you yet (I didn’t write it in German, but it’s math – which, seemingly, Bernanke and Summers should understand even if I wrote this in Mandarin-Canadian).


If I did lose you, here’s what it means in term of what’s changed from a Fundamental Macro Modeling perspective since we’ve made an explicit change in our call on Global Macro markets in December (we’re long Growth (Equities) and out of Fixed Income):

  1. GROWTH: US, Chinese, and German Growth (our Big Mac-cro 3) have all decelerated at a slower rate = bullish
  2. INFLATION: Globally, we’ve seen a Deflation of the Inflation (US CPI dropped from 3.4% NOV to 3.0% in DEC) = bullish
  3. POLICY: Bernanke/Geithner haven’t been able to debauch the US Dollar and Germany is being fiscally/monetarily conservative

What would make our models change back to the bearish side (i.e. Growth Slowing re-accelerates on the downside and Inflation re-accelerates on the upside)?

  1. Ben Bernanke goes to Qe3
  2. Obama and Geithner go way left on fiscal spending
  3. Germany folds to French demands for Euro bonds (money printing) and bank bailouts

After 4 long years of Jobless Stagflation, look at what getting Bernanke, Geithner, and Sarkozy out of the way is doing – yesterday’s US jobless claims print of 352,000 was the best jobs number we’ve seen since March of 2008!


Strong Dollar = Stronger Consumption (inflation deflates), Stronger Confidence, and Stronger Employment. Period.


Whoever is begging Bernanke for policies to inflate (Qe3) is effectively begging for my model to break down (begging for Inflation to accelerate and slow real (inflation adjusted) US, Chinese, Brazilian, etc. Consumption Growth).


If you’re an exporter in Michigan, you don’t like this. If you’re making BMW’s in Germany, or putting gas in yours in New Jersey, you love it. The only people that want weak currencies are the people who need them to get paid.


Rather than having CNN focus a US Presidential Debate on “open marriages”, it’s time to get real in this country. It’s time to get serious about the evolution in our economic thinking. It’s time to Inspire, Re-work, and Re-Shape the Real-Time Economic Debate.


My immediate-term support and resistance ranges for Gold, Oil (Brent), EUR/USD, US Dollar Index, Shanghai Composite, German DAX, and the SP500 are now $1640-1672, $109.85-112.11, $1.26-1.30, $80.19-80.97, 2263-2353, 6260-6467, and 1293-1315, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Re-Shape The Debate - Chart of the Day


Re-Shape The Debate - Virtual Portfolio



TODAY’S S&P 500 SET-UP – January 25, 2012


As we look at today’s set up for the S&P 500, the range is 21 points or -0.81% downside to 1304 and 0.79% upside to 1325. 













US DOLLAR – We #SOTU Word Scored the entire speech last night and the US Dollar was not mentioned once. #FairShare had 5 mentions and #Capitalism = 0. Just words, but they matter – Even the NYT and BBC ran #FairShare in their headline this morning. It’s just not good for our Strong Dollar case. Clinton and Regan both rolled w/ Strong Dollar, Strong Consumption (ie 71% of US GDP).


TREASURIES – stocks lost all of their Pre-#SOTU speech Apple momentum and have gone red this morning as UST Bond Yields fall a few beeps and the Yield Curve compresses by 3 basis points d/d. If you had to score the speech on Growth, it didn’t score well either. 10yr UST Yields of 2.03% is the most important Global Macro line in our model right now. If we snap it, I’ll get more defensively positioned.


GLOBAL EQUITIES – at about 6PM last night we thought the futures had it right and Apple was going to bust a move taking the SP500 to a fresh YTD high – no dice. Instead we are looking at what’s called an Outside Reversal from Monday (testing new highs intraday of 1322, failing, and closing at/below prior closing high). Asian, European, and Latin American stocks are at risk of doing the same.

  • ADVANCE/DECLINE LINE: 236 (-262) 
  • VOLUME: NYSE 742.71 (2.74%)
  • VIX:  18.91 1.29% YTD PERFORMANCE: -19.19%
  • SPX PUT/CALL RATIO: 1.78 from 2.24 (-20.54%)


  • TED SPREAD: 52.35
  • 3-MONTH T-BILL YIELD: 0.03%
  • 10-Year: 2.04 from 2.06
  • YIELD CURVE: 1.81 from 1.83

MACRO DATA POINTS (Bloomberg Estimates):

  • 7:00am: MBA Mortgage Apps, week of Jan. 20
  • 10:00am: House Price Index (M/m), Nov., est. 0.0% (prior - 0.2%)
  • 10:00am: Pending Home Sales (M/m), Dec., est. -1.0% (prior 7.3%)
  • 10:30am: DoE inventories
  • 11:30am: U.S. to sell $35b 5-yr notes
  • 12:30pm: FOMC rate decision, est. unchanged at 0.25%
  • 2pm: FOMC to release projections of economy, fed funds rate
  • 2:15pm: Fed’s Bernanke to hold press conference


      • Rep. Gabrielle Giffords to resign today
      • House, Senate in session
      • 8am: House Oversight subcommittee hears from General Motors CEO Dan Akerson and NHTSA Administrator David Strickland on Volt vehicle fires


  • More than 2,500 business, political leaders gather at World Economic meeting this week. More Davos coverage
  • Roche Holding made hostile bid of $44.50-shr, or $5.7b for Illumina to bolster cancer-drug sales
  • Apple shares rose in German trading after profit doubled, putting it on track to surpass Exxon Mobil as world’s most valuable company
  • President Obama pushed drilling for gas in shale rock and support for cleaner energy in State of Union
  • Obama also proposed new plan to help borrowers reduce monthly mortgage payments
  • Facebook trading on secondary markets may be suspended for 3 days
  • FOMC plans to release a policy statement at 12:30 p.m. in Washington after 2-day meeting. Central bank for the first time will release forecasts from participants for the main interest rate at 2pm, Bernanke plans to hold a press conference 2.15pm
  • Apollo Capital, Riverstone Capital said to consider $7b joint bid to acquire energy assets from Kinder Morgan: New York Post
  • German business confidence jumps to 5-mo. high
  • U.K. economy shrank more than forecast in 4Q, leaving Britain on brink of recession
  • Ericsson drops to 3-yr low after earnings miss est.
  • Starwood Hotels President Matthew Avril said in interview in Davos occupancy rates in U.S. hotels are back above their level before the financial crisis started
  • International investors say capitalism is in crisis, with almost one in three backing radical changes to the system: Bloomberg survey


      • Wellpoint (WLP) 6 a.m., $1.11
      • TE Connectivitiy (TEL) 6 a.m., $0.70
      • Praxair (PX) 6:01 a.m., $1.37
      • Textron (TXT) 6:30 a.m., $0.34
      • Xerox (XRX) 6:45 a.m., $0.33
      • Motorola Solutions (MSI) 7 a.m., $0.82
      • United Technologies (UTX) 7 a.m., $1.46
      • Dover (DOV) 7 a.m., $1.04
      • General Dynamics (GD) 7 a.m., $1.99
      • Corning (GLW) 7 a.m., $0.33
      • RLI (RLI) 7 a.m., $1.13
      • Rockwell Automation (ROK) 7 a.m., $1.21
      • US Airways Group (LCC) 7 a.m., $0.03
      • MeadWestvaco (MWV) 7:05 a.m., $0.26
      • Abbott Laboratories (ABT) 7:24 a.m., $1.44
      • Boeing (BA) 7:30 a.m., $1.01
      • Delta Air Lines (DAL) 7:30 a.m., $0.38
      • Hess (HES) 7:30 a.m., $1.26
      • Molex (MOLX) 7:30 a.m., $0.41
      • Occidental Petroleum (OXY) 7:30 a.m., $1.96
      • St Jude Medical (STJ) 7:30 a.m., $0.84
      • Automatic Data Processing (ADP) 7:30 a.m., $0.68
      • Allegheny Technologies (ATI) 7:30 a.m., $0.54
      • Southern (SO) 7:30 a.m., $0.30
      • Exelon (EXC) 8 a.m., $0.88
      • WW Grainger (GWW) 8 a.m., $2.12
      • New York Community Bancorp (NYB) 8 a.m., $0.27
      • ConocoPhillips (COP) 8:30 a.m., $1.80
      • Varian Medical Systems (VAR) 4 p.m., $0.75
      • LSI (LSI) 4:01 p.m., $0.11
      • Owens-Illinois (OI) 4:02 p.m., $0.46
      • Symantec (SYMC) 4:04 p.m., $0.41
      • Lam Research (LRCX) 4:05 p.m., $0.30
      • Netflix (NFLX) 4:05 p.m., $0.54
      • SanDisk (SNDK) 4:05 p.m., $1.26
      • Citrix Systems (CTXS) 4:05 p.m., $0.76
      • First Cash Financial Services (FCFS) 4:05 p.m., $0.69
      • E*Trade Financial (ETFC) 4:05 p.m., $0.21
      • Raymond James Financial (RJF) 4:08 p.m., $0.53
      • Stanley Black & Decker (SWK) 4:20 p.m., $1.29
      • Noble (NE) 4:33 p.m., $0.49
      • Murphy Oil (MUR) 4:47 p.m., $1.41
      • Jacobs Engineering Group (JEC) Aft-mkt, $0.70


  • Gold Proves Safest as Goldman Forecasts Record: Riskless Return
  • Oil Falls a Second Day as U.S. Supply Gain Counters Fuel Demand
  • Copper Falls From Four-Month High on Debt-Crisis Growth Threat
  • Uralkali Ready to Cut Potash Output to Shield Price: Commodities
  • Corn Poised for Longest Winning Run Since December on Argentina
  • Cocoa Gains as Ivory Coast Supplies May Be Curbed; Coffee Falls
  • Rubber Climbs to 3-Month High on Yen Drop, Thai Price Support
  • Gold Drops a Second Day in London as Physical Demand Slows
  • Ethanol May Face Second Down Year on Oversupply: Energy Markets
  • Natural Gas Glut Foils Junk Utility Bond Rally: Credit Markets
  • Kazakhstan, Mongolia Increased Bullion Reserves in December
  • IMF Forecasts Bigger Declines in Non-Oil Commodities for 2012
  • Corn Isn’t Chicken Feed on South African Farms: Chart of the Day
  • COMMODITIES DAYBOOK: Uralkali Ready to Cut Potash Production






















The Hedgeye Macro Team

Early Look

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Relied upon by big institutional and individual investors across the world, this granular morning newsletter distills the latest and most vital market developments and insures that you are always in the know.


We’re higher on Macau and LV but lower on Singapore.  Going forward, a lot will ride on whether Singapore resumes growth and the incremental add from Sands Cotai Central.



Sands is reporting results on February 1st after the close, and we are projecting $2.55BN of net revenue and $909MM of EBITDA.  Our estimates are slightly higher than the Street: 3% above on net revenue and 2% higher on EBITDA.  Since the Q4 slowdown and seasonal market share loss in Singapore has been well telegraphed, we don’t expect that the quarter itself will be much of a stock driver.  The two big issues for us will be the 2012 Singapore growth rate – we’ll take the under vis à vis the Street – and the NET impact from Cotai Central.  The Street has a history of underestimating cannibalization. 



Our estimate for Macau property-level EBITDA and net revenues is 6% and 7% above the street at $439MM and $1.31BN, respectively.  More specifically, we’re ahead of the Street on Four Seasons and Venetian, and below the Street on Sand’s performance.  Venetian played a little lucky while FS and Sands experienced lower than “theoretical” holds.  Net/net, we estimate that EBITDA would have been $4MM better if hold was 2.85% across the Macau portfolio.



Venetian is projected to report net revenue of $765MM and EBITDA of $291MM, 4% and 9% above consensus, respectively.

  • Net gaming revenue of $658MM
    • $265MM of net VIP revenue     
      • RC volume of $12.6BN (up 7% YoY) assuming 23% direct play and a hold rate of 3.04%
      • Rebate rate of 94bps of 31% of hold
      • Assuming ‘theoretical’ hold of 2.85%, net revenues would have been $16MM lower and EBITDA would be $9MM lower
    • Mass table revenue of $334MM, up 23% YoY
      • Drop of $1.2BN and 28% hold
    • Slot win of $59MM
  • $105MM of net non-gaming revenue
    • $57MM of room revenue ($235 ADR/92% Occ/$216 RevPAR)
    • $19MMof F&B revenue
    • $61MM of retail, entertainment and other revenue
    • $29MM of promotional expenses
  • Variable expenses of $356MM
    • $303MM of taxes
    • $34MM of junket expenses assuming a commission rate of 1.21% (rebate + promoter expense )
  • $23MM of recorded non-gaming expense
  • $95MM of fixed costs, down 4% YoY but up from an estimated $88MM last quarter



We expect Sands to report net revenue of $328MM and EBITDA of $87MM, 3% and 6% below the Street, respectively.

  • Net gaming revenue of $320MM
    • $141MM of net VIP revenue     
      • RC volume of $7.9BN (up 5% YoY) assuming 15% direct play and a hold rate of 2.70%
      • Rebate rate of 92bps of 34% of hold
      • Assuming ‘theoretical’ hold of 2.85%, net revenues and EBITDA would have been $7MM and $4MM higher, respectively
    • Mass table revenue of $150MM, up 12% YoY
      • Drop of $750MM and 20% hold
    • Slot win of $29MM
  • $8MM of net non-gaming revenue
  • $184MM of variable expenses
    • $153MM of taxes
    • $21MM of junket expenses assuming a commission rate of 1.19% (rebate + promoter expense )
  • $4MM of recorded non-gaming expense
  • $53MM of fixed costs, up 10% YoY but down from an estimated $59MM in 3Q11


Four Seasons

We estimate $220MM of net revenue and $61MM of EBITDA, 33% and 17% above the Street, respectively.  Results would have been much stronger if not for the weak hold in the quarter.  1Q12 should be huge if the ramping trends we saw in 4Q continue or if we simply ‘quarterize' the December RC volumes and apply a hold rate.

  • Net gaming revenue of $189MM
    • $132MM of net VIP revenue     
      • RC volume of $7.25BN (up 58% YoY) assuming 25% direct play and a hold rate of 2.61%
      • Rebate rate of 78bps of 30% of hold
      • Assuming ‘theoretical’ hold of 2.85%, net revenues and EBITDA would have been $12MM and $9MM higher, respectively
    • Mass table revenue of $43MM, up 32% YoY
      • $113MM drop and 38% hold
    • Slot win of $14MM
  • $31MM of net non-gaming revenue
    • $9MM of room revenue
    • $6MM of F&B
    • $26MM of retail, entertainment and other
    • Promotional expenses of $10MM
  • $128MM of variable expenses
    • $96MM of taxes
    • $26MM of junket expenses assuming a commission rate of 1.15% (rebate + promoter expense )
  • $9MM of recorded non-gaming expense
  • $22MM of fixed costs, down 9% YoY but up from an estimated $19MM in 3Q11



We project $784MM of net revenue and EBITDA of $415MM, 1% and 2% below consensus, respectively.

  • Net gaming revenue of $630MM
    • $265MM of net VIP revenue     
      • RC volume of $12.1BN, up 49% YoY but down 28% sequentially
      • Hold rate of 2.9%
      • Rebate rate of 1.27%
    • Mass table revenue of $276MM
      • Drop of $1.2BN, up 30% YoY and 22.5% hold
    • $156MM of slot & EGT win
  • $154MM of net non-gaming revenue
      • $77MM of room revenue ($333 ADR/98.5% Occ/$328 RevPAR)
  • $133MM of gaming taxes
  • $228MM of fixed costs, flat sequentially or up slightly if you exclude the $6MM of one-time expenses from last Q



We estimate that Venetian and Palazzo’s net revenues will be $350MM with EBITDA of $96MM, which are 2% and 3% ahead of Street estimates, respectively.

  • Net casino revenue of $128MM
    • Table revenue of $112MM
      • Drop of $533MM, up 15% YoY and 21% hold
      • Interestingly, hold is always higher QoQ in 4Q since Venetian opened
    • $43MM of slot win
      • $491MM of slot handle, down 15% YoY and 8.7% hold
    • Rebates of $27MM or 5% of GGR
  • $112MM of room revenue - $174 RevPAR (up 13% YoY)
  • $133MM of gaming taxes
  • $134MM of F&B revenue
  • $23MM of promotional allowances or 15% of GGR
  • 10.5% YoY increase in operating expenses to $244MM – up $1MM QoQ



We expect Sands Bethlehem to report $109MM of revenue and $28MM of EBITDA, 9% and 18% above consensus estimates, respectively.

  • $98MM of gaming revenues
    • Table revenue of $31MM
    • $67MM of slot win
  • $11MM of net non-gaming revenue
  • $42MM of taxes
  • $39MM of operating expenses (flat QoQ)


The Macau Metro Monitor, January 25, 2012



Singapore CPI rose 5.5% YoY in December.  November CPI gained 5.7% YoY.



This is the first Lunar New Year since the recent taxi fare hikes in Singapore.  Taxi drivers said takings are generally about the same as last year's despite the higher rates.  For a minority, business is up by 10 to 15%, but that could be dependent on where they ply their trade such as at hotspots like the airport and Marina Bay Sands.  


Top Line Problems Are Harder to Fix

TCF Financial (TCB) put their revenue issues front and center in their 4Q11 report yesterday.  Separate from the expected $15M decline in card income from Durbin, fee and service charge revenue fell $7M as the new fee product that management had hyped turned out to be a debacle.  In all, the company saw a 21% sequential decline in total fee income (excluding gain on sale of securities and loans), a reduction of $25M. This top line weakness led to the company reporting a $0.10 quarter vs. expectations for $0.14. 


TCB's "innovation" (as they persisted in calling it in their remarks) was to charge depositors $28 per day whenever the customer has a negative balance, rather than a per-item NSF charge. Management has spent the last several quarters talking up their new system, including how much customers "love" it.  As it turns out, some customers dislike the fees so much that they're "changing their behavior" to avoid them and closing their accounts. The potential for bad press from the "innovation" is also high. For example, the Chicago Tribune carried a story last month about a teenager whose savings account balance of $4.85 had turned into a -$229.10 deficit after TCB assessed a monthly maintenance fee of $9.95 followed by a daily $28 fee for the next 8 days.  


The company had been running a pilot program in certain areas earlier in the year, then rolled out the initiative to everyone in 4Q, only to be met with a resoundingly negative reaction, as evidenced by the sequential revenue decline.  Where do they go from here?  Clearly, TCB could backpedal completely and revert to the old structure.  However, closed accounts are unlikely to come back.  The company promised additional "innovations" in 1Q12 (hopefully revenue-positive this time around) and expects the fee income to rise starting in 2Q12.  We expect that a new baseline has been established, and incremental revenue gains will be as challenging as ever.


TCB:  A REVENUE PROBLEM - TCB waterfall chart


Other items from the quarter:

- Net income fell slightly in the quarter, with 4 bps of NIM pressure. TCB was able to squeak out 9 bps of decline in deposit interest costs, driving an 8 bps reduction in total cost of interest-bearing liabilities, plus a further 4 bps decline from increased volume of non-interest-bearing deposits. Thus, they were largely able to offset the 8 bps of yield pressure they faced. This is largely consistent with the rest of the space, and underscores how hard the banks need to work to offset asset yield declines.  

- Credit remains an issue at TCB, despite the company's choice of accounting.  Since 1Q11, the company has been shifting delinquent borrowers into short-term modifications, and then rolling them into long-term modifications when the original modifications expire.  The long-term modifications can be up to 5 years.  In 4Q, residential TDRs increased to a new high of $433M, up $54M QoQ. We believe that the company ultimately will bear credit costs on these loans, the vast majority of which will not cure and resume paying the higher amount. With the use of TDR accounting, TCB postpones the costs and drags them out over a long period.  It's a good strategy for optical earnings, but doesn't change the true earnings power. 

- Loan growth is also an issue.  TCB reported the second-worst loan growth of all the regionals that have reported so far.  The following table demonstrates.


TCB:  A REVENUE PROBLEM - regional scorecard


Lowering Our Estimate

In light of this loss of revenue, we are lowering our 2012 earnings expectations to $0.49 from $0.73.  We are decreasing our estimate of their ability to offset lost Durbin revenue, efforts which management had promised in 1Q12. TCB is talking a good game about its need to reinvent itself, as its regional model has been hit hard by credit costs, legislation, and interest rate policy over the last five years.  However, such things take time, and we ultimately believe that 2012 earnings estimates need to come down significantly.  Prior to this morning's report, consensus expected $0.84 in 2012 - a high bar when the current run rate is $0.40.  


The Stock

While negative throughout 2011, we previewed the fourth quarter on January 12th with a relatively neutral disposition, as our estimate was more or less in-line with consensus, even though our full-year 2012 estimate was below the Street at $0.73 (vs consensus $0.87). Our argument at the time was that we didn't expect the company to lose money and with the stock was trading at 105% of tangible book value, downside in the stock was limited. Shame on us. The reality is that when estimates need to come down, the stock has downside, as this quarter clearly showed. Given the 4% sequential decline in tangible book value per share due to the goodwill brought on from the closing of the Gateway acquisition, the stock, even after the sell-off yesterday is trading at 101% of tangible book value. However, we are still below the Street. While we expect estimates will come down in the wake of the quarter, we'd be surprised if they come down to our $0.49 level. Until they do, we will maintain our bearish bias.  




Joshua Steiner, CFA


Allison Kaptur


Robert Belsky


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