A soft landing and continued low unemployment rates. The promise of coming interest rate cuts. A recent surge in bank valuations. A renewed wave of fintech-driven innovation. The potential for a long-awaited rebound in merger-and-acquisition activity.
There are plenty of reasons for bankers and their boards to feel optimistic about the year ahead — but also more than a few challenges — and they’re all on display at Bank Director’s 2024 Acquire or Be Acquired Conference. This year’s annual event has attracted more than 1,600 bank leaders to Scottsdale, Arizona, to learn more about industry trends — and to network and talk deals.
Thomas Michaud, CEO of investment bank Keefe, Bruyette & Woods, kicked off the conference with an overview of conditions confronting the industry. The failures last spring of three large regional banks, combined with rate-driven margin pressures and worries about the economy and credit quality, cast a pall over the industry through most of 2023. Some of the best-run banks were trading below book value.
The turning point, Michaud said, occurred with a lower-than-expected inflation report on November 14. The KBW Nasdaq Bank Index surged 6% in one day. It was as if many of the worries investors had about the industry began to fade. In just the fourth quarter, the average tangible book value per share jumped 7%.
Michaud said there’s more to come. He anticipates two rate cuts in 2024, the first coming sometime in the summer, and three more in 2025. That might not be as robust as some bankers want, but things are moving in the right direction and investors are responding.
“Given that forecast, we think it’s likely that the negative operating leverage banks have been experiencing — revenue growth less expenses — will turn,” he said.
Challenges loom. Margins remain under pressure, while credit quality and stepped-up regulatory scrutiny are concerns.
Even so, the sense of anticipation for better times — and an accompanying surge in M&A activity — is palpable. The promise of lower interest rates and recent surge in bank valuations has bankers and their boards getting their ducks in a row so they can strike quickly when opportunity arises.
“When the dam breaks on M&A, it’s going to be a rush,” said Robert Fleetwood, co-chair of the financial institutions group at law firm Barack Ferrazzano Kirschbaum & Nagelberg LLP. “People want to be sure they’re positioned to take advantage because [after] that initial wave happens, there could be a lull.”
The external environment always plays an outsized role in bank M&A, and this year is poised to be no exception. The difference is that the stars appear to be aligning for a long-awaited uptick in activity.
Speakers throughout the day cited a variety of reasons why banks could consolidate more aggressively this year: nonbank and fintech competition, CEO succession issues, restive shareholders and the power of scale to drive profitability.
Private equity firms, big enough to absorb the risks of a $2 billion loan on their own without syndicating it, continue to make inroads in areas like commercial and industrial credits. Just four of the top 10 mortgage lenders today are banks, compared to eight 15 years ago.
One telling slide in Michaud’s presentation showed that banks with assets below $10 billion, and those in the $80 billion to $120 billion range, had normalized returns on tangible common equity (ROTCE) of below 13% and were priced near tangible book value. Those above $120 billion had ROTCEs north of 16% and were valued between 1.2 times and 1.5 times tangible book.
“The banks with scale have higher profitability and better valuations than those that don’t,” he said.
Another issue driving consolidation is CEO succession. Data shared by KBW showed that the average CEO age of M&A targets was 67, compared to a median of 61 for the industry as whole. Chief risk officers, Fleetwood said, are often even tougher to replace.
As for disincentives to greater deal activity, look no further than Washington, D.C. Regulators, burned by the failures of Silicon Valley Bank, First Republic Bank and Signature Bank, have extended the times between merger announcements and closings to all-time highs, with some prospective deals languishing for more than 17 months.
Perhaps more daunting are proposals to lower the asset threshold for banks classified as systemically important to $100 billion from $250 billion. Michaud said a $100 billion bank could spend $50 million to $100 million extra per-year on compliance if such a proposal was enacted.
The dynamic of extra regulatory costs has bankers thinking hard about getting bigger — and doing so well in advance of any deal. “If you cross $10 billion, you need to get to at least $12 billion to break even on the costs,” said Al Laufenberg, a KBW managing director.
“The public markets understand that the costs are very significant,” Laufenberg added. If you want to cross that threshold, “they want to know the plan.”
While headwinds remain, the attractive pricing means that if there’s a strategic reason for a merger, it will go through. Banks looking to sell would be smart to consider not only their valuation but also where the potential buyer’s stock sits.
If a bank is offered 1.3 times tangible book but the buyer is valued at 1.5, then it might be about the same as a bank being offered 2.2 times book value by a bank trading at 2.5 times book.
“There are still really good banks trading at nine- or 10-times earnings,” Michaud said. “On a relative basis, the industry remains super-cheap.”