For someone who has covered the banking industry as long as I have (hint: I wrote my first banking story in 1986), these are among the best days to be a banker—or director of a bank—that I can remember. Profitability is high, as is capitalization, and the industry is gliding on the updraft of a strong economy and lower taxes.
The current health of the industry was apparent from what we did not talk about at Bank Director’s Bank Board Training Forum, which took place on May 9-10 in Nashville. There were no sessions about deteriorating loan quality, or the best way to structure a loan workout program, or the need to raise capital. Indeed, our managing editor, Kiah Lau Haslett, wrote a story that published Friday on this website warning against the perils of complacency.
When your biggest challenge is guarding against complacency, you’ve definitely found yourself in tall cotton.
It’s worth drilling down a little bit into the industry’s strong fundamentals. In addition to the continuation of a strong U.S. economy, which will be a record expansion if it continues much longer, banks have also benefited—more than any other industry—from last year’s steep cut in corporate tax rates, as well as a modest rollback of regulations in the Dodd-Frank Act.
Joseph Fenech, managing principal and head of research at the investment banking firm Hovde Group, explained during a presentation that thanks to the tax cut, both return on average assets and return on average tangible common equity jumped to levels last seen prior to the Great Recession. And not only has deregulation had a measurably positive impact on the industry’s profitability, according to Fenech, it has also brought new investors into the sector.
“It’s really driving change in how investors think about banks,” he says.
The only bad news Fenech offered was his assessment that bank M&A pricing has peaked. From 2008 to 2016, stocks of the most active acquirers traded at a premium to book value while many distressed targets traded at a discount, which translated to favorable “deal math” for buyers, according to Fenech. Deal pricing began to edge up from 2016 to 2018 as more acquirers came into the market. Many transactions had to be priced at a premium to book value, which began to make the deal math less favorable for the buyer.
Generally, the higher the deal premium, the longer it takes for it to be accretive. Since the beginning of this year, says Fenech, many investors have become wary of deals with high premiums unless they are clearly accretive to earnings in a reasonable period of time. Undisciplined acquirers that overpay for deals will see their stocks shunned by many investors.
This new dynamic in bank M&A also impacts sellers, who now may receive a lower premium for their franchise.
“I think the peak pricing in bank M&A was last year,” says Fenech.
An important theme during the entire conference was the increased attention that board diversity is getting throughout the industry. Bank Director President Mika Moser moderated a general session panel discussion on board diversity, but the topic popped up in various breakout sessions as well. This is not always a comfortable discussion for bank boards since—let’s face it—most bank boards are comprised overwhelming of older white males.
For many proponents, the push for greater board diversity is not simply to accomplish a progressive social policy. Diverse groups usually offer a diversity of thought—and that makes good business sense. Academic research shows that diverse groups or teams make better business decisions than more homogenious groups, where the members are more inclined to affirm each other’s biases and perspectives than challenge them. Larry Fink, the chairman and CEO of Blackrock—the world’s largest asset manager—believes that diverse boards are less likely to succumb to groupthink or miss emerging threats to a company’s business model, and are better able to identify opportunities that promote long-term growth.
The banking industry still has a lot of work to do in terms of embracing diversity in the boardroom and among the senior management team, but I get the sense that directors are more sensitive—and more open to making substantive changes—than just a few years ago.
The Bank Board Training Forum is, at its core, a corporate governance conference. While we cover a variety of issues, it’s always through the perspective of the outside director. James McAlpin, Jr., a partner and leader of the financial services client services group at the law firm Bryan Cave, gave an insightful presentation on corporate governance. But sometimes the simplest truth can be the most galvanizing.
“The responsibilities of directors can be boiled down to one simple goal—the creation of sustainable long-term value for shareholders,” he says. There are many decisions that bank boards must make over the course of a year, but all of them must be made through that prism.