How do investors see the banking sector right now, and why are they buying bank stocks?
Most of the tone is fairly optimistic and bullish. You want to own bank stocks when you’re going through a credit recovery cycle. Mergers and acquisitions is another big theme that stimulates investor interest.
What are some of the factors that will drive bank stock valuations in 2011?
It’s early yet, but the names that are outperforming so far are those that still are seeing declines in nonperforming assets, declines in reserve levels and net interest margin improvement.
How will M&A drive stock values?
With valuations at trough levels for some decent banks, not specifically broken banks, but banks in good markets, with good deposit share, I think there is a great investment opportunity to own a basket of potential sellers.
How much M&A activity do you expect this year?
I expect considerable amount and even more in 2012 and beyond. My outlook for the economy is still going to be low growth, especially for the banking sector. Banks are going to have to grow through consolidation. They’re going to have to grow through collapsing the cost structure.
It’s been a couple of years since we had a strong M&A market. Do you think investors still remember that not all acquirers are created equal and that an acquisition can destroy value if it’s not executed properly?
We’re reminding investors about exactly your point. You want to be in a position to own the acquirers that have shown a track record of managing the capital base well, extracting earnings power, getting the costs out, and being mindful of the cultural differences within the banks. I think this year will be a year where any M&A is almost good M&A, but a higher level of scrutiny will be placed on deals the further we get into this cycle.
How did investors react to the Dodd-Frank Act?
The elevated expense structure is probably going to prevent banks from achieving 15 percent return on equity or 1.5 percent return on assets, which they historically produced. You’re going to get volatility in the near term. Partially, that’s because we don’t really know what the profit model is going to look like for banks.
How do investors feel about the higher capital requirements for the industry?
Investors think the capital levels are too high, and they want to see these banks deploy it or leverage it as much as they can. The investment community has much more foresight and vision than the regulatory community. The regulators are looking in the rearview mirror and saying, “We need to build capital now.” I think the investors have it right, quite frankly, and the regulators have it wrong.
In an environment like this, I thought we’d see more emphasis on efficiency. I can remember a time, five to seven years ago, when there was a premium in your stock if you were a low-cost operator. Is this something that investors are focused on?
Banks are not very good in general about finding ways to cut the expense line when they see revenue decreasing. I would argue banks, in general, are still overstaffed. From a technological perspective, they still haven’t embraced efficiencies in processes and procedures. I think that’s a theme that’s not being talked about very much right now, but I think it will emerge as a much more important factor as we continue with low revenue growth.
Are there a couple of banks historically that have a reputation for being good low cost operators?
The one that comes to mind is (Paramus, New Jersey’s) Hudson City (Savings Bank). These guys operate at an 18 to 22 percent efficiency ratio.
“With valuations at trough levels for some decent banks—not specifically broken banks—but banks in good markets, with good deposit share, I think there is a great investment opportunity to own a basket of potential sellers.”