Texas banks, which had become known for trading at a “Texas premium” relative to the broader U.S. banking market, saw that premium evaporate in the first quarter of 2016. These banks hit a low on January 25, 2016, trading at 16 percent discount to the SNL U.S. Bank and Thrift index on a price to tangible book value basis. Texas public banks were down 25 percent year to date as of January 25, 2016 as the market threw the baby out with the bath water. This shift contrasted to the 50 percent to 70 percent premium that Texas banks had enjoyed over the broader U.S. banking market during 2013 and 2014.
As one might suspect, this lost premium greatly impacted Texas publicly traded banks’ ability to pursue acquisitions. The price that public buyers could offer to potential sellers was significantly lower if they intended to use their stock as part of the deal consideration. Yet prospective sellers’ price expectations remained the same despite the market sell-off, widening the bid-ask spread. Couple this with a general aversion to potentially inheriting someone else’s asset quality problems, a fear that was shared by both buyers and sellers, and M&A volume suffered as a result.
While the start to 2016 seemed bleak, the market sentiment has changed significantly since that low point in late January. Stock prices for Texas public banks have rebounded 54 percent. An investor brave enough to buy into Texas banks at their low point would have made approximately 106 percent on stock price appreciation alone. These returns are meaningful on their own merit, but compared with the S&P 500, which had returned 10 percent year to date through December 7, 2016, Texas banks have significantly outperformed the broader market.
There are four factors impacting this turnaround.
Oil Price Improvement
Just as everyone feared that there was no bottom to oil prices, prices began to stabilize and trend upward in the second quarter of 2016, up from the mid $20s in January. Crude has traded at $40 to $50 per barrel since April 2016. The improvement in oil prices has given significant relief to Texas banks via real economic impact on their balance sheets as well as market perception. The rebound and increased stability have given confidence to investors that the worst is over, and that the remaining impact to balance sheets is manageable.
Texas Economic Environment
Despite the negative impact lower oil prices have had on the Texas economy, overall conditions remain positive. The unemployment rate in Texas sits at 4.7 percent, still below the U.S. unemployment rate of 4.9 percent as of October 2016. The overall business-friendly environment continues to attract businesses to the Lone Star State in droves.
The Dodd-Frank Act
The Trump Financial Services Policy Implementation team has indicated that it will dismantle Dodd-Frank and replace it with new policies that encourage economic growth and job creation. While no one knows what that exactly will look like, the overall comments, if directionally correct, could result in a reduced regulatory burden for the community banking sector.
Steepening Yield Curve
The yield curve has been steepening since Donald Trump’s election win, as many market participants speculate that the Federal Reserve will be forced to take a more aggressive stance on raising rates to fight inflation. This steepening yield curve will greatly benefit community banks that largely rely on spread lending for a signification portion of their income. In the roughly 30 days following Trump’s election win, the 2-to-10 year curve steepened by 23 basis points. The 10-year Treasury itself increased 46 basis points, from 1.88 percent to 2.34 percent as of December 7, 2016. This represents a 24 percent increase in yield over a very short time period.
Given significant improvement in the Texas banking landscape, we expect that bank M&A is back on the table as a viable option for board and management teams considering their strategic options. The significant improvement in public valuations will allow public buyers to use their stock as a currency and assist them in bridging the bid-ask spread between buyer and seller. We also suspect that with a number of large public banks that have been sidelined over the past year, there is pent up demand for larger bank M&A. So while we expect the aggregate number of transactions to increase, we also suspect that the transactions will be larger than most deals have been year to date. It should be an interesting and exciting 2017 for the Texas banking sector.