The Shape of Banks: Part I

by Nancy Bush, NAB Research for Banks Street Partners

As we go into 2018 and face the realities of the American political and economic landscape — global headline risk, capital markets that are rocketing skyward (and provoking debate about valuation and bubbles in the process), and the rise (and fall) of new and mysterious currencies, among other things —it’s often hard to see how this pivotal year may play out. The newly-enacted tax bill will likely result in enhanced economic activity at the same time that we may see the Congress turn blue in a “wave” election. At this juncture—who knows how 2018 will go?

But there is one thing that we can say without hesitation or equivocation—the banking industry will continue to grow and change in the coming year. We think that the present state of rising bank earnings—the actuality of lower taxes combined with the likelihood of a period of faster growth and better loan demand—should power a year of good bank stock performance and growing returns to shareholders. In the banking industry, that is an environment that inevitably gives rise to enhanced “animal spirits”, and those spirits also inevitably manifest themselves in greater merger activity. 

It’s hard to believe that there could be more deals—and bigger ones—in 2018 than there were in the fevered deal environment of 2017, but we believe that could indeed be the case. For one thing, the large regional banks—which have been largely quiet on the deal front in the years since the Financial Crisis—may finally see a window of high stock prices and regulatory forbearance that will encourage them to do deals of some size. It has long been speculated, for example, that exemplary regional banks like U.S. Bancorp might finally make a move toward multi-regional dominance—and we would point to the western U.S. as the place they would most likely go—and there are others who would like to similarly expand their footprints. And while BB&T CEO Kelly King said recently that his bank will remain focused on organic growth in the near future, our belief remains that for that acquisitive bank, it is only a matter of time.

Readers know well the story of the emergence of the “mega-community” segment of banks here in the Southeast, and the tremendous success of companies like Pinnacle Financial Partners (PNFP), South State Corporation (SSB), Ameris Bancorp (ABCB), United Community (UCBI), Center State (CSFL), and others in making significant moves into new markets and into new businesses. That trend will continue unabated in 2018 (note—we did not say “may continue”), and indeed will likely quicken if the regional banks begin making incursions into the region. Terry Turner of Pinnacle Financial has already said that his company will likely be acquiring again after a two-quarter hiatus to consolidate their 2017 acquisitions, and we believe that this is likely the year that Center State (now completing two in-state deals) may choose to move out of Florida and into the Atlanta marketplace. Under any scenario, more deals are coming, and more may indeed be a LOT more in 2018. 

We have been bank analysts long enough to worry that periods of rapid merger activity might result in regrets down the road, and we hearken back to the pre-crisis years when the nation’s largest banks were being formed.  Readers can easily remember the torrid pace of deals in the late 1990’s, when the pattern was do a deal, slam the companies together, gather a few expense saves, declare victory—and then on to the next one. After a hiatus in the early 2000’s in the wake of the Tech Bubble and the events of September 11, 2001 deal activity and prices rose again through 2006—the acquisition of Golden West Financial by Wachovia in that year marks the apotheosis of that “why not?” time for us—and then we all know how it ended (in tears) in 2008-2009.

We want to make very clear that we (thus far, anyway) see no—repeat, no—similar warning signs in the deal activity so far in the mega-community segment, and indeed most of these deals seem to have been unusually thoughtful in their planning and execution. In almost all instances, attention has been given to expanding into contiguous markets where the customer bases are well understood and the acquirers can bring an enhanced set of products and sales skills immediately into play. The execution trend has been prompt but measured and efficiency and capital ratios have seen little (and largely temporary) impact from even the larger acquisitions.

But with our strong belief that “forewarned is forearmed”, we took the time to talk to some banking industry insiders—including some regional bank CEOs who have done their share of large deals—about the lessons that they had learned throughout their careers and about the ways that “this time may be different” in a period of rapid consolidation. Those observations surprisingly all centered upon the concept of “process”, and there was a general belief that there will simply be a greater emphasis on processes as the key to deal execution and minimization of risks during a time of rapid consolidation.

How about the regulatory view of the frenetic deal activity in this segment? We spoke with one industry observer who is very familiar with the regulatory view of community banks, and his observation was that there will be increased scrutiny from both Wall Street and from regulators as these companies continue on their acquisition programs. He sees one area of regulatory concern as the acquisition of specialty business lines within acquired banks—especially lines like indirect auto lending, where a “marginal borrower” is often the customer—and the regulators will require that such activities be “professionalized” by strong talent and systems. Indeed, the whole risk management process (note that the word “process” pops up again) for these companies is being emphasized right now, and the regulators have “sharpened their pencils” in the approval process.

Well, so far and so good on the mega-community growth path and on what we may see in 2018, and we are somewhat mollified on our concerns in this area. But that still leaves one big question—what happens to all those community banks that get left behind? And especially what happens to the community banks under $1 billion in assets, a size that has been deemed uneconomic by many industry observers? That’s why we have deemed this piece to be Part I of “The Shape of Banks to Come”. Stay tuned for Part II, where we will tear into the subject of the fate of the smaller community banks.

To read NAB Research’s disclosures for the preceding commentary, please follow this link:

http://www.BushOnBanks.com/disclosure.shtml

This commentary was provided by Nancy A. Bush, CFA of NAB Research, LLC and is being distributed by Banks Street Partners, LLC. The views of the author do not necessarily represent the view of Banks Street, and Banks Street has neither directed nor had editorial oversight over the content. Material in this report is from sources believed to be reliable but no attempt has been made to verify its accuracy. Past performance is no guarantee of future results. Banks Street Partners actively seeks to conduct investment banking in the financial institutions and services sector, including with the companies listed in this report. To learn more about Banks Street Partners, please visit www.BanksStreetPartners.com.