Bank stock rally could fuel more M&A, stock issuance

Bank stocks are trending higher this summer, and advisers say it could encourage banks to transact in common equity raises and M&A.

The S&P 500 Banks Industry Group index gained 17.5% between May 15 and July 15, and advisers believe bank stocks have even more room to run. Better-performing bank stocks give potential buyers more valuable currency in all-stock transactions, which could encourage those banks to act on any M&A aspirations, industry experts said in interviews.

Capital issuance could also increase on the heels of better bank stock performance, since a higher stock price is an incentive for a bank to issue new shares.

Banks' fundamentals seem to be in a good place as they report second-quarter earnings, KBW analyst Christopher McGratty said in an interview. Loan growth, credit quality, expense discipline and operating leverage are all generally healthy across the board, and all this makes investors feel more comfortable putting their money in bank stocks, he said.

"The capital markets are wide open," McGratty said. "Banks are buying back stock. So, all of that is leading to double-digit earnings per share growth."

Before banks begin acting on better stock performance, the market needs proof that this pricing is going to hold, Brean Capital LLC managing director Dan Flaherty said in an interview.

Banks' stock performance is not likely to change the pace of bank IPOs or capital issuance dramatically, but it is helpful, Piper Sandler Cos. co-head of financial services investment banking, Bill Burgess, said in an interview.

"And it's helpful for kind of sentiment and morale within the bank space more broadly," he said.

M&A help

When stock prices go up, valuation multiples go up and M&A activity follows suit.

"The math of, 'Hey, can we make this accretive to our shareholders?' That's gotten a little easier," McGratty said.

A higher valuation for a prospective seller could drive up its price expectations or make it seem less necessary to sell, Stephens Inc. managing director Frank Sorrentino said in an interview.

That said, the pricing divide between buyers and sellers usually has more to do with the headline price at announcement than the percentage ownership position the seller receives in the acquiring company, Burgess said. So, when the buyer's stock price goes up, it can make the offer look more attractive even if the exchange ratio is lower, he said.

McGratty and Sorrentino both said there is a perceived "shot clock" for banks to transact before the end of the current administration and associated regulatory regime.

The more accommodating regulatory environment could survive a change in administration in 2028, but if a bank has any intention of acting, now is a good time to do so, McGratty said.

Conversations are plentiful right now, but few have translated into announced deals, Sorrentino said.

"Similar to last year, you're probably going to see a spurt of deals in the back half here, especially with where stock prices are," he said.

Capital moves

It will be interesting to see whether capital raising returns when bank share prices are higher, Flaherty said.

"Common equity, I think that's something to keep your eye on," he added.

Ironically, this green light to raise capital comes at a time when most banks have more capital than they need, experts said.

Many are at multi-decade highs for capital ratios, and should be buying back stock, McGratty said. With returns on equity statistics around 15% and average growth rates of 5%, many such banks will have capital left over after paying their shareholders dividends, he added.

Banks only benefit from buybacks to a certain extent, Sorrentino argued. He tells his clients that even if a bank does not need the capital immediately, raising capital can be helpful if it can be deployed over the next two to three years.

Fast-growing institutions such as Isabella Bank Corp. and Wintrust Financial Corp. could take advantage of the market to raise capital, Burgess said.

"If there's a great window, which there's a really nice window now to raise, you might want to do that even if you don't have a direct use for it," Sorrentino said, "because markets can open and close very, very quickly."