Research — Sept 30, 2024
Bank boards capitulating, pushing for scale to combat challenges
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The operating environment remains challenging for many banks, but experts at Raymond James' annual whole loan conference in September 2024 noted that there is a growing acceptance and willingness to pursue deals to counter the headwinds facing the group.
In the latest "Street Talk" podcast, three veterans at Raymond James — John Toohig, head of whole loan trading; Bill Sammon, head of financial services capital markets; and Bob Toma, managing director in financial services investment banking — discussed the highlights of the event, including the outlook for bank earnings, the health of the consumer, the threat from institutions' exposure to commercial real estate and the impact of lower rates on future performance. The group also discussed how the fundamental environment will impact sentiment among investors and bank boards, the recent rebound in M&A and capital raising activity, and the potential for more deals.
M&A activity has picked up modestly from anemic levels over the last 18 months. Sammon said there is an understanding at many banks that it is hard to keep shareholders happy in the current fundamental environment. He said many bank management teams and their boards came into 2024 thinking they did not want to play defense for another year and begin pursuing deal conversations with other banks.
"I think those conversations have been happening for a long time. But I think what we saw at the beginning of 2024 was just this mentality of enough is enough," Sammon said. "I think that's what's pressing this is we need to find a way to provide reasonable returns given the balance sheet risks we have. And a lot of that is going to come through getting bigger."
Raymond James' Toma, who has been one of the active bank deal advisers this year, noted that many banks have struggled to grow profitability on a stand-alone basis and began to position themselves with other partners early in 2024. He said investors have kept capital on the sidelines to fund deals that bring earnings accretion.
"Banks wanting to get together because margin pressures aren't going away. Even with the relief in rates, we're going to struggle to see [margins] rebound in a significant way, and most community and regional banks have 75% or more of their revenue driven by spread," Toma said. "The need to get scale hasn't gone away. In fact, it's probably increased in urgency."
Toma said investors and acquirers are focused on not buying tomorrow's problems in a deal today but noted that credit quality has remained strong and not served as an impediment to deal activity thus far.
Investors have been skeptical of banks' exposure to commercial real estate, particularly those with elevated CRE concentrations. The shift to hybrid work has challenged the cash flows associated with some income-producing properties, particularly in the office space. Many borrowers also face the looming threat of trying to refinance maturing credits at notably higher rates.
Raymond James' Toohig put together a panel of originations and distressed real estate investors at the whole loan event and noted that he expected the group to share a negative view, but ultimately, he came away feeling more optimistic about banks' CRE portfolios. Toohig said there are a few strategic sellers on specific properties, particularly those in the class B and C office arena in center city districts, that show up in headlines, but most depositories are not seeing the end of the world.
"All parties, even those more opportunistic buyers, are saying, listen, we're just not seeing the deal volume that we thought we were. We aren't seeing capitulation," Toohig said.
Toohig noted that loan modifications, often referred to as "extend and pretend," have mitigated problems. He said certain institutions will take their loss and move on, but many others are more focused on keeping borrowers afloat through various modifications, including allowing for interest-only payments, reductions in principals or extension of maturities. Toohig said the prospect of lower interest rates could help credit quality as well.
Lower rates and resiliency in bank credit quality have brought some investors back into the bank group, Sammon said. He said investors are not "sounding the all-clear bell" but have started to dip their toes back in the water as they see an increased likelihood that credit will hold up.
He further noted, though, that investors continue to pay up for scale and have assigned higher valuations to larger banks. Years ago, Sammon said the most highly valued banks had roughly $8 billion to $9 billion in assets — large enough to be seen as competitive but small enough to avoid key regulations seen as punitive. But that has changed in recent years as investors believe the path to higher returns lies in building scale.
"If you are a community bank in the United States and somebody asks you or if you're an investor in those companies, somebody asks you, what's the right size today? In almost every case, the answer is bigger. And there's not a number that you are ultimately working for. It's just getting larger," Sammon said. "I really don't think that, that theme is likely to go away, certainly for the foreseeable future."
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This article was published by S&P Global Market Intelligence and not by S&P Global Ratings, which is a separately managed division of S&P Global.