A steepening of the yield curve brought a relief rally for bank stocks late in 2019. The prospect of further increases in long-term rates and improvements in efficiencies will drive the group in 2020, according to one longtime bank investor.
Bank stocks came under significant pressure in the summer of 2019, erasing many of the gains sustained in the early in the year as recession fears, in part related to a brewing trade war between the U.S. and China, hung over the market. The Federal Reserve responded by cutting interest rates, but long-term rates continued to fall even further, causing the yield curve to invert.
Anton Schutz, a senior portfolio manager at Mendon Capital Advisors, said in the latest Street Talk podcast that the "giant move" in the yield curve and concerns about the trade battle with China weighed heavily on the bank group.
In late August 2019, the SNL Bank and Thrift Index's price-to-earnings multiple fell to 10.7x last-12-months earnings — the lowest level in five years — from just more than 12x at the beginning of 2019.
Schutz said valuations simply fell too far in the summer, when the group became "oversold and underowned and hated." Eventually, the macroeconomic outlook improved, long-term rates rose, and the yield curve steepened. Bank stocks rallied with the change, jumping close to 30% in the last four months of 2019.
"People started to feel more comfortable that a deal was going to get done, the curve was actually getting steeper again, and perhaps the Fed was going to stop cutting rates. In the second half of the year, I think the narrative really changed from what was looking like really tough," Schutz said in the episode.
Schutz hopes the rate environment will prove more favorable in 2020 and allow banks to lower funding costs. That should cause net interest margins, which have been under pressure in recent quarters, to stabilize soon.
Schutz also believes there is investor support for bank M&A, at least in the case of smartly priced transactions. He said smaller acquirers remain in the optimal position because they can evaluate a larger pool of potential sellers and have the option to sell to another institution.
"Well-struck transactions, particularly on the smaller side, have rewarded the buyer," Schutz said, pointing to FB Financial Corp. and First Bancshares Inc. as examples of acquirers that saw their stocks rise in the aftermath of deals. "Those stocks have gone up either on the headline or shortly thereafter."
Still, Schutz noted that the Street remains price-sensitive. He said acquirers announcing transactions that result in a tangible book value dilution not expected to be earned back in less than three years will face pressure.
"If you're really looking at an earnback that is north of three years, your stock is going to get hit and stay down for some time," Schutz said in the episode.
The investor said banks continue to sell due to succession issues but also because they feel the need to invest in technology to remain relevant. He further noted that some banks are looking to partner because they are fearful of what could change in the coming year.
"Sell while the selling is good," he said. "Sell before there is a recession. Sell before there is a regulatory change."
"Street Talk" is a podcast hosted by S&P Global