Bank stocks and bank M&A activity have rebounded strongly from the depths of the pandemic, and the factors driving the resurgence remain in place, according to KBW CEO Tom Michaud.
That was the view Michaud offered in the latest Street Talk podcast. In the episode, the executive discussed current bank stock valuations, the Street's view of the group, the competitive threat of financial technology companies, recent bank M&A activity, the outlook for transactions in 2022, and how the banking and advisory business has changed during a decade of being the firm's CEO.
KBW, a unit of Stifel Financial Corp., has benefited from the resurgence in bank M&A activity, having advised on eight of the 10 largest deals announced since the start of 2020, including People's United Financial Inc. on its $7.6 billion sale to M&T Bank Corp. TCF Financial on its $5.9 billion sale to Huntington Bancshares Inc. and Columbia Banking System Inc. on its $5.1 billion merger with Umpqua Holdings Corp. Michaud said KBW has the highest market share in its nearly 60-year history and sees more opportunity to capitalize on bank M&A activity next year.
Bank M&A activity in 2021 set a new post-global financial crisis record, with the aggregate deal value through early November already representing the highest level since 2007. However, Michaud said deal activity could slow modestly as active acquirers digest acquisitions announced in 2021. A new regulatory framework under the Biden administration could more heavily scrutinize deals involving larger banks as well.
Still, Michaud said the main drivers of consolidation remain in place. The executive noted that banks tend to be more profitable as they become larger, underscoring the importance of scale, and added that banks also see increased competition stemming from the rise of fintechs, nonbanks and shadow banks that have encroached on their business.
Michaud noted that many of the fintech-backed digital banks expect to eventually report efficiency ratios in the mid-30s, well below and far superior to the 50%-plus efficiency ratios reported by the vast majority of banks in the industry today. If those entities are able to operate with such a lower cost structure, they would represent a "very competitive threat" to traditional banks, Michaud said.
"I think that is what has gotten bankers and boards' attention and is part of the reason why there's consolidation," Michaud said.
The executive further noted that smaller banks continue to trade at far lower valuations than their larger counterparts. That leaves acquirers trading at substantial premiums to would-be targets, creating a rich consolidation arbitrage where buyers can purchase smaller institutions at substantial discounts to their own valuations.
Bank M&A pricing has recovered along with the strong rebound in bank stock prices over the last 12 months. Michaud said bank deal pricing will track bank stock performance, at least when measured on price-to-tangible book and price-to-earnings multiples. The CEO noted that targets in larger transactions have been willing to accept lower premiums. Michaud believes that will continue since the management teams are trying to build stronger banks and recognize the Street could punish institutions involved in deals with sizable premiums.
Bank stocks broadly have fully recovered from the losses sustained during the downturn in 2020 and now trade at higher levels than seen before the pandemic. Michaud expects the rally to continue.
Michaud said the bank group lagged the recovery in the broader market initially due to fears over deteriorating credit quality, but the focus in the investment community shifted to concerns over a lack of revenue growth as institutions faced pressure on net interest margins. However, the executive said KBW's bank research team upgraded bank stocks in early September, adopting a bullish stance on the group based on the outlook for revenue growth. The research team believed that loan growth would improve and interest rates would rise, offering a boost to earning-asset yields and encouraging banks to deploy more excess cash. Those factors would lead to higher net interest margins.
"We believe that over the next year or two, you're going to see these inflection points start to kick in, which is going to accelerate earnings-per-share growth and start to improve profitability. And our analysts felt that you wanted to get out ahead of that," Michaud said.
The executive noted that many banks reported improved loan growth dynamics in the third quarter. The Federal Reserve also appears poised to raise short-term rates late in 2022, if not earlier, Michaud said.
"We think that all the pieces for an acceleration in revenue growth are in place and are playing out, so the bank stocks have been doing better because of that," Michaud said.
While bank stocks trade at higher valuations now than pre-pandemic levels, Michaud said the group still trades at substantial discount to the overall stock market. The CEO said regional banks currently trade around 65% of the broader market multiple, well below the historical average of 90%.
"If you're still bullish on the economy, we believe there's a lot of relative value in the gap and that it will close," Michaud said.
"Street Talk" is a podcast hosted by S&P Global Market Intelligence.
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