Nancy Bush is a veteran bank analyst. The following does not constitute investment advice, and the views and opinions expressed in this piece are those of the author and do not necessarily represent the views of S&P Global Market Intelligence.
I've decided that there are times when it's good to be — well, not old exactly, but more experienced than some of my peer bank analysts. I was in a meeting with a group of bankers recently and we were bemoaning the fact that so many bank investors and analysts today have never seen a period of rising interest rates, and that those of us who lived through the exploding bond portfolios of the mid-1990s have been so severely thinned in the years since the Financial Crisis. Part of this loss of analytical experience has been due to cost-cutting by investment banks — younger is generally cheaper on Wall Street — but a large part has been due to the fact that after so many crises and so much turmoil over the past few decades, spending time on the beach just started looking like a lot more fun for some very smart people.
Yeah, I get that. But I have found it useful to have a "been there, done that" perspective on the banking industry as many younger analysts dwell on the minutiae of quarterly earnings, pondering the basis point path of the NIM or how an under-60% overhead target will be achieved — necessary information, to be sure, but not sufficient to know where a company or indeed, the banking industry, is headed. A news flash for my young friends — the NIM can be doing great even as a bank falls apart, and we are entering a time when it will be WAY more important to see more of the forest and less of the trees.
I'm becoming a bit concerned that we have all been lulled into a false sense of security about the future path of the banking industry. I have no doubt that the changes wrought by Dodd-Frank — welcomed at the time or not — have massively increased the margin for error in this industry, and while the stress tests may be an imperfect tool, they have nevertheless reinforced an imprimatur of soundness and safety for American banks as many of their global competitors continue to struggle.
But I don't think that we should take it as a given that American banks will not begin to make some of the same mistakes as in the previous cycle. I'm not referring exclusively to mistakes in credit quality — although there are clearly some banks that are pushing the edge of the envelope on exposures to commercial real estate and in structure and pricing of C&I loans. I think (hope?) that the regulators are way more vigilant this time around about the issue of loan concentrations and are testing more stringently the assumptions behind underwriting decisions.
No, I'm talking more about mistakes of strategy, especially with regard to acquisitions. Those who have heard me speak know that I have my own (admittedly somewhat idiosyncratic) theories about the causes of the Great Meltdown, and one of them concerns the role of mergers in contributing to the unhealthy state of American banks at that time. Anyone who was covering the banking industry from the mid-1990s to 2007 likely has a list of their all-time worst banking deals — the "merger of bad equals" between Banc One and First Chicago NBD and First Union Corp.'s purchases of both Money Store Inc. and CoreStates Financial Corp. are the deals that top my list — and the time and capital squandered in transactions like these definitely helped to lay the foundation for the depleted condition of American banks as they descended into the chaos of late 2008.
I don't see the equivalent of a Money Store or a Countrywide lurking in the shadows, but I do hope that the regulators are alert to the possibilities. The just-passed modification to the Dodd-Frank rules will give some of the larger regional banks — companies like Synovus Financial Corp. come most readily to mind — the ability to do some material deals, so long as they do not push past the $250 billion asset threshold that will now be the boundary of "systemically important." And the mega-community banks — Pinnacle Financial Partners Inc., South State Corp., United Community Banks Inc., CenterState Bank Corp., et. al. — after having blown through the $10 billion mark initially will now see almost boundless growth possibilities ahead.
And there's the rub — just because a bank can do a deal, does that mean that it should? This question came to mind very recently as I read the parameters of the acquisition of Chicago's MB Financial Inc. by Fifth Third Bancorp of Ohio. The price was hefty — roughly $4.7 billion (a 24% premium to the market) for a $20 billion franchise in a very competitive market — and the damage to TBV was material (a 7.7% hit that will not be earned back for nearly seven years.) The assumptions are aggressive — cost savings of 45% of MB Financial's cost base accompanied by a $300 million restructuring charge — and investor and analyst reception has been skeptical and harsh.
Good for the analysts. Back when investment bankers held more sway over what we all could say in the wake of a deal, there was seldom a peep when seriously bad or over-priced deals were announced. The fact that Fifth Third's stock took an immediate 8% hit in the wake of the deal and has not rebounded — and that the deal is priced with about a 90% stock component — may give other managements pause when they think about deal pricing and the potential impact on existing shareholders going forward. That's a consideration that I think has gotten WAY too little management attention in the past.
I also want to give a piece of advice to bank CEOs and CFOs concerning the justification of rich deal pricing — i.e., don't try. (Just remember that old maxim: Never complain, never explain.) I noted the commentary of Fifth Third CFO Tayfun Tuzun: "There will be questions about the valuation of this firm. ... but let me indicate that you pay the price that the franchise deserves to get paid, and this is not a project. This is a very well-run company." OK, then that begs the question — how are you going to improve the performance of the bank to justify the premium deal price?
I would also note a couple of the noteworthy bloopers by bank CEOs in the wake of controversial deals as proof positive of my advice. My all-time favorite was Ed Crutchfield's comment in the wake of his $3.25 billion purchase of Signet Banking Corp. of Richmond, Va. in 1997: "I just kept stacking billion-dollar bills on the table until Mac (Malcolm McDonald, Signet's chairman and CEO) said yes." (Funny at the time but cringe-worthy now in the wake of Wachovia's de facto failure.)
So, is the silly season in bank deal-making and deal pricing about to return? I hope not, but I would note that historically, events on the ground can quickly get away from banking regulators. The slight step back from the stringent regulation of the Obama era should not be taken as a signal to do stupid stuff, and that includes "strategic" deals done for other than financial reasons. Hope springs eternal — but common sense sometimes eludes bankers.
