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KBW CEO says bank stocks could be a bargain, push for scale driving bank M&A

Investors are fearful of what could lie ahead for U.S. banks, but current valuations might have created some bargains, according to KBW CEO Tom Michaud.

Bank stocks have come under pressure over the last 12 months as fears of a global economic slowdown and a challenging interest rate environment weighed on the group and caused stock multiples to erode. The yield curve has been inverted for much of the last three months, with the 3-month Treasury yield trading higher than the benchmark 10-year Treasury yield. That inversion, which has preceded past recessions, has contributed to negative sentiment toward the bank group.

A number of bank stocks now trade at high single-digit multiples of forward earnings, well below the historical average of 15x for midsize banks, Michaud, president and CEO of Stifel Financial Corp. unit Keefe Bruyette & Woods Inc., said in the latest Street Talk podcast. The executive said he would expect the price-to-earnings ratio to decline some but called the current gap "really wide."

"My own opinion is that bank stocks have already incorporated a very negative view of the future, and you may be buying in at a bargain price. You just don't know when that catalyst is going to show up," Michaud said in the episode.

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Michaud, who has covered the banking space for 34 years, discussed investor sentiment toward banks and whether their fears are overblown, as well as his thoughts on recent M&A activity, including the sales of some FIG-focused investment banks.

The executive said investors are concerned about the impact lower interest rates will have on bank profitability and are also eyeing the prospect of increasing credit costs, since they believe the economy is in the late stage of an expansion. He said many investors are pricing in the likelihood of four 25-basis-point rate cuts by the Federal Reserve as well as a turn in the credit cycle and deterioration in asset quality. That view stands in contrast to the industry's current performance.

"If you were to take a snapshot of the banking industry, all is really pretty good," Michaud said. "What investors are worried about is 'bank stocks, the movie,' which is what is the next scene going to be and what is going to happen in the future. Myself sitting in the middle of all of this, I ask what has been priced into bank stocks, [and] what has been priced into bank stocks is a pretty gloomy next chapter."

Meanwhile, bank M&A activity has rebounded considerably over the last few months after a relatively slow start to the year in terms of the number of transactions. Michaud said some banks have looked at deals as an attractive way to drive earnings higher in a world where earnings growth has slowed. A transaction that produces 8% earnings accretion could essentially buy a bank two years of earnings growth, he said.

Michaud also said more institutions are looking at M&A as a way to achieve the necessary scale to invest in new technology, including digital banking offerings. He acknowledged that the argument for scale has existed his entire career, but for many years, bigger did not equal improved profitability. That dynamic is starting to change, he said. Michaud said many larger institutions are beginning to grow faster, are becoming more profitable than smaller banks, have less exposure to net interest income — which remains under pressure in the current rate environment — and have the ability to invest in new technologies. He said many bankers fear falling behind competitors if they do not make necessary investments today.

"I really believe it's the scale argument that is taking root right now because you can look at the numbers and see it," Michaud said in the episode.