The best thing about Truist Financial may be its 6.8% dividend yield. Like many banks, its stock is ailing amid high interest rates and sluggish loan growth. The company declined to comment on its performance. But it has been a long slide, down 29% this year and 43% since early 2019, when Truist became the country’s sixth-largest bank through a merger of two regional powerhouses.
Bank mergers, while promising on paper, have a spotty track record for investors. Yet a wave of mergers could be coming as banks try to bulk up and grow amid one of the toughest operating climates in years.
Banks face a slew of pressures. They are grappling with higher regulatory costs and a surge in interest rates, which act like a pincer on loan growth and profitability. Tighter lending standards don’t bode well for profits, and banks are raising provisions for defaults.
An earnings recession, in fact, has already settled into the sector. The Invesco KBW Bank exchange-traded fund (ticker: KBWB) is expected to produce $4.70 in earnings per share this year, down 25.2% from $6.28 in 2021, according to consensus estimates. The industry isn’t expected to get back to 2021 earnings levels until at least 2026.
Adding to the pressure, banks aren’t just competing with each other; increasingly, they need to fend off fintechs like Rocket Cos. (RKT), PayPal Holdings (PYPL), and Apple (AAPL)—the last a leader in digital wallets, offering credit cards and high-yield savings accounts paying 4.2%. Private-equity firms and other nonbanks are also financing more loans.
The stocks reflect a dour outlook. The Invesco KBW Bank ETF is down 16% this year against a 17% gain for the S&P 500 index. Among the megabanks, only JPMorgan Chase (JPM) has notched a positive return, up about 8%.
All this is laying the groundwork for banks to try to grow through acquisitions, especially at the regional level, where they face both higher regulatory costs and viselike competition from megabanks and fintechs.
“If you don’t allow banks to merge, you make it hard for a midsize bank to compete against big banks and nonbanks,” says Tom Michaud, CEO at Keefe, Bruyette & Woods, an investment bank owned by Stifel Financial (SF).
The megabanks aren’t likely to pursue major deals due to pushback from regulators; they’re already considered “too big to fail,” and JPMorgan pushed the limits, with a nudge from top regulators, when it snapped up deposits and assets from the failed First Republic Bank.
Analysts say hostility to mergers from the Biden administration has had a chilling effect. It has been almost a year since U.S. Bancorp (USB) bought MUFG Union Bank, the last major deal to go through without a government rescue backing it up. One that got scuttled: Toronto-Dominion Bank (TD) called off its $13.4 billion deal for First Horizon (FHN) as regulators dragged their feet on approving the tie-up.
One positive for the sector now is that rates appear to be stabilizing.
Higher rates have scrambled the math on acquisitions. Valuations have plunged, making it costlier for buyers to use stock as currencies in deals, says David Ellison, manager of the Hennessy Large Cap Financial fund (HLFNX). Smaller banks that might be targets have also taken valuation haircuts and could be reluctant to sell at depressed prices, he adds.
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Banks are also sitting on $558 billion of unrealized losses on securities, primarily Treasuries and other government debt. The losses have piled up as rates have climbed, pressuring bond prices. Acquirers would need to realize those losses in a transaction, potentially weakening their own financial position. Commercial real estate debt, another trouble spot, could also make buyers wary of buying assets that may have to be marked down.
Still, a merger wave could build over the next few months and into 2024. A stable rate climate will help. Treasury Secretary Janet Yellen has indicated support for bank consolidation. And some analysts expect the politics of mergers to improve in Washington.
“When a Republican wins the White House, whether it’s next year or five years, you are going to see a wave of consolidation in the banking industry,” predicts BTIG analyst Isaac Boltansky.
Banks that have fallen behind in the technology arms race could seek tie-ups to fend off fintechs that are expanding their digital wallets and nibbling into fees. “There is an accelerating cost to stay digitally relevant,” says Tom Collins, senior partner at financial consulting firm West Monroe. “As you get into 2024, regional banks are going to conclude they need a partner to scale quickly.”
A sweet spot for mergers could be banks with just below $100 billion of assets. The Federal Reserve and other regulators plan to impose new safeguards on banks above that level, including a 16% increase in capital buffers. The changes mean banks with above $100 billion in assets will face similar regulatory costs to those with at least $250 billion in assets.
“The rarest bank is going to be the one with $101 billion in assets,” Michaud says. Banks below $100 billion will also feel pressure from regulators, he adds, and if they’re going to get bigger, they will want to get much bigger.
One of the few major banks that’s thriving off acquisitions is First Citizens Bancshares (FCNCA). The company has grown through deal making for years and took a major step up to the big leagues when it won the bidding for pieces of Silicon Valley Bank. That catapulted First Citizens to the country’s 15th largest bank, with $210 billion in assets and $141 billion in deposits as of June 30.
Investors love the story: The stock is up 75% this year and it’s returned an annualized 15.7% over the past five years, beating the S&P 500.
“A lot of First Citizens’ success revolves around getting deals done at attractive prices,” says Brian Foran, an analyst at Autonomous Research. Recent acquisitions of CIT Group and SVB were done at roughly 50% of tangible book value, deep discounts to their asset base, he says. “When you get things [essentially] for free, it’s easy to make them work.”
Analysts see the deals lifting First Citizens’ profits sharply—earnings are expected to jump 110% this year thanks largely to SVB, according to consensus estimates. The stock trades at 7.7 times earnings, below its five-year average of 10.1 times. First Citizens also has capacity for buybacks, which it elected to pause this year while it integrates SVB. Foran thinks the stock can get to $1,800 over the next year, from recent prices around $1,325.
One small lender that looks attractive is Arkansas-based Home BancShares (HOMB), according to analyst Brett Rabatin of Hovde Group. The bank has “strong asset quality, a flexible balance sheet, and a management team prepared for uncertainty,” he says. Shares are down just 3% this year, reflecting the bank’s “highly selective” lending practices. Trading at 2.2 times tangible book value, the bank is in a good position to make acquisitions, Rabatin says. He sees the shares up 28% in the next year from a recent price around $22.
Large regional banks like M&T Bank ( MTB ), Fifth Third Bancorp (FITB), and KeyCorp (KEY) are in a tough spot. All have more than $200 billion in assets and face pressure to get bigger, Ellison says, but mergers that would double or triple their assets could face regulatory roadblocks, concentrating even more assets in a handful of megabanks. Bolt-on deals are more likely, he says.
In most cases, investing in banks for M&A may not be a winning strategy, given the challenging operating environment. Ellison, who has covered bank stocks for decades, says he’s “not superexcited” about the sector in light of near-term credit concerns. “We need a financial surprise that creates opportunities,” he says, seeing scant returns in most of the stocks—aside, of course, from their dividends.
Write to Carleton English at carleton.english@dowjones.com
