For today's Friday Addition Edition, I am going to stay with the banks. I got a copy of the full KBW Bank M&A report, and I want to share the information and ideas with you. KBW is one of the best banks and financial stock research forms in existence, in my opinion, so it's worth paying attention when they write on banks and the potential for M&A in the industry.
First, however, we have to take a quick victory lap. One of our first Friday Addition Edition stole some ideas from Bulldog investors, including a SPAC trading slightly below liquidation value. That SPAC has flow higher by about 80% since then as rumors about potential deals flew around the markets.
Keep in mind that this type of volatility can flow both ways. If you own Churchill IV, you might want to consider using a trailing stop going forward to protect your gains from a drop if no deal gets announced.
Of course, you could just sell and take the gains as well. 80% in a couple of months is not normal.
On to bank M&A. The KBW analysts acknowledge that bank M&A has been depressed by the pandemic over the last year. We have seen some Mergers of equals, but not much buying to grow activity has occurred in the last year. That should change in 2021, with boom times returning. Activity is expected to be hottest in the Southeast and Southwestern regions of the United States.
KBW notes that low rates mean low Net Interest Margin, which will pressure the bottom line at smaller banks. While we have seen some steepening and some observers think we may see more, it's not enough to drive massive gains in bottom line profits.
Cost savings is going to be an important way to grow profits in 2021. The highest level of cost savings can be achieved by buying a smaller bank, removing redundancies, and closing branches.
Banks could also be faced with continued slow organic loan growth and higher credit costs. Credit looks great right now, but that because of stimulus and deferral programs. As the pandemic nears an end, we will see higher losses than banks have had to deal with the past few years.
The combination of low growth and higher costs could send some banks running into the arms of a suitor.
The growing level of competition from fintech is also going to be a factor that drives banks to consider merging. KBW analysts point out in the report that "As shown, at year-end 2015, the KRX had a combined market capitalization roughly 3.0x larger than PayPal's. Since then, PayPal has grown exponentially versus the KRX to the point where PayPal's market capitalization now stands 1.5x higher than the entire KRX combined."
Americans love bigger, better, faster. Smaller banks will have a tough time competing on the technology front. That could drive many to consider selling to a bigger, more tech-savvy bank.
We will see M&A from fintechs in the banking space as well. Several FinTechs such as Square (SQ) (SQ), Sofi, which is coming public via a SPAC merger this year, and Lending Club (LC) have either applied for bank charter or are buying bank this year.
With a charter in hand, they will look to grow via M&A almost immediately.
KBW identified banks that they think will grow by acquisitions in 2021. They cherry-picked a couple off the list, but my cherries are different than theirs.
Home Bancshares (HOMB) is on the list, and I have said many times over the years they are the best deal-making bank in the United States.
Eastern Bancshares (EBC) is in our portfolio, and I think they will be using that stack of cash from the conversion IPO to make deals and grow their bank. That should drive earnings and stock prices a lot higher.
First Financial Bankshares (FFIN), out of Abilene, Texas, has a price to tangible book ratio of over four right now. That's a very attractive currency to buy banks at lower ratios that are accretive right away.
KBW also makes a list of potential targets, but I like our list a lot better. We have plenty of targets in our portfolios that have an above-average chance of being acquired.
KBW also lists a group of banks that have hard to duplicate business lines that might attract a buyer. The standout on that list is triumph Bancorp (TBK). This bank owns rural banks with very sticky deposits. They then use those deposits to provide financing and factoring services to the trucking industry.
The bottom line is that this should be an outstanding year for bank M&A. High performing tech-savvy banks are going to buy underperforming less tech-friendly banks. By taking out costs and adding the digital services needed to be competitive, they can bring the ROA and ROE up by a dramatic amount and grow earnings at a rapid rate.
That should make this a very nice year for community bank stock investors.