In today's episode, we (Joe Fenech) discuss
State of the Banking Cycle: Where Do We Go From Here?
Following another earnings season and a strong move in bank stocks, GenOpp CIO Joe Fenech discusses where we believe the banking sector stands today—and where it may be headed next.
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The current state of the banking industry—why we believe we're in a bull market for bank fundamentals and bank stocks, why recent valuation gains are supported by improving fundamentals, and the primary macro risk we're continuing to monitor.
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Why bank M&A continues to build momentum—including how valuations, deregulation, and management succession are shaping the next phase of industry consolidation.
This session is also available on Spotify or Youtube
Joe Fenech:
Hello and welcome back to Talking Banks. I’m Joe Fenech, Chief Investment Officer at GenOpp Capital Management.
Before we jump in, a quick disclosure.
Disclosure
Joe Fenech and Kevin Swanson are employees of GenOpp Capital Management, an investment advisor that maintains exempt reporting status in the state of Indiana. This podcast represents the views, beliefs, and opinions of GenOpp members and does not assert to be complete. The information presented in this podcast is provided as of the dates indicated and opinions presented may change. You should not rely on this podcast as a basis upon which to make an investment decision. This podcast is not intended to provide and should not be relied upon for tax, legal, accounting, or investment advice. GenOpp’s clients or its members may hold or recommend to GenOpp’s private fund clients the purchase or sale of securities of companies discussed.
Ok, so it’s been a little while since our last episode.
We’ve made it through another earnings season, bank stocks have had a great run over the last several months, and naturally the question is where do we go from here?
That’s really what I want to talk about today. I want to spend a few minutes talking about where I think we are in the banking cycle, why we continue to believe we’re in a bull market for banks, the risks to that bullish thesis, and then finish up with an update on bank M&A because we continue to think consolidation is one of the biggest stories in the industry.
So let’s start with the big picture.
We’ve been saying for quite awhile now that we’re in a bull market for banks. Early on, that wasn’t always obvious. In fact, if you were simply watching stock prices, it probably didn’t feel much like a bull market at all. And I think that’s because two different things were happening at the same time.
The fundamentals were getting better, but the stocks just weren’t reflecting that improvement. Now, I think that’s changed. The way we look at it, the first phase of this cycle was improving fundamentals. The second phase is the market beginning to recognize those fundamentals. When you think about everything that’s happened over the last couple of years, coming off what I call the crisis years of ’22, ’23, and the early part of ’24, net interest margins bottomed and have improved now for 7 consecutive quarters. Credit has been resilient. Capital levels are strong, and the pace of capital return has picked up. Regulation is more constructive. M&A has picked back up. When you step back and look at all of those things together, it’s difficult to find many fundamental headwinds today, and that’s been true now for awhile. What’s different today is that stock prices and valuations have finally begun reflecting it.
Now, because that move has happened fairly quickly over the last several months, I hear the obvious question, are bank stocks now ahead of themselves. Our answer is, probably not. And here’s why.
Let’s use large regional banks as an example. Today, most of these companies are targeting minimum returns on tangible common equity of around 15%. Many of the better operators are already producing returns well above that. Historically, businesses earning those kinds of returns have generally traded around two times tangible book value, and usually higher. Let’s go back one year. The average large regional bank traded just over 1.6x tangible book. So that’s obviously a big discount to where history would suggest those returns deserve to trade.
Fast forward to today. They’re trading almost exactly at two times tangible book. So yes, the move recently has been sharp. Some of the chart moves definitely look dramatic. Could stocks pause for a bit after a move like that? Absolutely. Things rarely move in a straight line. But that’s a very different question from whether the move itself has been justified.
Our view is that it has. This isn’t just a situation where investors paying higher multiples for the same businesses. It’s the market gradually recognizing businesses that have been performing much better than investors were giving them credit for.
I think it’s also helpful to think about how this cycle has unfolded. One analogy we’ve used internally is what I would call a cascading waterfall. The first beneficiaries were the big money center banks. JPMorgan, Bank of America, Wells Fargo, Citigroup. That made perfect sense. Those banks emerged from post pandemic with stronger balance sheet liquidity, more diversified business models, and balance sheets that were much better positioned for rising rates. And then came the regional banking panic in 2023. Deposits migrated toward these banks that were perceived to be too big to fail. And then in 2024, the largest banks became the biggest beneficiaries of deregulation because they also carried the heaviest regulatory burden. So fundamentals improved early for these banks. And stock prices followed fairly quickly.
The next group was the large regional banks. Their fundamentals also improved pretty noticeably. But remember – this group of banks spent most of 2023, especially early in the year, directly in the eye of the storm. So once fundamentals turned up, investors understandably wanted some proof that the upturn was sustainable. I think now, three full years later, we’ve seen that proof. And so this move in the stocks is really just the stock prices and valuations catching up to where the fundamentals have been for awhile now. Which brings us to today.
I think the next phase of this cycle is beginning to move further down the capitalization spectrum. Smaller regional banks, community banks, particularly the stronger operators and better franchises. A lot of these still trade at meaningful discounts despite improving fundamental performance. That doesn’t mean every small bank is cheap. But broadly speaking, we still think the valuation recovery has further to run as you move down the market cap spectrum.
So when we think about positioning our portfolio today, we’ve adjusted right alongside that evolution. We still own banks across every part of the industry because we still see opportunities throughout the sector. But increasingly, we think some of the most attractive opportunities are further down the waterfall, where valuations continue to lag improving fundamentals and where the M&A backdrop is becoming more favorable.
So stepping back, that’s where I think we are today. We’re no longer debating whether bank fundamentals have improved. I think that debate has been settled. The question now is whether the valuation recovery has further to run. We think it does. That doesn’t mean the road will be completely straight, and every bull market has risks. So maybe let’s spend a few minutes talking about one we continue to watch closely.
If you’ve listened to this podcast for any length of time, you probably know where I’m going next. We’ve spent a lot of time talking about system liquidity – the Fed’s balance sheet, quantitative easing, quantitative tightening, and what people sometimes refer to as the plumbing of the financial system. I realize it’s not always the most exciting topic. But the reason we keep coming back to it is simple.
I don’t think you can fully understand risk assets today without understanding liquidity. 25 years ago, you could. Back then, if you were analyzing a bank for example, you focused on management, credit quality, deposits, capital, expenses, market share, and franchise value. Macro certainly mattered, but it generally, except in times of crisis, wasn’t the dominant driver of stock performance.
Since the financial crisis, I think that’s changed. Today, you still have to do all of that bottom up work. But you also have to understand the macro backdrop because we’ve seen, time and time again, that changes in system liquidity can overwhelm even very good fundamentals for extended periods of time.
I think the last several years provide another good example. Quantitative tightening officially began in June 2022 and continued until December 2025 – almost exactly three and a half years. During that period, the regional bank ETF, KRE, went from about $64 to about $65. Essentially flat, over a three and a half year period. Now compare that with the broader market. Over that same three and a half year period, the S&P 500 gained roughly 67%. The NASDAQ gained more than 100%. Even the Russell 2000 gained nearly 40%. So while the broader market was producing very strong returns, bank stocks essentially went nowhere.
Then something changed. The Fed ended quantitative tightening and began expanding its balance sheet again. Now, the Fed went out of its way to say this wasn’t another round of quantitative easing. Maybe that’s technically. But from the standpoint of liquidity entering the financial system, and the Fed growing its balance sheet, the practical effect has been the same. And since then, now an 8 month period, the picture has changed dramatically.
The KRE has gained roughly 14%, doubling the performance of the S&P, and also beating the NASDAQ and Russell 2000 over that same period. Now, I’m not saying liquidity explains everything. Fundamentals matter, deregulation matters, M&A matters, valuation matters. All of those things have contributed to the improvement we’ve seen. But I also don’t think the timing is entirely coincidental. We’ve now been through enough of these cycles since 2008 that I think it’s difficult to ignore the relationship between changes in system liquidity and bank stock performance. That’s why we spend so much time thinking about it.
So why I do still view system liquidity as a macro risk to this bull market in bank stocks? Mostly b/c of where we could be headed next. Kevin Warsh at the Fed has been very consistent for years in his criticism of the Fed’s balance sheet policy. He thinks the balance sheet should ultimately be much smaller. Frankly, I think many of those criticisms are valid.
It’s difficult to argue that 15+ years of extraordinary monetary policy hasn’t changed the way financial markets function or influenced asset prices. The challenge isn’t deciding that the balance sheet should eventually be smaller. The challenge is getting there, b/c every attempt to shrink the Fed’s balance sheet since the financial crisis has produced some element of stress somewhere in the banking system. Now, Warsh has also been clear in his writings and his speeches that he understands that history. But understanding the challenge and successfully navigating it are two different things. So when people ask us what we’re watching closely today, that to us is a big issue. Not because we think it’s an immediate problem. But if something eventually interrupts this bull market, history suggests that system liquidity is one of the first places we could potentially see it.
The last topic I wanted to touch on today is bank M&A. We’ve been talking about this theme for quite awhile now, and while activity probably hasn’t accelerated quite as quickly as we thought it might coming into the year, I think it’s fair to say the momentum is clearly building. So what’s driving that? I think there are really three things.
First, bank stock prices are higher. That matters from a sentiment perspective, and b/c the strongest acquirors are generally using their own stock as acquisition currency. The higher your stock trades, the more purchasing power you have. Second, the interest rate marks that complicated acquisitions over the past few years continue to burn off. Remember, after interest rates moved sharply higher, one of the biggest obstacles to community bank M&A was that acquiring banks had to mark acquired loans and securities to current market values. Those are referred to as fair value adjustments, and they can make otherwise attractive deals difficult to make work from an economic perspective.
That issue hasn’t disappeared. But it’s becoming less severe with each passing quarter as these assets mature and portfolios gradually reprice to today’s higher rate environment. That process will continue over the next few years.
The third tailwind is deregulation. Deals are easier to get approved today than they were just a few years ago. In fact, we’re now seeing some banks announce – or actively prepare for – their next deal before the previous one has even closed. That would have been unheard of as recently as just a few years ago and for most of the past nearly 20 years. That tells you obviously that management teams have a lot more confidence in the approval process than they did not very long ago.
So taken all together, I think it’s fair to say we are fast approaching a true M&A cycle. One thing we’ve noticed recently is that the market has already started assigning an M&A premium to banks viewed as likely sellers. There’s now a fairly large group of high quality franchises in attractive markets that all seem to trade within a remarkably narrow valuation range. I don’t think that’s a coincidence. Many of these banks trade right around 11x 2027 earnings and roughly 175% or so of tangible book value.
Earlier, I mentioned that the average large regional bank now trades around 2x tangible book. We’ve also started seeing many of the strongest franchises in recent transactions command valuation multiples in that same neighborhood. That naturally raises an interesting question.
Is 2x tangible book the ceiling in an M&A scenario? Because if it is, then a bank that’s already trading around 175% of tangible book probably doesn’t offer much upside in a takeout scenario after you account for merger arbitrage. On the other hand, if this cycle develops the way successful M&A cycles have historically developed – and buyers become increasingly competitive as consolidation accelerates, and (a lot of ands here admittedly), and valuations for the acquirors trade up a little bit more, then that picture could look very different.
Historically, peak acquisition pricing rarely occurs at the beginning of an M&A cycle. It usually comes later. Momentum builds. Confidence builds. Scarcity becomes increasingly valuable. And buyers gradually become more willing to stretch. Are we there today? From our conversations and based on the modeling we run, I don’t think we are there yet today. I don’t think most high-quality acquirors have the valuation currency today to consistently justify paying 225% or more of tangible book for trophy franchises.
Could they get there? I think they could, especially if operating performance continues improving and valuations expand a bit more. But the jury is definitely still out. There’s another factor I think is equally important. Time. The regulatory environment today is dramatically different than it was for much of the past 15 years. Management teams understand that political windows don’t stay open forever. So for management teams that are thinking about a transformative deal, there’s a real strong incentive to pursue it while the regulatory environment remains favorable rather than assuming those same conditions will still exist several years from now. Now, I don’t think management teams are acting with a sense of urgency just yet, I don’t think it’s warranted, but as that clock continues to tick, the urgency will only grow. It’s certainly not going to lessen.
Then layer on top of that another issue we’ve talked about repeatedly. Management succession. We estimate that over one quarter of the country’s 4500 bank CEO’s are now age 65 or older. Think about what that means. If a CEO who’s 65 today decides to wait another three or four years before addressing succession or looking for an upstream buyer, now they’re approaching 70. If the regulatory environment changes during that period, the options available today may no longer be available then. So there are really several clocks ticking at the same time.
The regulatory clock. The succession clock. And the market opportunity itself. All of those factors we think will push some banks to action rather than waiting. Does that guarantee a wave of acquisitions? Of course not. There are always risks. The economy could weaken. Credit could deteriorate. Geopolitical events could change sentiment. But if the operating environment remains reasonably supportive, we think all signs point to increased M&A momentum and activity. And that’s why we continue to think consolidation remains one of the most compelling long-term investment themes in banking today.
So maybe one final thought to sum up what we’ve talked about today. When we look at the banking industry, we don’t see the sector we were talking about two or three years ago. We see an industry that’s fundamentally stronger. Stronger margins, healthy asset quality, strong capital levels and increased capital return, much stronger profitability metrics, less restrictive regulation, building M&A momentum. And after several years of lagging the fundamentals, bank stock valuations are finally catching up.
That doesn’t mean we won’t continue to see periods of volatility or periods of consolidation of stock gains. And there are risks, which we’ve articulated. But when we step back and look at the bigger picture, we continue to believe this is the most compelling operating environment we’ve seen for banks since the early to mid 2000’s.
Thanks, as always for listening. Talk again soon.
Disclosures:
The information in this newsletter does not constitute an offer to sell or a solicitation of an offer to buy any security. This information does not purport to be complete, is subject to change, and is qualified in its entirety by the definitive offering documents related to any private fund managed by GenOpp Capital Management LP. All time-sensitive references are made as of the date set forth above, unless otherwise expressly indicated, and there is no obligation to update any such reference. The delivery of this information does not imply that the information is correct and no representation or warranty is made as to the accuracy of any information contained herein. This information is not a recommendation to buy any security and does not constitute any form of legal, tax, investment, or other advice.
