In today's episode, we (Joe Fenech & Kevin Swanson) discuss
Summary:
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Why this transaction validates two pillars of our bullish bank sector thesis – deregulation and M&A.
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How the “hunters vs. hunted” dynamic is likely to define the regional bank landscape.
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Why geographic positioning – especially in Texas and Florida – is shaping strategic and valuation outcomes in bank M&A.
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How this M&A cycle differs from past ones – and what it could mean for both regional and community banks.
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A look at emerging leadership and the shifting market momentum from large-cap to regional banks.
This session is also available on Spotify or Youtube
Transcript
Intro
Hi everyone, it’s Joe Fenech, Chief Investment Officer of GenOpp Capital Management. We’re going to divert from our usual format here, we hadn’t planned to do another episode of our podcast this week, but there was a very significant M&A deal in the banking sector and so I thought I’d jump in here with some takeaways from that, including what we see as the implications for others. So let’s jump right in after a quick disclosure.
Before we start, a quick 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 to you as 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 in episodes of this podcast.
Joe Fenech:
Earlier this week on Monday morning, first thing, Fifth Third Bank announced an agreement to buy Comerica, a smaller sized regional bank in what is the largest non-distressed bank M&A transaction since the SunTrust and BB&T tie up just before the pandemic in 2019, but that was more of a merger of equals transaction, this is the largest pure bank M&A deal, of a non-distressed nature, one bank clearly buying another since really before the financial crisis in 2008, so it’s really a milestone event.
So definitely some thoughts to share.
First, we now have some tangible evidence of the realization of a few key aspects of our bullish on banks sector thesis. So from prior podcasts, you’ll recall that our sector thesis really has 5 key components to it: improving fundamentals, deregulation, M&A, the convergence of technology and financial services, and then the attractive valuation backdrop.
So this deal hits two aspects of that thesis, deregulation and obviously M&A. On the deregulation, there have certainly been very strong signals, on capital requirements, shortening the M&A approval process on smaller deals, on the receptiveness of bank regulators to large regional bank M&A. But a lot of that is still either theoretical or in the very early innings. This M&A announcement between Fifth Third and Comerica is something concrete, it’s like ok, now we know this is happening, it’s not just talk and speculation. And on the M&A front, yes, we already got the Pinnacle Synovus announcement, that was a regional bank deal, but we characterized it on our last podcast as sort of a false start. You had all this chatter behind the scenes about regional bank M&A being a catalyst for stock prices, we hadn’t seen regional bank M&A in quite awhile, so people were getting excited about it, and then you get this clunker of a deal, it wasn’t well received, so it was sort of like the curtain goes up, and sector specialists like us had been talking up consolidation and how good it was going to be, and then the curtain goes up and you get the generalists saying, and rightly so, that’s it? That’s what we’ve been waiting for? But as we said on the last podcast, that deal was not representative in our opinion of how this M&A cycle is likely to play out. There were a lot of unique aspects of that deal that made it an anomaly, but it understandably wasn’t looked at that way by the broader investment community b/c it was the first one.
This deal though between Fifth Third and Comerica is representative of what we expect to see and it is illustrative of the regional bank M&A-themed investment opportunity. So that’s takeaway number 1, is that an announcement like this begins we think to fulfill the promise of several aspects of the bullish thesis.
So our second takeaway I think answers the question of why we think this deal is so good. This deal in our opinion is how M&A should work. Too often, the only beneficiaries of M&A in the bank sector are the investment bankers collecting fees on the deal, value is destroyed more often than not, the synergies aren’t realized, the only thing that gets bigger and better is the paycheck of the acquiring bank’s management team, b/c they’re now running a larger company.
This deal is a win-win for shareholders of both Fifth Third and Comerica. Full disclosure, we owned both stocks, we were fortunately much larger in Comerica than Fifth Third, but we were happy with the deal also from the Fifth Third perspective. It’s a deal that checks all the boxes of what M&A is supposed to be. You have a strong bank with a strong stock currency in Fifth Third buying a smaller, weaker counterpart. It’s big but it’s digestible, Fifth Third is $210 bil. in assets, Comerica is less than 40% of its size, at just under $80 bil. Comerica has been a fundamental underperformer literally for my entire career, going back 27 years now. The profitability has not been good, the returns to shareholders haven’t been good. But that being said, it’s a tremendously valuable franchise, both in terms of the geography it inhabits and the value of its core funding base. There is a clear leader in this deal in terms of the management team and in the Board room, you don’t have the situation you had with BB&T and SunTrust and then more recently with Pinnacle and Synovus. So it checks that box for sure. BB&T and SunTrust, you had two iconic brands merge together, but instead of selecting one of those iconic brands for the new company, they compromised and rebranded the bank and moved the headquarters to a new city. And them with Pinnacle Synovus, you have Pinnacle leading the Board 8-7, but Synovus management running the company, you’ve got a very distinctive culture at Pinnacle. So there’s a lot of risk that comes along with that. Here you have a very clearly delineated situation, again, a much stronger company in Fifth Third, a much larger company, buying a weaker performing company that had been under pressure from an activist investor and from the analyst community. So again, this is the structure that we think works well in M&A. And then strategically it just sort of fits with Fifth Third hand in glove. Comerica had a split Midwest / Texas franchise, and then a not-insignificant franchise in California. Comerica had ranked third in deposit market share in Michigan, Fifth Third was 7th, and then Texas, has a nice presence in high value MSA’s Dallas, Houston, and Austin, areas where Fifth Third would like to grow its presence. So again, checks just about all the boxes, strategically, financially, structure, digestibility, Board and management dynamics.
Another takeaway from this deal is it fits our thesis for how this regional bank M&A cycle is likely to play out. Our theme with regional bank M&A is you’re either a hunter or you’re among the hunted. There will be very few regional banks that don’t fit into either of those categories. So excluding the big 4 too big to fail banks, there are only 25 banks over $50 bil. in assets left in the U.S., and only 7 of them now are based in Texas or the Southeast. And we’ve bucketed these banks as either hunters or the hunted. I’m not going to go through the names individually, but back of the envelope, we count 11 hunters, including a few that aren’t necessarily hunters but have a strong desire to remain independent, we count 10 that are potential sellers, and then 5 wildcards. So if you play that out, what you could wind up with here is a few banks, maybe 1 or 2, that graduate to that trillion dollar asset club, with the too big to fail names, and then overall this list of 25 companies, potentially gets whittled down to about half that number. And remember too that the things we’ve seen politically over the last decade, the window to do these sizeable deals, people have to consider that that window doesn’t remain open forever, remember we saw regulators open to these deals for a brief time in the first Trump administration, but during the Obama and Biden administrations, banking regulators took a dim view of these larger deals. So if this plays out the way we think it could, we could see quite a bit of regional bank M&A activity over the next few years.
Another takeaway in terms of potential implications for others, is that M&A, when it’s done right and when it’s well received, as we saw with this deal, it tends to lift all boats from a valuation perspective even for the banks that aren’t involved. So I always use the example of Florida in 2014, this was 6 years after the financial crisis, no one was interested in Florida banks, and then Valley went down and paid 1.8x book for First United Bank, and everyone looked around and said if that one was worth 1.8x, why are the other ones trading at half that level. And that was really in my mind the inflection point for Florida bank stock valuations. So similarly here, I think people look at this healthy multiple for a Comerica, and then immediately turn and look across at a First Horizon, based also in desirable markets over in Tennessee and across the Southeast and they say ok, First Horizon, better run company, better franchise, why shouldn’t they get more. And then they look at some others, I’m not going to name them all, I said First Horizon b/c it was already involved in announced deal with TD that was terminated, and they’re sort of always speculated about, but looking around just at companies that aren’t necessarily widely acknowledged takeover targets, M&A just tends to help to refocus attention on franchise value, and scarcity value and so it just tends to benefit all players in the market whether or not they are likely to be involved in M&A. And so with this scarcity situation in terms of regional bank M&A there being only 25 banks left, and 7 in the Southeast and Texas, as you get down to just a handful of opportunities left in the most desirable markets, does that lead one of these acquirors to say, ok, I really need to be in the Southeast and Southwest longer-term, and now there are only 3 or 4 or 5 opportunities left to do that with scale, and now that’s where the scarcity factor can come into play. So what tends to happen is early in the cycle, like right now, in this deal, both shareholders I think win – Fifth Third got a really good deal here, but Comerica also got a 20% premium to market, which isn’t bad. As you move through the cycle, the deals tend to get better for the targets shareholders and less so for the acquirors.
Another interesting takeaway is the extent to which so far in this M&A cycle anything with the words Texas or Florida as it relates to the geography of the target continues to be a huge draw. It’s interesting, we ran the numbers and the average multiple paid this year on all deals announced where the target is based in Texas or Florida, the median multiple paid is 1.6x and everywhere else it’s 1.4x. And keep in mind that deals like Synovus, which was a healthy multiple goes into the non-Florida / non-Texas bucket b/c they’re based in Georgia, but they have a significant presence in Florida too. So that multiple disparity would be even wider if we took situations like that into consideration.
Couple more quick takeaways: One is that we don’t think you should extrapolate regional bank M&A to what we’re likely to see and have been seeing in community bank M&A. Because the dynamics are a little different. In past M&A cycles, you get into one of these waves, and you can really just blindly buy a basket of takeout targets and you’d probably do pretty well. We think that approach can work well as it relates to regional banks, but not community banks. Now look, there are still going to be nice premiums in community bank M&A, we’ve already seen them, and again, especially in the most desirable markets. But it’s not going to be across the board where you see healthy premiums for community banks. For community banks, you have a significant management succession challenge. We’ve talked quite a bit about this, you have aging community bank leadership, you have an almost full generation gap of management talent, so there is an imbalance of sellers needing to solve for management succession on the one hand, there are more of those than there are capable buyers. So there is an imbalance of supply and demand. You don’t have that with the regionals b/c remember there are only 25 of these things left and you have larger banks that want to get much larger. The community banks are also more likely to be bogged down still by punitive interest rate marks, which makes the deal math difficult. And it’s not just AOCI, it's the held to maturity investment portfolio, it’s the fair value marks on the loan portfolio also. You don’t have that issue quite as much with the regionals, the deal math is easier, b/c the fair value marks aren’t as prohibitive. Again, there will be exceptions on the community bank side for sure – we own plenty of smaller banks on this M&A theme in our Fund, we just think you need to be more discerning than you’ve needed to be in the past. This issue will also be less challenging overtime though too, the deal math will get easier as multiples improve and as rate marks burn off.
I think another quick takeaway is we are seeing the banking industry’s next superstar leader emerge onto a national stage. We’ve been admirers of Fifth Third’s CEO Tim Spence for awhile now. He’s always been very thoughtful on the key issues, the company has performed very well under this leadership, and now this first mover regional bank M&A advantage with what we think is a very good deal. Also, we think he offers a bit of a different perspective, he’s by far the youngest large regional bank CEO, at 46.
And then lastly, to close out our list of takeaways, in keeping with the comments on our last podcast, we think the transition of the spotlight from the largest banks to the regional banks continues with this transaction. The very largest banks have been the best performers to date, fundamentally, stock price performance, and they trade at the highest multiples. The macro environment has been terrific the last few years for the largest banks, and we think they’re still going to perform well. But we think the favorable macro winds now are shifting to increasingly favor the regional banks, you have this regional bank M&A phenomenon, you have a steepening yield curve, you have regional banks as more of a pure play on that steepening yield curve. So again, we see a gradual baton pass here in terms of stock price performance from the largest banks to the next tier down, which is the regionals.
And on that note, we will wrap it up, thanks very much for listening.
Disclosures:
Of the individual stocks mentioned, our investment fund currently has positions in Comerica Inc (CMA), First Horizon Corp (FHN), Truist Financial Corp (TFC), Toronto-Dominion Bank (TD), and Valley National Bancorp (VLY).
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.
