In today's episode, we (Joe Fenech & Kevin Swanson) discuss
Summary:
- What actually drove the recent sell-off: why a handful of credit issues made headlines, but tightening system liquidity played an even more important role.
- Why we view the pullback as a temporary bump in the road: fundamentals remain strong, earnings continue to be revised higher, and the long-term bullish thesis is unchanged.
- Regional bank M&A is accelerating: three large regional bank deals and what these “hunter vs. hunted” dynamics signal about the next phase of consolidation.
- Shareholder activism is resurfacing: why it’s returning now, why activism is uniquely challenging in banking, and what recent campaigns reveal about growing investor frustration.
- What to watch from here: the key liquidity indicators we’re focused on, how Fed action is shifting from headwind to tailwind, and what that could mean for what comes next.
This session is also available on Spotify or Youtube
Transcript
Spotify Intro
Hi everybody, it’s Joe Fenech, Chief Investment Officer of GenOpp Capital Management. Welcome to podcast episode #6.
Our last episode came right after Fifth Third announced it planned to acquire Comerica, and we walked through what that meant for the M&A landscape. Since then, we’ve been through third quarter earnings season. Layered onto that, we had the government shutdown, the Fed meeting and Powell’s commentary, the Jamie Dimon “cockroach” comment after a few wayward credits surfaced, renewed activist noise in the space, and pretty significant volatility in the stocks. And that’s just the past few weeks. So with that, let’s get into it after 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:
Ok, so let’s start with bank stock performance over the last couple months. The stocks have traded poorly. They had a really strong run off the Liberation Day lows in April, things peaked in early September, and then the stocks fell 12% in a month. They’ve bounced a bit since, but we’re still down just under 10% from September highs. The S&P is up over the same period – so you’ve got an 11-12 point spread, which is meaningful.
Normally, we don’t draw sweeping conclusions from two months of performance. And to be fair, there are definitely things you can point to that give credence to a bearish argument and a justified sell-off. You had the Tricolor and First Brands bankruptcies, some fraud-type situations disclosed at Western Alliance and Zions, you had Jamie Dimon dropping the cockroach comment. The peak of that concern came when those disclosures clustered together – the worst of it coalesced in that 6%+ down day in the regional bank index in mid-October.
So that’s the bear case in a nutshell. But when you take a step back, you have to ask: does that explanation really hold up? We’ve been through dozens of earnings reports at this point. Talked to a lot of senior executives around the country. And the evidence just doesn’t support the idea that we’re heading into some broad credit cycle. I think back to 2007 when I was on the sell side. Heading into 2008, of the 20+ stocks I covered, I didn’t have a single Buy rating. Not because I predicted Lehman a year ahead of time, but because when I traveled around meeting with the small banks I covered, when you juxtaposed where the stocks were trading against the stories that people had to tell, nothing seemed compelling. It was very difficult to come up with price targets that were higher than the market price at the time. The bottom up work informed the top down call.
Right now, it feels like the reverse. We’ve got what we call our regional gurus – multiple bank executives in every corner of the country who we trust. When things get choppy, we check in with them and ask: does what you’re seeing on the ground match what the market narrative seems to be? But we also talk to the subpar performers, b/c problems don’t start with the A students. And when you take their commentary measured against the valuations in the market today, we come to almost the opposite conclusion we came to in ’07 – it’s kind of hard to find stuff that we don’t like.
So there’s that. And then another thing caught our eye recently: since October 1, the bank sector has had the strongest positive revision to fourth quarter earnings expectations of ANY sector in the market. So since October 1, analysts have taken up their fourth quarter EPS projections for banks on average by about 3%. No other sector saw more than a 2% upward revision.
Sometimes, not always, but sometimes, you have to look through the market reaction and almost ignore it. Take the emotional reaction to the stock performance out of it and ask: what are the actual facts? And when you do that, the hard data just doesn’t line up with the idea that the sector is on the cusp of disaster.
The qualitative indicators also don’t seem to line up with that disaster scenario either. We’ve seen now three large regional bank merger announcements. I want to focus for a second on the Fifth Third/Comerica deal, we’ve talked about the high regard we have for Fifth Third’s CEO, Tim Spence. This deal is sort of his coming out party on the big stage, the big stage being you know front page of the Wall Street Journal type stuff. Tim Spence is also by far the youngest of the big regional bank CEO’s. Doing a deal this size at the very front end of a major credit cycle is a potential career killer. So, look, no one is infallible, but in our view, one of the brightest minds in the industry is not stepping into the largest bank transaction we’ve seen in awhile, with all eyes on him, to buy one of the largest commercial middle market lenders in the country if he has any real concern about the macro backdrop. Steve Steinour, CEO of Huntington, similar theme, Huntington now has two significantly sized transactions they’ve announced in the last few months.
So you put all of that together and you consider it against the recent stock price action and the narrative that’s developed around that and it just doesn’t seem to fit.
Now, this is not to say we don’t have concerns or things we’re watching closely. We’re very wary about some of the things we’ve seen in private equity and private credit, and the regulated banking system certainly isn’t immune to what’s taking place there. We’re going to do a podcast episode on that at some point soon. The point isn’t that there are no warning signs – just that the totality of what we’ve seen and heard doesn’t support the idea that we’re on the verge of some credit conflagration. So what else could be going on here?
We’ve talked about this before we even launched the fund – and it’s been a consistent theme ever since – that the ’08 financial crisis changed everything. The response to that crisis pushed monetary and fiscal policy into totally unprecedented territory. You see the fiscal side in the federal debt. On the monetary side, the big tell is the size of the Fed’s balance sheet. Before ’08, it was under $1 trillion. A few years later it was $4 trillion. Then COVID hits and it goes to $9 trillion. And before COVID, every time the Fed tried to shrink the balance sheet, something somewhere in the system broke and the Fed had to reverse course.
The best example of this was in the 2018-2019 timeframe. The Fed started QT, and bank stocks fell sharply in the back half of ’18. That all culminated in the repo market blow-up in September 2019. It was serious but short-lived, because the Fed moved immediately to restart a light form of QE. Markets stabilized and bank stocks drifted higher into early 2020.
At the core of what happened was some key money market rates that spiked – and the one I would point to is SOFR, the secured overnight financing rate. It’s essentially the cost of borrowing in the repo market. SOFR went from 3% to 9% in two days. That’s the plumbing of the financial system clogging up somewhere.
Now, none of this stuff gets the attention it deserves b/c it’s complicated, it’s behind the scenes, and it’s boring. So people default to talking about the Fed funds rate b/c it’s a simple concept – they raise the rate, lower the rate, great. But we would argue that QE and QT – and the associated liquidity dynamics behind the scenes – matter a heck of a lot more than a 25 basis point move at a Fed meeting.
And banks are right at the tip of the spear on all of this. They’re risk assets. They depend enormously on the plumbing of the system functioning properly. So a lot of the seemingly mysterious moves in bank stocks since ’08 – both up and down – can be traced we think to these liquidity dynamics.
So what happened this September? Well, SOFR went a little haywire again. Not to 2019 levels, but enough to raise eyebrows. And honestly, you could argue it might’ve been better for the stocks if it had spiked more dramatically, b/c that probably would have forced the Fed’s hand right away. So here’s what you had: fundamentally, banks were cruising. The Fed had just pivoted toward a lower rate stance. Bank stocks trading at all-time low valuations relative to the S&P, M&A picking up again. Deregulation happening. Earnings estimates being revised higher, that was where we were late summer. And then out of nowhere the stocks start to slide.
And remember, a good portion of this slide happened before the credit headlines really surfaced. Another worrying sign for us is that bank reserves held at the Fed – the liquidity cushion – fell sharply over the summer and into September, down to basically the lowest level since the pandemic. Then the government shutdown starts on October 1 and that has implications for the Treasury’s actions in all of this – I won’t hit the details there but bottom line, that also impacts liquidity.
So now you have all these things hitting at once -- a perfect storm of plumbing-related liquidity pressures. Then earnings season rolls around, and earnings are very solid, but the credit blips show up, and it’s sort of like throwing a match on a pile of wood soaked in kerosene – the liquidity backdrop was the kerosene.
Then Powell speaks after the October Fed meeting. Going into that meeting, the consensus among liquidity watchers was that QT would end immediately. Instead, Powell said QT would continue till December 1. And that added more pressure. And when liquidity tightens unexpectedly, that’s when you get these weird, exaggerated moves in bank stocks, which don’t tend to align with the fundamentals.
The good news – sitting here now on November 14 -- is that some of these pressures have started to ease, but not by nearly enough yet. On the one hand, the shutdown is over, so some relief there. On the other hand, SOFR, bank reserve levels, and a few other indicators are still signaling liquidity stress. Interestingly, John Williams, the President of the New York Fed, gave a speech earlier this week laying out the rationale for ending QT – and even went so far as to suggest the Fed may soon start growing its balance sheet again, which is a tailwind we think for risk assets.
So why does this all matter? Because for years we’ve been saying that you cannot analyze this sector in a vacuum. You can’t look only inside banks to explain how the stocks trade. You have to consider the macro foundation and these policy distortions, b/c those forces have had an outsized influence on these stocks since ’08.
To us, the underperformance since ’08 is really a two-part story: first, the macro foundation has been unstable, and this is a sector that needs some semblance of stability; and second, the distortions in monetary and fiscal policy since ’08 – and especially since 2020 – have had huge but underappreciated effects on bank stock behavior.
And when the key drivers of stock performance are things the companies can’t control – opaque outside forces – the market just won’t give the sector a big multiple. Similar to the mortgage business – you can run the best mortgage shop on earth, but if rates go the wrong way, the business shrinks. So the market says, ok, we’re not giving that a premium.
So our thesis is that we’re at an inflection point right now – one that’s favorable for the banks. Fundamentals are excellent – margins are expanding for the first time in almost 20 years; Regulation is loosening; M&A is picking up; bank stocks are extremely cheap, while the overall market is very expensive by historical measures. So everything tied to the fundamentals of this sector is pointing in the right direction.
That’s the upside. The risk is that these outside distortions don’t fade as cleanly or as quickly as we’d like. So the setup is moving in our direction, but we think it’s important to understand the risks and what to watch for – and to also understand that sometimes the risks and the drivers of stock performance aren’t what the consensus narrative thinks they are.
So our strategy as fund managers is really pretty simple: First, try to correctly diagnose the problem which we think we have. So these liquidity challenges are very real, but at the same time, the Fed has the tools to fix this very quickly, so if you misdiagnose this situation as a major credit problem, and then the Fed steps in and solves for the real issue, then you’re too defensively positioned. So you want to be cognizant of that. At the same time though, it’s very very difficult to try to market time these situations where the situation is opaque and there’s a lack of transparency. So our approach is to be appropriately cautious, prepare for any potential outcomes, including that we’re wrong and the credit problem is more significant than we think, but ultimately we’re staying focused on the fundamentals, which remain excellent and still improving, and the attractive valuation backdrop overlaying all of that, and weather the storm in the interim through all of these bumps and bruises along the way. We see that as the surest path to long-term success.
Ok, let’s move on. That last topic is important, but not the most exciting discussion topic. Let’s shift gears to something that is both important and exciting: M&A and shareholder activism. M&A is going to play an increasingly important role in this sector over the next several years.
We talked last time about our thesis on regional bank M&A – how we divide the 25 regional banks over $50 bil. in assets into two buckets: the hunters and the hunted. And we’ve said that in this M&A cycle, the vast majority of those 25 banks are going to fall squarely into one of those two categories. Very few we think will just stand pat and do nothing.
And since our last podcast, which was only a month ago – we saw two more banks in that group get sorted definitively into those categories. Huntington fittingly played the role of hunter with its acquisition of Cadence, which obviously goes into the hunted category. No big surprise there in terms of where those banks fit, and again, it fits into the broader theme.
So we’ve now seen three large regional combinations: Pinnacle/Synovus, Fifth Third/Comerica, and Huntington/Cadence – six companies already and Huntington also announced the deal for Veritex which was smaller but still significant. These are pretty transformational moves, and we think there’s more to come.
Within that M&A backdrop, activism has resurfaced in the sector in a way that we haven’t seen in quite some time. Over the summer, we saw an activist go public with its campaign at Comerica. That same activist has been vocal at other regionals more recently. And here in Indiana, where we’re based, we saw an activist take issue with a bank after it completed a large balance sheet restructuring. CNBC even ran a piece highlighting the increased activism in banking.
So a few thoughts on that: First, we think there is going to continue to be a lot of noise around activism, but the bark might turn out to be bigger than the bite. Activism is just tough in this sector. The regulations, the ownership rules, the approvals you need – it’s not like other industries. Warren Buffett and Charlie Munger have famously said that if it weren’t for the Bank Holding Company Act making it so hard to acquire controlling positions in banks, Berkshire Hathaway would have been built with banking at its core and not insurance.
So if you’re an activist – especially at the big regionals – you might own a mid single digit, low single digit percentage of a stock. That gives you a soapbox, but it doesn’t give you the ability to force action. And if your pressure campaign doesn’t work, you’re left with a concentrated portfolio of underperforming companies. Not a great place to be in our opinion. And it’s a terrible place to be if you don’t get the consolidation wave you’re expecting. And if you’re a good sized fund in this space, let’s say a billion dollars or more – you can’t even focus on small bank activism where a campaign might actually be more effective, b/c you can’t own enough of the stock for it matter. Even if the company ultimately sells for a 25% premium, it doesn’t move the needle for your fund’s performance. So you’re stuck in this weird business model where you’re betting on subpar companies and hoping for improvements you can’t force or an M&A premium you can’t guarantee. It sounds great on paper, but the reality is tough.
Now with all of that said, it doesn’t mean the activists are wrong. In fact, some of the broader points they’re making have merit. Take Comerica. It has been a fundamental underperformer for basically my entire career and I’m not young – I’ve been at this for 25 years. The stock was just below $70 dollars per share in the late 90’s when I started in this business, and it sold in 2025 for just over $80. That’s not exactly a victory lap.
And I think those of us have been in the industry for awhile have become almost desensitized to this notion that banks often decide to sell when the primary decision maker – usually the CEO, occasionally a key Board member – decides they’re ready to retire. It’s a fact that over the past 25 years, the single best predictor of when a bank will sell is the age of the CEO.
Investors in most sectors would find that decision tree totally unacceptable, but we’ve sort of become accustomed to it and accepting of it in banking. So the same rules that sort of make the activist ineffectual in banking enable the management team and the Board to sort of run it like a fiefdom.
And look, if bank stocks were performing well, like they did for the first third of my career and briefly for periods of time since then, people would continue on living with some of these quirks. But when the stocks have underperformed and companies are making decisions – not just around selling the company – that seem disconnected from shareholder value creation – and at the same time, the long-awaited window for large bank M&A is finally open for the first time in almost 20 years – well, that’s a recipe for frustrations boiling over. So that’s what we think is happening, and we think we’re going to see a lot more of it. And with that, we will sign off for today. As always, please give us your feedback, and we’ll be back soon with another episode. Thanks for listening.
Disclosures:
Of the individual stocks mentioned, our investment fund currently has positions in Comerica Inc (CMA).
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.
