Last week, I was fortunate enough to attend the Bank Director's Acquire or Be Acquired Conference in Phoenix. I go to several conferences and investment shows a year, and this one was a completely different duck. This was not the traditional dog and pony "look at me" event, but much more of a hands-on, how-to-get-it-done event.
I've traded in community bank stocks for two decades and like to think I'm pretty knowledgeable about the industry, but I can honestly say that I left feeling like I know a lot more than when I walked into the room Sunday morning. On top of it all, the Bank Director staff did a fantastic job with all of the logistics, food was great, and there was free wine each evening. The only negative was the nasty cold snap that rolled through Monday and reminded me how much I detest cold weather.
Odds and ends
Before I get into the specifics of the conference, let me share a couple of observations about the event.
There is an air of inevitability hanging over the community bank space, and it was very much present at the conference. Bankers know they need to grow or face extinction by merger. They also know that organic growth is a near impossibility in a low-growth economy.
Competing against their bigger, better-funded rivals is another huge obstacle to growth. The days of opening branches on the other side of town, then the next town over and so on to grow a bank are over.
Every corner in the U.S. that doesn't have a McDonald's (MCD) or a Walgreens (WBA) on it already has a bank branch occupying the space. You have to grow, and to grow, you have to buy. If you're not in a position to buy, you're probably going to have to sell. Some smaller banks with a strong niche, or those that can dominate a small market, may be able to survive but most simply cannot. This is doubly true if they are publicly held banks where shareholders expect return on their investments.
The older bankers all have a look of almost resignation and exhaustion on their faces. This attitude also shows in their demeanors, their postures and their conversations. After decades of having one of the best jobs in the world, banking has changed and not for the better. After a few years of foreclosures, calling loans, tightening loan standards and falling stock prices, small-town bankers are not liked any more than their Wall Street counterparts.
Bankers are about as popular as tax collectors and loan sharks these days. The regulators are a constant presence, and the average banker is spending a lot more time talking to lawyers and government officials than customers and employees. As Richard Lashley of PL Capital recently noted, banking is just not fun anymore. Many older bankers are looking for an exit; if someone meets their price, they're out of there. They didn't sign up for this, and it is time to cash in and go home.
Diversity
I have one observation that is very unlike me. I'm big on meritocracy and think that the push for diversity for the sake of diversity is counterproductive at best.
I've noted over the years that most companies end up looking like their customer base and that is as it should be. Having said that, banking has a massive diversity problem. It's not just that the crowd was almost entirely white. It was almost all white, middle-aged males who have no clue what business/resort casual actually means. This was noted last year on the GonzoBanker Blog and is still true this year.
The banking industry really needs to come up with some type of education, internship or employment program that brings minorities and women into the industry. The demographics of the U.S. are changing; last I looked, even if that wasn't true, roughly half the population is female. The industry needs to make a real effort to look more like the population it serves.
The conference
Presentations kicked off Sunday at 8:15 a.m (PST). I'm not a morning person at any time, but I'm really not a Sunday morning person. However, Tom Michaud, CEO of Keefe, Bruyette & Woods, gave an eye-opening presentation of the key themes for community banks in 2016. Along with the generous, never-ending supply of great coffee, this helped me deal with the ridiculously early hours.
Michaud noted that, while the continued selling pressure to start 2016 has reopened scars from the financial crisis, Keefe, Bruyette & Woods believes the risk impacts near-term earnings, not whether the industry has sufficient capital. His firm stress-tested the banking industry and found that, while profits would fall if the economy slumped further, there would not be credit crisislike capital destruction. Financially, the industry is in solid shape with tangible equity ratios at the highest level in 70 years. He did note that, because of higher capital requirement and low net interest margins, both ROA and ROE have fallen dramatically from precrisis times.
Thanks to the brand-new fixing, yesterday's problem regulatory environment noninterest income has also fallen. It's much tougher to make a buck in banking today.
We have seen 20 straight quarters of improving credit quality, the longest since 1991, which was the aftermath of the S&L crisis. Credit really can't get any better. In fact, we're seeing some signs of developing credit issues. Oil exposure is going to be a big problem for some banks, and the regulators are warning about CRE concentrations. There are some signs of slowing in portions of the commercial real estate market.
I personally tend to agree with Chris Marinac at FIG Partners, who has expressed the opinion that it may be prudent for many banks to begin increasing loan loss reserves a little while credit conditions are still near perfect.
Michaud touched on consolidation. He noted that in 1988 when the interstate banking act passed, there were more than 18,000 banks in the U.S. Today, there are right around 6,000, and the number is getting smaller pretty much every day.
Bank M&A deals per year as a percentage of total banks are at historically high levels, according to his presentation. On average, about 3.45% of banks get acquired per year and in 2015 that number was 4.7%. It's no great secret that I think we will see that or more again this year. It's the stronger, bigger banks doing the buying as 70% of all acquirers were banks trading above 1.5% of tangible book value. Michaud also noted that markets are rewarding the buyers right now, as many of the acquiring companies are seeing a post-announcement price pop.
Is bigger better?
My next session was titled "Is Bigger Better?" (perhaps a similarly titled breakout session at the AVN Expo in Las Vegas) and one of the speakers was Steven Hovde of The Hovde Group. He is one of the best speakers I've seen in some time; if you have a banking or finance-related conference coming up and need a speaker, get this guy. He's active in consulting, investment banking and capital markets activities in the community bank space, and he also owns controlling interest in some banks. He knows the industry and knows it well.
Hovde pointed out that, in the current environment, large banks are outperforming smaller ones on just about every metric. Smaller banks are feeling the pinch of regulatory costs and rule changes; that lower fee income is hurting the little banks more than larger ones. The smaller banks are also seeing tougher competition – not just from banks, but credit unions and nontraditional lenders.
To thrive, you have to get bigger. To get bigger you probably have to buy and again, if you can't buy you probably have to sell. He pointed out that the "sweet spot" for most profitable banks lies within the $5 billion to $25 billion range and looking at his data, it looks like the sweet spot of the sweet spot is in the $5 billion to $10 billion size.
The markets like bigger as well.
Banks between $1 billion and $5 billion in assets are trading at 1.69 times TBV, while banks between $5 billion and $10 billion in assets are trading at 2.33 times TBV. Buyers have been paying more for bigger as well as, since 2000, sellers with more than $1 billion in assets have commanded a 40% premium over those sellers with less than $1 billion. The headwinds for smaller banks are intense, and you have to get bigger fast. If you can't, you have to sell.
Roundup
Lest you think I'm going to run through every session over the two days, be assured that I'm not. I wanted to highlight these two presentations because they really set the tone for the conference. I attended a lot of nuts and bolts presentations about how and when to get the deal done and other related topics. To cover everything I heard and learned in Phoenix would be a small book.
If I included all the conversations in hallways, around the fire pits and bars about banking, the economy, wine, scotch, Kentucky basketball, Kansas City sports teams, fashion, fintech, financial journalism and snow removal, I would be months writing this and would probably have to bring in John Feinstein, Al Roper and Ben Stein as co-authors. It was an incredibly productive, entertaining and educational few days.
I do want to touch on more sessions. On Monday, there was a session with two lawyers and an investment banker titled "Shareholder Activism – Be Prepared When It Happens." I closely track bank stock activists and the session, along with hallway and cocktail conversation, reinforced a long-held belief.
One of the reasons bank stock activists have so much success is that the community bank industry isn't prepared for activism, and they have a limited selection of tools to fight back. There is a "give them some board seats and maybe they will quiet down" mentality in the industry, and it's a huge reason activists (and, by default, me) have done so well. Putting the bank activists I follow and know on your board is like inviting lions to a sheep herd. They may be polite about it, but they're going to eat well.
You and your board will find ways to improve returns, buy back stock, increase dividends or whatever else it takes to get the stock price higher, or you are probably going to come in one day and find a "for sale" sign on the door. They will not go quietly into the good night without a big payday.
I also noted a disturbing "how do we protect our bank" attitude on the part of bankers and board members. Keep in mind, folks, that once you sold stock to the public, it became our (shareholders') bank, and you work for us. Our mindset is not all that different than the activists. We want to see decent returns on our money. Your absolute best defense against active shareholders is to make sure you, your officers, employees and board members are significant shareholders in the bank.
Activists will leave you alone if you have enough votes to make a proxy fight expensive and difficult to win (most of them can count votes). You may also find yourself strangely motivated to do things that get the stock price higher.
Parting wisdom
If you're a community banker, you should be at this conference every year. You should be sending your senior officers and board members.
If you're a significant bank stock investor, you should go once for the educational experience.
If you sell to the banking industry, you're making a huge mistake to not get involved as a sponsor or vendor (please bring more free office supply giveaways). I barely put a dent in my annual supply needs and will now have to go to the Orlando Money Show to obtain more pens, pencils, calculators, highlighters and coffee cups.
The message was simple: To perform you must be bigger. To get bigger you must buy. If you can't buy, you probably have to sell. As a minor point, bank stock activists are going to continue to have a great deal of success and outside investors need to be tracking their buying and selling carefully.
