We recently attended the Bank of America Merrill Lynch Banking & Financial Services Conference in New York City. Representatives from major banks, asset managers, and consumer finance companies participated in very informative Q&A sessions, providing us and other investors with their thoughts on interest rates, M&A, and the credit environment. We would identify the following key takeaways:
Catalysts for Mid-Cap Bank Stocks Expected to be Rising Rates and M&A
When asked what would be the catalyst for mid-cap bank stocks in 2016, 44% of investors at the conference chose an increase in interest rates, and 31% chose M&A. All presenters, that were asked, thought that the Fed should raise rates in December (not surprising, given the general benefit to the sector), and all but one thought that the U.S. central bank would go through with the rate increase this month.
As part of the rate conversation, the topic of deposit beta came up in multiple presentations (measuring how much of an increase in the Fed funds rate a bank will pass on to their depositors, i.e., how much they will need to pay their customers for their deposits to keep them from switching banks). Although some participants provided predictions, most acknowledged that, as it has been over 10 years since the last rate cycle began, changes in technology and consumer behaviour in the interim make this very difficult to predict with accuracy.
Negative Large-Cap Deal Reaction Not Likely to Impact Mid-Cap Bank M&A
Given the market’s reaction to the recently announced deals (NYCB/AF and KEY/FNFG – click here for our Insight), bank executives were asked for their views on both the M&A market in general and their companies’ plans as buyers and/or sellers. Multiple banks noted that they are receiving numerous inbound calls from potential sellers, but said that they are staying cautious, citing the high purchase premiums necessary to end up as the successful bidder in these deals. One executive downplayed the importance of M&A in general, noting that his bank is increasing assets by $5 bln per year organically, which is roughly the size of a small bank. Investors in attendance were bullish on the bank M&A market. 52% of audience members thought that larger bank M&A would increase in 2016, and interestingly, only 10% thought that the negative reaction from the recent transactions would slow activity.
Asset Quality Trends Remain Benign
Credit quality was a mainstay topic throughout the conference. Aside from energy and taxi medallion loans (the latter under pressure due to Uber’s impact), credit has been relatively benign across the U.S., as one executive noted that consumer balance sheets are now the healthiest he has seen in decades. Companies with exposure to the aforementioned sectors down-played the importance of those loans to their overall earnings, citing geographic and business sector diversification within their portfolios. Multiple participants spoke of seeing rival lenders lowering their lending standards (i.e., covenant terms) to win business in certain markets, particularly in real estate and commercial and industrial (i.e., C&I), both categories which have historically landed banks in trouble when previous cycles have turned.
Hamilton Capital Global Financials Fund LP