At Hamilton ETFs, the prospects for M&A is one the supporting factors for our investment thesis for the U.S. mid-cap banks, in which both the Hamilton Global Bank ETF (ticker: HBG) and Hamilton U.S. Mid-Cap Financials ETF (USD) (ticker: HFMU.U) are heavily-weighted.
Recent meetings in New York, Dallas and Washington, DC provided us with an opportunity to hear nuanced comments and feedback on the state of U.S. bank M&A from interested parties, including investment bankers and senior bank management.
Below are the highlights from the said conversations and presentations:
Investment Bankers: Expect activity to accelerate
- Expect the number of U.S. banks to be halved over the next decade
- 2019 M&A volume is down vs. 2018 on an annualized basis, with financials as a portion of the total global M&A volume continuing to lag pre-2015 levels
- In recent transactions, where the target bank is public, the premium has been skinny (i.e. more mergers of equals, “MOEs”)
- The receptivity of banks to large bank M&A (think $100 bln+ in assets) appears to have increased. One banker suggested he would not be surprised if another 1 or 2 large bank deals were announced in next 12-18 months following the STI/BBT transaction (see our February 8, 2019 insight, “U.S. Bank M&A: Implications from the Largest Deal in a Decade”). This runs contrary to what the banks themselves are saying (see next section).
- That said, when asked why another deal comparable in size to the BB&T/SunTrust transaction has yet to announced, bankers cited culture and CEO succession as being the primary hurdles. The adage that the closer a CEO is to retirement the more likely they are to sell appears to still hold true.
- Primary motivators for a deal? Access to additional customers or products, geographic diversification (sometimes), scale to invest in technology (increasingly important)
Banks: Large regionals circumspect; Mid-caps more opportunistic though still judicious
- The large regionals (think assets above $100 bln) generally played down the prospects for large-scale M&A, notwithstanding interest from investors (see next section):
- One large regional CEO said management does not see bank M&A as a priority; they have what they need to grow. That said, the same CEO did cite interest in non-bank M&A, specifically in fintech that they could leverage across the broader bank
- Another executive pointed to recent bank M&A as having solved a strategic objective for the bank, and that its current priority was to grow that business organically. However, they too expressed interest in non-depository transactions, specifically in capital markets or fee income businesses
- The mid-cap banks (think assets of less than $100 bln) we met were more mixed on M&A:
- Several executives said their own recent M&A transactions were keeping them internally focused on integration currently
- More than one team indicated that they had a short list of potential targets, but that they were not actively seeking a transaction; potential targets tended to be in footprint or contiguous and with strong deposit franchises
- In several cases the potential targets were either currently too expensive or had too high expectations for a sale premium, and no one was interested in doing a dilutive deal
- Several bankers told us that bank boards didn’t want to compromise on financial discipline on potential M&A, particularly in an uncertain economic climate
- The possibilities of an MOE were largely downplayed despite their popularity with investors; some cited it as being too much risk to take on, others that there was the lack of an appropriate partner
- All that said, several executives said more and more banks were talking to each other than had been the case in some time
Since regulatory reform was passed in the early 1980’s, U.S. bank M&A has been both a cyclical and secular theme, with periods of significant activity. Post crisis, activity has been muted, as banks were focused on building capital for some time. However, with the capital building process over, we continue to expect activity to accelerate should the volatility recede, and the environment become more accommodating.
A word on trading liquidity for ETFs …
Hamilton ETFs are highly liquid ETFs that can be purchased and sold easily. ETFs are as liquid as their underlying holdings, and the underlying holdings trade millions of shares each day.
How does that work? When ETF investors are buying (or selling) in the market, they may transact with another ETF investor or a market maker for the ETF. At all times, even if daily volume appears low, there is a market maker – typically a large bank-owned investment dealer – willing to fill the other side of the ETF order (at net asset value plus a spread). The market maker then subscribes to create or redeem units in the ETF from the ETF manager (e.g., Hamilton ETFs), who purchases or sells the underlying holdings for the ETF.
 As of September 13, 2019, HBG held almost 50% of NAV in U.S. mid-cap banks, and HFMU.U held ~66%.
 As of June 30, 2019, there were 5,303 FDIC insured institutions in the United States, down from 5,542 (or 4.3%) from a year earlier. Source: FDIC.