The KBW Bank Index (BKX) has surged nearly 20% since the election. Investors are hopeful that decreased regulation and tax reform can break the multi-year slump in the financial sector.
President-elect Trump may have a tough time completely repealing the massive Dodd-Frank banking reform act as he pledged to during the campaign, but there is no doubt the new administration will at least attempt to chip away at pieces of it. The banks that stand to benefit most from this are regional banks, which received good news in late November when legislators started discussing a measure that would redefine the threshold for ‘systemically important’ institutions. The current threshold of $50 billion or more in assets may be raised, freeing some regional banks from much of the regulatory burden.
In addition to clearing the regulatory costs and oversight on the industry, the macroeconomic backdrop is shifting to become more favorable to banking. The rate on the 10-year Treasury jumped 35% in November, rising to 2.44%, giving banks a lot more room between borrowing costs and lending rates. Unemployment is hovering around a decade-low and consumer confidence jumped just before the all-important holiday shopping season.
FDIC-insured banks reported 12.9% earnings growth in the third quarter, demonstrating strength in both larger institutions and community banks. Just 4.6% of reporting institutions had net losses in the quarter, the lowest since Q3 of 1997, and the level of non-current loans has dropped in 25 of the last 26 quarters.
M&A activity is already picking up as banks look to better times ahead. Independent Bank Group (IBTX ) recently agreed to acquire Carlile Bancshares Inc. for $434 million, just days after Cascade Bancorp (CACB) agreed to an offer by First Interstate BancSystem Inc (FIBK) for $570 million.
Three Banks With Room To Run
Despite a reduced regulatory burden on the industry in general, several banks are still weighed down by specific restrictions.
However, the rebound in balance sheet strength and a stronger overall outlook could mean these institutions could be cleared soon.
That could lead to M&A opportunities, increased dividends, and a pop in the shares on stronger investor sentiment.
Regions Financial Corp (RF) and Fifth Third Bancorp (FITB) both hold “needs to improve” ratings under the Community Reinvestment Act (CRA). The CRA was implemented in 1977 to oversee banks’ lending practices in underserved and low-income communities. All banks with $1 billion or more in assets are rated on the percentage of loans to these areas and rated either outstanding, satisfactory, needs to improve, or substantial non-compliance. Ratings in these last two categories can result in delays or denials of M&A or expansion of services.
Regions Financial has a strong deposit base throughout the Southeast and is growing its non-interest income sources. Management plans to consolidate up to 9% of its branch network and cut up to 10% of operating expenses through 2018. This move to efficiency could make the relatively smaller bank a target for others looking to add to their deposit base.
The bank has averaged 6.9% return on equity over the last three years and shares trade cheaply at just 1.0 times book value. The dividend yield of 1.9% was just 29% of net income last year and nearly $650 million in shares were repurchased.
Fifth Third Bancorp has a commanding presence in the Midwest and Southeast, notably in rust-belt states that could benefit from Trump’s promises to reinvigorate manufacturing. The bank has the highest average return on equity among the three at 11.6% over the last three years and trades at 1.3 times book value, a discount of 13% against the industry average 1.5 multiple. Shares pay a 2.0% yield, which was just 23% of net income last year, and the bank repurchased $720 million in shares outstanding.
M&T Bank Corporation (MTB) is restricted from expanding until its “letter of agreement” on anti-money laundering and Bank Secrecy Act programs is lifted by the Federal Reserve. CFO Darren King told The Buffalo News early November that the bank had fulfilled every component of the agreement except one piece that it expects to complete early in the first quarter of 2017. After that, the Federal Reserve will conduct a review and is expected to lift the restrictions against expansionary activities including acquisitions or being acquired.
M&T Bank is one of the largest regional banks in the Northeast. Nearly a fifth of the outstanding shares are owned by employees or directors and 6% of the company is owned by Warren Buffett’s Berkshire Hathaway Inc. (BRK.A,BRK.B).
The bank has averaged 9.4% return on equity over the last three years and trades at the industry average of 1.5 times book value. Shares pay a 1.9% dividend yield but could go higher from the 38% payout ratio.
The simple lifting of restrictions on these banks could improve investor sentiment and drive share prices higher. All three banks are financially healthy and have strong share in their regional markets. Each may benefit from the improved environment for community banking and may become acquisition targets themselves.
Risks To Consider: Bank stocks have already rebounded, so investors may need to see actual policy changes in the new year to send shares higher.
Action To Take: Position in regional banks ahead of policy reform by the new administration. Watch for banks that have ongoing regulatory burdens that could be cleared early next year.
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