I spent the last two days in Atlanta at one of my favorite conferences of the year, the Bank CEO Forum hosted by FIG Partners. Being a banking junkie, this was like heaven for me.
I talked with community bankers and community-bank investors and came away with some interesting insights about the trade of the decade in small-bank stocks. Several panels featured bankers talking about the industry but, as always at events like these, the real lessons were learned in the hallway and over cocktails after hours.
It is worth noting that none of the bankers I spoke with are looking for any sort of meaningful rate hike out of the Federal Reserve in the near future. A 25-basis-points increase this year would not have much impact on deposit rates or spreads. Bankers expect net interest margins to remain very tight. And this should be a driver of further consolidation as smaller banks will continue to find it difficult to deal with tight margins and rising costs.
Meanwhile, regulatory costs and pressures continue to be a concern. The CEO of one Texas bank said that he had 100 employees handling just regulatory compliance and there were regulators in his branches and executive offices more than 40 out of the past 52 weeks.
Everyone I spoke to felt that the recent revelations about Wells Fargo (WFC) and deceptive account openings would bring heightened scrutiny from regulatory agencies and that sales and marketing policies would be under the microscope for the next few years.
M&A remains the most favorable path for growth. One banker said if you were experiencing strong growth without M&A in the current economy you needed to back up and look at the risk levels assumed in your loan book. While everyone would love to have double-digit organic growth it is almost impossible to come by right now given slow growth rates.
No one I spoke with believes the economy will pick up strongly anytime soon, so M&A still appears to be the best growth strategy.
The other path to growth is cost cutting. Banks are really starting to focus on bringing down their efficiency ratios as a way of increasing earnings. The best way to cut costs, according to one banker, is through the delivery system. Reducing the branch count and replacing bricks and mortar with technology can reduce costs drastically and all the savings drops straight to the bottom line. Using fintech to automate many processes was also seen as a way to lower costs and improve profits.
Banks with low efficiency ratios such as Home Bancshares (HOMB) , Prosperity Bancorp (PB) and United Bancshares (UBOH) are going to have a huge cost advantage over competitors and should continue to trade at premium valuations. Their ability to buy banks with higher efficiency ratios and take out costs will be a profit driver for these highly efficient banks.
Commercial real estate is becoming a hot topic. CRE lending has been one of the best loan categories for the past few years and it is now coming under increased regulatory scrutiny. Banks with CRE loans that are 100% or more of tangible risk-based capital are considered to have a CRE concentration; those over the 300% threshold should be implementing heightened risk management practices. While the 300% level is considered guidance and not yet a rule, many think regulators will be more aggressive in curtailing new CRE lending at banks at or above that threshold.
Finally, geography is becoming more of an issue in community-bank M&A. As banks cross the $1 billion asset level, expanding in attractive markets becomes as important a consideration as gaining scale. As an investor, it would make sense to sit down with the Milken Institute's list of best performing cities and buy every bank in those cities with less $1 billion in assets.
You could also use the CNBC list of best states for business to find investment candidates among smaller banks. I did that with the state of Florida a few years ago and to say it has worked out well would be an understatement.
The banks that end up surviving and thriving will be those that gain scale and efficiency, and the only path available to achieve that right now is via merger. There continues to be a large pool of banks that need to buy, and a pool that need or want to sell. That bodes well for us as bank-stock investors.