Bank Stocks - The Outlook for 2017

Bank Stocks - My 2017 Guess
After a very strong year end run, can it continue?

Banks closed out 2016 with a very strong run following the presidential election in November. I don’t think I’m going out on a limb to say that the result of the election caught almost all of us by surprise.

While the election results were a surprise, the resulting bank stock rally occurred for reasons not too hard to comprehend.

First, there are higher expectations of growth in the economy: which means more loan demand, higher interest rates, better credit quality, and a positively sloped yield curve. All good things for banks.

Second, there is the perception that regulatory burdens — and the costs associated with them, which have risen dramatically in recent years — will be eased. How that will play out remains to be seen, but that’s the perception.

Third, the light for merger and acquisition activity is now a very strong ‘green’. As bank stock prices move higher, particularly for the larger banks (typically seen as the acquirers in bank transactions) it becomes easier for these banks to use their currency — their stock — to buy other banks. For small banks that have a predisposition to sell, they are now in the sweet spot. They can sell at a healthy multiple and thus have a good story for their shareholders, but even better: they can take the currency of a bank that may itself go much higher, either because of a good growth story, and/or because they plan eventually to sell the combined entity.
Let’s take a step back for a brief moment and review.

Bank stock prices — though they have risen — do not appear to be overstretched. A recent item in the Wall Street Journal noted that, even after the strong year end run, bank stock prices are 22% below where they were before the onset of the financial crisis of 2008/2009.

As an example, Fifth Third Bank (FITB) is trading at about 150% of tangible book value at the moment: I remember times in the past when it traded at 300 or 400% of tangible book, and higher. That data point, in and of itself, doesn’t really prove anything . . . . . but at least you can have a sense that current valuations are not at the high end of the historical range. Fifth Third is not a community bank — it is a super-regional — but community bank stock prices tend to be linked to the prices of larger banks: their potential acquirers.

Finally, I would describe the recovery in bank stocks, coming out of the financial crisis of 2008/2009, this way:

1) phase one, was the recovery of the banks from the immediate damage done by the economic implosion that was the Great Recession, i.e. many banks were simply struggling to survive;

2) phase two, was the transition to normalcy. The bank sector is now largely healthy. There are few if any ‘walking wounded’. Merger activity is now for the most part based on strategic considerations, rather than a need to take over a failing institution.

3) phase three, the current period, in which banks are getting more aggressive and confident in their growth plans, driven in part by expectations of a stronger economy, and higher stock prices. Higher bank stock prices mean buyers can afford to pay more for the selling banks. Expect to see continued merger activity, especially in the lower size tier of banks: i.e. the community banks. And in fact, acquisition multiples are climbing.

So, to sum it up: I believe 2017 shapes up to be a good year for the bank sector. There are still, in my opinion, attractively priced community banks out there, but care is needed in their selection. Banks have run up a lot recently. Are they due for a breather? Some of the banks that have made big moves are, definitely, but not all, in my opinion. And of course there is always the unplanned ‘exogenous event’ that can cause volatility. But I think right now it’s ‘stay the course’ and continue looking for attractively priced bank stocks. I’ll be looking to trim back a position here or there that looks ‘maxed out’ and where it seems that the rationale for purchase has run it’s course, replacing them with the best current ideas I can find.

I’ll do these updates from time to time. Coming soon, I’ll start to send out brief profiles of some of the banks we’ve purchased in your portfolio.

Please call me to discuss at any time!

best,

Brian