Last week, an incredible report crossed my desk.
With so much happening in the market right now, I want to ensure that you didn’t miss this.
Yes, inflation is surging. Gasoline shortages ruled the headlines. Everything is much more expensive today than just a year ago …
Meats, produce, cars, houses, furniture, RVs … you name it, it’s way more expensive right now.
And on top of that, tensions in the Middle East continue to swell.
But this story speaks to a remarkable long-term trend that you can exploit right away.
Despite the huge challenges facing the economy, this trend will only accelerate over the next decade. Now you have a chance to enjoy the ride.
Let’s dive in.
Don’t Invest in Just M&A
Typically, investors shouldn’t speculate too much on whether or not a company could become a takeover target.
One should invest in a sound organization. It should have strong fundamentals, a strengthening balance sheet, great products and services, and a growing customer base.
Any mergers and acquisitions (M&A) deal should be considered a bonus.
It is a reward for investing in a company that another firm wants so badly that it will pay a big premium for the stock.
But – if you’re going to speculate on consolidation – there is one industry that has consistently delivered blockbuster deals for decades: the banking industry.
Here’s the report I mentioned above.
In April, the industry announced 19 bank mergers and acquisitions, according to S&P Global. That figure is the largest one-month total for deal-making since before the COVID-19 crisis started.
Now, not a lot of people spend time thinking about bank mergers. And, let’s be honest, banking isn’t the most exciting business in the world.
But did you know that the industry has been consistently consolidating at a roughly 3% to 5% annual pace since the mid-1980s?
The industry has gone from 14,496 FDIC-insured banks in the U.S. in 1984 to 4,518 FDIC-regulated banks at the end of 2019.
By comparison, Canada, our neighbor to the north, only has six banks across the country.
April’s uptick in deals is positive for the industry. It’s a sign that the industry consolidation has recovered. But anyone with knowledge of this space knows that this consolidation trend has plenty more room to run.
Four Real Trends Behind Bank Consolidation
Let’s take a look at why this trend isn’t going to slow down any time soon.
There are four key trends driving consolation in banking in 2021 and beyond.
- Deposit Growth Gold Rush: Banks require customer deposits for lending and growth of their balance sheet. However, only two ways exist to increase these deposits by a significant amount. A bank can either benefit from robust local economic growth and/or strong demographic migration from new customers. Or, the bank can purchase another one. Right now, banks in places like Florida and Texas (where population growth is expanding) have benefited from the first trend. M&A remains the best option for banks where customer growth has stalled or economic growth remains muted.
- Weak Succession Plans: Large financial banks like JPMorgan and Goldman Sachs benefit from their brand and prestige. Young bankers flock to these large financial institutions to launch their careers. Smaller regional or community banks have struggled to cultivate and retain talent. Many boards of directors at banks with less than $1 billion under management exited in the wake of the 2008 financial crisis. Departures by those remaining could accelerate after the COVID-19 crisis comes to an end.
- Tax Reform and Public Policy: The last decade of public policy has created stable conditions for greater M&A activity. The Tax Cuts and Jobs Act created more favorable tax conditions to bolster bank balance sheets and boost cash for potential deals. In addition, a 2018 provision that modified the Dodd-Frank Act of 2010 has also been a factor in driving M&A. Specifically, the rollback raised a critical threshold for bank holding companies that were deemed “systemically important financial institutions” from $50 billion to $250 billion. Previously, banks with more than $50 billion in assets required greater oversight, high compliance costs, and increased reporting. This provision change gave banks fewer reduced oversight costs and greater access to capital for the purposes of M&A activity.
- Cybersecurity and Digital Banking Costs: Finally, the ongoing threat of hacking events has accelerated in the last two decades. The federal government has increased regulatory oversight to not only protect banking clients, but also to ensure that no bank acts as a backdoor vulnerability to the Federal Reserve’s systems. These regulations come at a significant cost to smaller banks, which traditionally spend less on cybersecurity. However, it’s not just the cost of cybersecurity that remains inhibitive. Smaller banks also lack the required capital to compete with larger rivals in mobile banking, online partnerships, and other digital benefits.
Two Ways to Ride the Banking M&A Wave
What good is a trend if you’re not able to trade it?
Below, here are two different ways to play this ongoing trend.
- Home Bancshares (HOMB): Headquartered in Conway, Arkansas, Home Bancshares is one of the most active buyers of community banks across the nation. It operates similar to a hedge fund riding this M&A trend. Over the past five years, it has been extremely active in buying, with multiple additions to its portfolio. The stock has remained in the Green Zone on TradeSmith Finance for more than five months. It also maintains strong momentum in this market. That said, the stock does provide a higher category of risk based on its VQ of 34.37%.
- StoneCastle Financial (BANX): The corporation operates as a closed-end fund that specializes in investments in the community banking space. These financial institutions typically have less than $2 billion in assets under management and are likely more attractive takeover targets than their larger competitors. BANX trades at a slight discount to its net asset value (NAV) due to its structure and investor sentiment. BANX might not have significant upside potential, but it does pay a rock-solid dividend of 7.1%. BANX has been in the Green Zone for more than 10 months. However, momentum has stalled in recent months. It currently trades more as a buy-and-hold option for investors seeking yield as an alternative to upside appreciation.
Tomorrow, I’ll discuss one of the biggest myths in the financial markets. You don’t want to miss it.
