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An Activist's View Of U.S. Banks

Higher U.S. bank stock valuations might have reduced the number of investment opportunities, but PL Capital Group's Rich Lashley still sees a number of places to put dollars to work.

Bank stocks have risen close to 50% over the last 18 months on hopes of higher interest rates, stronger economic growth, and regulatory and tax reforms coming in the aftermath of the U.S. election in November 2016. The rally has left the bank group trading at roughly 2.0x tangible book value, compared to 1.5x a year and a half ago.

Lashley, a longtime bank investor and shareholder activist, sees fewer attractive investments today, but noted that the market has done a good job discerning between higher-performing banks and institutions with below-average returns. Strong performers might now trade at 250% of tangible book value versus 160% before the election, while weaker-performing banks trade at 160% of tangible book value, compared to 120% pre-election.

That spread still creates desirable entry points for the likes of PL Capital, which looks for its portfolio companies to improve their value independently or eventually partner with another institution at a favorable sale price.

"Even though the absolute values have risen, there is still a relative value spread between targets and acquirers," Lashley says on the latest Street Talk podcast. "Until that math doesn't work, we're going to continue investing."

In the episode, we spoke with Lashley, principal at PL Capital, about his firm's investment thesis and his outlook for M&A activity and bank fundamentals, including the prospect of rising deposit costs that he believes will separate the "haves" from the "have nots."

Lashley said it is hard to be bearish about bank fundamentals given that credit quality is "phenomenal" and seems unlikely to deteriorate soon: Efficiency ratios are improving, net interest margins are expanding with increases in interest rates, and proposed tax reforms would offer an even greater boost to earnings. However, he said higher rates will challenge banks' deposit bases and not every institution is prepared for the change.

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Lashley noted that in the last seven years, every bank benefited from low-cost deposits rushing in their doors. Now that short-term rates are rising and deposits are beginning to carry annual percentage yields in excess of 1%, customers are moving their money around.

"The 'haves' that have nice core deposits and good C&I customer and good deposit relationships, they're going to be fine," Lashley said. "But the 'have nots' who may have fooled themselves into thinking they have stable deposit bases, I think they're going to find that it's not only hard to grow those deposit bases, it may even be hard to keep what they have."

Some banks with stable deposit bases and large slugs of noninterest-bearing deposits such as Comerica Inc. and Zions Bancorp. have already outperformed the bank sector over the last year, he noted. 

Lashley believes bank investors will receive continued support from a healthy bank M&A environment, perhaps even buoyed by some institutions' desire to bolster their deposit franchises. He expects close to 4% to 5% of the U.S. banking industry to sell every year and noted that lower tax rates, should they come to pass, will create even greater cost savings from transactions, resulting in even stronger deal multiples.

No matter what the next year brings, Lashley remains confident that changes will create new investment opportunities.

"There's always an opportunity. There's always some bank that gets in trouble. There's always a bank that stumbles. There's always something that happens that is a temporary change in valuation. And we think we'll be able to invest our money for a long time to come," Lashley said.

Street Talk is a podcast hosted by S&P Global Market Intelligence. Listen on SoundCloud and iTunes.

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Dec 15, 2017
Dec 14, 2017