I want to make two points.
The first is that, in my opinion, this is a great time to be running a bank. I don’t want to wax too Panglossian, but the economy is growing, banks are generally seeing an immediate positive impact from tax reform, industry wide asset quality is fantastic, the regulatory environment is significantly more constructive than it has been in years, unemployment is dropping, core deposits are gaining in value—the list just goes on.
However, as Abe Lincoln once said, “this too shall pass.”
While current conditions are generally positive for most of the banking industry, that is not going to stay that way forever. Rising rates obviously cut both ways and, once the Fed stops raising rates and deposit betas catch up with loan betas, it will be all too apparent who has been swimming without a bathing suit (to paraphrase another folksy American hero). Technology will inevitably reshape the competitive landscape for banks and there will be a bigger run rate of expenses associated with cybersecurity. Loan growth will not be shared proportionally by all. Banks will have to grapple with CECL, which will be a costly headache for many. Finally, while I do not anticipate anything close to the credit issues experienced by banks during the financial crisis, asset quality has a lot more room to get worse than to get better.
None of that makes me a bear on banks—or, more accurately, none of that makes me a bear on some banks. I think the real impact of changing conditions will be that the banking sector will become even more clearly divided into the haves and the have nots, with the haves getting their disproportionate share of the benefits of economic growth, rising interest rates, implementation and adoption of technology, etc. All these benefits should be reflected in their results and stock price multiples, allowing these winners to be even more aggressive in making investments in their business, whether through acquisitions, hiring, spend on technology, whatever. You can already see the trajectory of this by looking names like Western Alliance (NYSE:WAL), Pinnacle (Nasdaq:PNFP), ServisFirst (Nasdaq:SFBS) and Bank of the Ozarks (Nasdaq:OZRK).
For others, things could be a little tougher.
This leads me to my second point. If you are not currently in, or soon to join, the haves category, now would be a pretty good time to think about selling. Put another way, if you are a bank and are not taking full advantage of this great climate for banks, I think it is going to be pretty hard to play catch up and the best route to maximizing stockholder value is probably finding a partner.
To put this into context, I was reading the Proxy Statement for MidSouth (NYSE:MSL) and came across this statement:
“Our aim is very simple – we want to achieve long-term, sustainable, above-average financial performance as measured against our peers. That is our stated goal and it will take time to get there, with an initial milestone of achieving peer levels of profitability at lower levels of risk within three years.”
I have a ton of respect for the board at MidSouth. They have faced a lot of tough issues head on and made some hard decisions without flinching. Their transparency and forthrightness are truly commendable. I also think they are completely serious about maximizing stockholder value. Unfortunately, I don’t think a three year journey to peer levels of profitability is the way to do it.
As an aside, I do think these guys are straight shooters—three years is a long time, but if feels about right in terms of the length of time to accomplish all that they are trying to do. I think other banks facing similar turnaround situations are probably less candid about how long and how difficult the process is likely to be.
Being straight shooters, though, MidSouth basically points out all the issues with embarking on this path in their proxy statement: the costs of significant investments in risk management infrastructure, the need to retool their business model, the costs of building out operating infrastructure, the challenges of attracting and retaining talented individuals, etc. More importantly, MidSouth acknowledges perhaps the most overarching concern of all--execution risk, which I don’t think is ever properly estimated in turnarounds. Finally, MidSouth points out perhaps the biggest issue to stockholders:
“These activities will not deliver much in the way of positive financial performance in 2018 . . .”
While I think that both the goals and intent of MidSouth’s board are laudable, I also think they should refresh their recollection of this statement from their 2017 Annual Shareholder Meeting Presentation:
“Independence is earned and not a God-given right.”
I am confident that many other banks would be interested in partnering with MidSouth. They have a valuable deposit franchise and an increasingly liquid balance sheet that would prove very attractive to banks in need of additional deposit funding. In addition, it is often easiest to deal with credit issues in the context of an acquisition—purchase accounting would offer an acquirer the opportunity to wipe the problem asset slate clean (and potentially provide for additional earnings down the road). Finally, as with almost all acquisitions, there is the likelihood of significant cost saves.
I can only hope that the MidSouth board (1) is not rebuffing bona fide overtures from banks capable of executing a transaction, whether made directly or through their intermediaries, (2) is fully informed as to the value MidSouth might obtain for stockholders in a sale transaction and (3) carefully and faithfully weighs the value that could be obtained in a sale against the value of remaining independent, after taking into account all risks associated with either path.
Going back to my first two points, I think it is pretty clear that MidSouth is not currently taking full advantage of the current excellent climate for banks. I don’t think that the current board and management team is at fault for that and I think that they are trying to make the best out of a tough situation. However, I think it would make more find a strong partner now, and allow MidSouth stockholders to fully reap the benefits of this great environment, rather than wait three years to see whether a tough turn around will be successful and hope that economic conditions will remain as supportive as today.