Banks are a hot investment ticket of late.
We're not talking certificates of deposit or money-market accounts, but the rising stock of banking companies because of worldwide merger-and-acquisition activity.
Everybody wants a piece of the action:
-- There's the multibid scramble for Dutch bank ABN Amro Holdings NV, prompted by an offer by Britain's Barclays PLC that would create the world's fifth-largest bank. ABN's LaSalle Bank is the crown jewel.
-- Spain's Banco Bilbao Vizcaya Argentaria SA has agreed to buy Alabama's Compass Bancshares Inc.
-- Merrill Lynch & Co. is buying a stake in Japan's fourth-largest bank by revenue, Resona Holdings Inc., while China Citic Bank Corp.'s initial public offering has been the biggest this year.
-- National City Corp. agreed last week to buy MAF Bancorp Inc. for nearly $2 billion.
Banks want to be suitors to increase their asset size or sellers to harvest the lofty price of their stock.
"Mergers and acquisitions have helped keep bank stock valuations up because it is such a fragmented industry, with more than 10,000 depository institutions in the U.S. that could potentially produce deals," said Lee Calfo, director of research for Cohen & Co. in Philadelphia. "Since there has been bank start-up activity, too, we haven't seen the large-scale consolidation many had expected."
But more bank consolidation is coming, he said. Whenever profit growth becomes difficult, smaller banks will be looking to sell. An increasingly difficult environment of tight interest-rate margins and rising loan pressure is making the exits look attractive to some banks.
"It's a very tough earnings year and bankers looking forward aren't going to see things getting easier," said Tom Brown, chief executive of New York-based Second Curve Capital, an $800 million hedge fund in financial services, and the operator of Bankstocks.com. "While that will lead banks to say they'll take their premium and sell, the underlying problem is that the stock prices of many of the likely sellers are so high."
Historically, a key factor in a bank acquisition has been the age of the bank's CEO, Brown said. If you formulated a list of banks whose earnings have hit the wall and whose CEOs are over 60, it would be a good starting point for a list of likely acquisition targets, he said.
For example, Brown notes that the CEO of Cleveland-based National City is over 60 and, even though there's a successor in place, that bank is a prime candidate for acquisition action. He also likes the stock of two fine Florida franchises that have underperformed, BankAtlantic Bancorp Inc. and SunTrust Banks Inc., which could be feeling pressure from their shareholders.
The increased M&A isn't quite a boom yet.
"The rash of bank deals in January slowed down because buyers have had some concerns about loan quality, with banks that are dependent on construction lending having an especially hard time," said Peter Kovalski, portfolio manager of Alpine Dynamic Financial Services fund in Purchase, N.Y. "Nonetheless, helping to drive the acquisitions is the reality that it is now more difficult to pick up low-cost deposits, because more money is going into mutual funds or higher-rate certificates of deposit."
When "push comes to shove," the boards of many banks will acknowledge that the easy part of the business cycle has passed and that making decent returns is going to become much more challenging, Kovalski said.
Some banks whose stock Kovalski considers particularly interesting due to their acquisition potential include Astoria Financial Corp. in New York; First Community Bancorp in southern California; Greater Bay Bancorp in northern California; and Dearborn Bancorp Inc. in Michigan.
Nobody seems to want to be left behind in the current flurry of activity that has included the world's biggest banks.
"We don't think there is a need for big banks to get together, yet they are paying a huge price in order to do it," said Ganesh Rathnam, banking analyst with Morningstar Inc. in Chicago. "For example, the merger proposed between Barclays and ABN Amro Holding is actually a bad deal for Barclays."
There has been a cyclical downturn in bank credit quality, with charge-offs increasing and profit margins compressing, Rathnam said. Banks with diverse revenue streams and good fee income are holding up much better than those dependent on the interest-rate spread. Despite all that, he still doesn't think it is reason enough to justify numerous mergers.
"It's like the arms race, with one bank doing a deal and everyone else clamoring to do a deal," said Rathnam. "It's a case of eat or be eaten."
The nagging concerns of the real estate industry aren't serious banking concerns, Rathnam said. That's because most banks don't actually hold real estate loans on their books, but rather parcel the vast majority into mortgage-backed securities and pass them on to investors. If the real estate market completely tanked, the charge-offs would increase at banks, but it would not be a catastrophe, experts said.
Disregarding acquisition potential, Rathnam considers the shares of several giant banks attractive because they are priced cheaply, including Bank of America Corp., JPMorgan Chase & Co. and Citigroup Inc. Bank of America is currently the best bargain of that trio, he said.
Andrew Leckey is a Tribune Media Services columnist.Copyright © 2015, CT Now