In October 2017, bank stocks increased 2.7% on mixed news and economic reports. Third quarter earnings announcements, including the financial sector, were more often better than expected by Wall Street. However, market growth was hampered by the uncertainty of the GOP’s ability to pass tax reform as well as the lingering effects of Hurricanes Harvey and Irma on the markets.
The effects of these major hurricanes in August and September challenged the Fed to read labor market conditions in anticipation of the December Federal Open Market Committee (“FOMC”) meeting when they are expected to announce the third increase to the federal funds target rate in 2017. Based on the September FOMC meeting minutes, Fed policymakers believe that inflation should revolve around 2% in the medium term, signaling a likely December rate hike. The European Central bank is expected to weigh the option of gradually ending its bond-buying program, according to the Wall Street Journal. The move would mark a shift to resemblance of the policy of the U.S. Federal Reserve which stopped its quantitative easing program in 2014. During the month the markets also closely watched President Trump’s pick for the next Chair of the Federal Reserve. Lastly in October the U.S. House of Representatives narrowly passed a budget that once signed by President Trump, will allow the tax writing committees to begin working on a tax reform.
Regulatory relief for community bankers continues to be a topic at the Federal Reserve. At a community banking conference in St. Louis, Chairwoman, Janet Yellen, said the Fed is working hard to reduce regulatory burdens on community banks by simplifying capital requirements. Analysts see Yellen’s remarks as positive news for easing post crisis strict requirements for smaller financial institutions.
In economic news, data from the U.S. Department of Labor reported that nonfarm payrolls decreased by 33,000 in September largely attributed to Hurricanes Harvey and Irma. The loss undershot analyst expectations of an increase of 100,000 jobs in the month and unemployment declined to 4.2% in September. Construction spending improved 2.5% year over year while U.S. manufacturing activity rose to a 13-year high in September. U.S. home sales declined in the month of September year over year by 4.2% while the median sales price rose 2.3%. U.S. Average Hourly Earnings increased in the month of September by $0.12, or 0.5% over the previous month.
Bank M&A pricing was up significantly year-to-date through October compared to the same period in 2016 on about the same number of transactions (see chart below).
The SNL Bank Index increased 2.7% in October, and outperformed the S&P 500 which gained 2.2% during the month, while banks below $500 million increased 1.2%, banks between $500 million and $1 billion posted an increase of 0.8%, and banks between $1 billion and $5 billion gained 0.4% during the month.
Over the three month period ending October 2017, the SNL Bank Index gained 6.6% while the S&P 500 increased 4.2%. Over the prior twelve months, the SNL Bank Index outperformed the overall market, as it increased 36.9% while the S&P 500 increased 21.1% and reflected the post election run-up in pricing.
REGIONAL PRICING HIGHLIGHTS
All but two of the regions reported higher price to tangible book multiples with the exception of the Mid-Atlantic which reported nearly a 3% decline lower loan to deposit levels and the West who reported an increase in non-performing assets (“NPAs/Assets”) in October. The Southwest region maintained its leading position reporting the highest price to tangible book at 200%. The West, which normally maintains high multiples, dropped to 189% exceeding only the Mid-Atlantic with a median price to tangible book of 174% as the West saw the largest increase in NPAs/Assets. The Midwest region at a median price to tangible book multiple of 189% saw the largest increase in pricing gaining 1% in October. The Northeast maintained the second highest median price to tangible book multiple (199%) while reporting the largest decline and lowest level of non-performing assets to assets (0.54%).
Strong pricing among the public banks in the Southwest region was supported by strong earnings (ROAA 1.00%) and Net Interest Margin (3.35%) while non-performing assets declined. The Northeast maintained strong pricing as asset quality improved (NPA/Assets of 0.54%), loan demand was the strongest among the regions (Loan/Deposits of 95.3%) and earnings edged up slightly (ROAA of 0.92%). The West continued to lead on earnings (ROAA of 1.08%) and net interest margin (3.75%) but reported higher NPAs/Assets causing the median price to tangible book to drop to 188% down from 192% in September.
On a median price to earnings basis, only two regions saw a decrease, the Northeast and Southwest, in October. However pricing multiples for all the regions maintained price to LTM earnings between 18.0x and 20.1x. The West region reported the highest increase on a price to earnings basis (3%) on the highest and most improved earnings. The Mid-Atlantic and Midwest were the only regions to report price to earnings at 18x as the Mid-Atlantic reported the lowest median ROAA (0.88%) and the Midwest reported the worst asset quality (NPAs/Assets of 0.79%).
PRICING BY SIZE
Size matters in bank stock prices. Financial institutions with total assets greater than $1 billion consistently report at least 50% higher median price to tangible book pricing than their peers with total assets less than $1 billion. In general, size affords higher profitability which has a direct impact on pricing multiples. During October, the three groups with total assets over $1 billion maintained their median tangible book pricing averaging 210% while the two smallest group medians increased to average 136% price on tangible. On a price to LTM earnings basis, the same is true with the median of the three groups with assets over $1 billion maintaining an average of 19.0x while the two smallest groups reported a small increase to an average price to LTM earnings of 19.1x.
Financial institutions under $1 billion reported much lower LTM ROAA (average of medians 0.65%) and lower asset quality (1.09% average of median NPAs/Assets) than institutions with assets over $1 billion (average median LTM ROAA 1.02% and NPAs/Assets 0.64%).
Mergers & Acquisitions by Region
Bank consolidation maintained a consistent pace with 193 transactions announced year-to-date 2017 compared to 192 through October 2016. However, median year-to-date pricing through October 2017 was substantially higher at a 22.1% increase on tangible book (median 1.65x), 20.4% increase on price to 8% tangible book (1.75x), 10.8% increase on LTM earnings (21.5x), and 23.6% increase on deposits (20.3%) compared to transactions announced through October 2016. Higher prices in 2017 for merger and acquisitions are the direct result of higher public bank stock prices.
The Southwest region reported the highest price to tangible book multiple at 1.94x (12 deals with terms)on deals with the highest median earnings (LTM ROAA 0.88%) and best asset quality (NPAs/Assets 0.6%). The West followed with a median price to tangible book multiple at 1.86x (20 deals with terms) followed by the South at 1.66x which also reported the most consolidation with a total of 54 deals announced (39 announced with terms). The lowest priced region, the East – New England, reported a tangible book pricing multiple of 1.35x (20 deals with terms) likely due to low LTM ROAA performance of the targets at 0.36% and high NPAs/Assets at 1.5%.
More information regarding nationwide M&A activity can be found here.