One of our themes for the U.S. banks is to “follow the sun”, which refers to our emphasis on banks domiciled in the higher population growth states/metropolitan statistical area (“MSAs”). Every single one of the 15 faster growing large MSAs (i.e., those with populations in excess of 1.5 million people) are located in the (sunny) Southeast, Southwest, and West.
Speaking of sun, we recently returned from sunny (and warm!) Phoenix where we took part in a SMID (small and mid)-cap bank conference. The event featured speakers and representatives from some 95 different public and privately-held banks and their investors from across the United States. In addition to the presentations and panel discussions, we had the opportunity to sit down with executives from 13 different public banks, including several holdings in our Hamilton Capital U.S. Mid-Cap Financials ETF (USD) (ticker, HFMU.U) and Hamilton Capital Global Bank ETF (ticker, HBG), the latter of which holds ~40% of NAV in U.S. mid-cap banks and, which is 13% ahead of the global bank index (in CAD). The banks varied both in size (from $1 bln to $30 bln in assets) and geographic footprint (from Washington to Florida to New York, and several places in between).
Here are some of the highlights from our trip:
- M&A continues with little indication of slowing down: Of the 13 banks we met with, over half had recently closed an acquisition or were awaiting approval of one (or two). With one exception, the approval process went smoothly as management teams proactively engaged their regulator(s) (i.e., getting them involved early in the process).
- M&A a key component of growth strategy for many: Most executive felt M&A would continue to be an important way of creating shareholder value (through expense synergies). Even those currently involved in integrations continue to “date” prospective targets. Executives from banks in the slower growth Midwest who we met indicated that M&A is expected to be a regular part of their expansion strategy. Instead of transformational deals, each anticipated doing a deal roughly one quarter to one fifth of their size every 2-5 years.
- …but not the focus of everyone: In contrast, we met with three smaller banks all focused on a different top 20 MSA whose management teams indicated a preference for de novo expansion.
- Texas most often cited as a target: With its superior demographics, the Lone Star state was mentioned as a target region for M&A for several banks, with caveats (sufficient scale, price, fit). One management team said the math was getting more challenging, though buyers were thus far remaining disciplined. Other areas of interest? Most indicated a preference for M&A within or adjacent to their current footprint (cost synergies), versus tackling new unknown territory.
Interest Rates, Sensitivity & Funding
- Varying rate sensitivity: The interest rate sensitivity of the group we spoke with varied from “liability sensitive” to “very asset sensitive”. Interestingly, despite market expectations of rising rates, four banks said they manage to interest rate neutrality or are looking to decrease their asset sensitivity.
- Pace of net interest margin (“NIM”) expansion expected to slow: Deposit betas (the rate at which deposit costs increase relative to changes in the Fed Funds rate) have been lower than modeled in most regions, contributing to NIM expansion. Why? Pricing power, general lack of competition, flexibility (those with low loan-to-deposit ratios), disciplined competitors. However, consensus was that deposit competition is picking up and hence deposit betas should move higher, slowing the pace of NIM expansion.
- C&I the favoured loan category for growth: Most executives we spoke to indicated that commercial & industrial (“C&I”) is their target for loan growth. Why? Higher demand, a way to diversify (away from commercial real estate, “CRE”, heavy portfolios), often comes with deposits (helping funding), valued more highly in M&A transactions.
- Despite investor focus, banks are comfortable with CRE exposures: Several banks we met with have considerable CRE, including four exceeding guideline exposures. However, in all but one case, executives indicated that they and their regulators are very comfortable with their exposures.
Risks & Opportunities
- Bank executives – generally – sleeping well…: The consensus was that there was no obvious near-term risk or credit problem (given the strong economy). However, no one was wearing rose-coloured glasses, with a couple areas of note:
- Economy: Will politics, rate moves, derail the economy?
- Overcapitalized (privately-held) peers: Seeing some private peers loosening underwriting standards
- Funding: More than one executive told us they spend a lot of time thinking about funding; one CEO suggested his bank’s biggest earnings risk was on the deposit-side (i.e., that funding costs rise faster than asset yields)
- Technology: Executives indicated a focus on keeping technology – both internal and external – relevant and sufficient to support M&A, appease regulators (to manage risks) and assist customers
- Culture: Smaller companies indicated they spend time thinking about how they will maintain their culture as they grow
- … and remain optimistic: Consensus was that the the economy continues to move along well, and regulation has generally kept banks acting prudently. In additional to benefiting from a good macro backdrop, many cited the ability to take advantage of disruption at peers stemming from regulatory/political headlines (read: Wells Fargo), management changes and/or M&A integration. Executives were confident in their ability to continue to generate positive operating leverage, while several said they expect to grow loans at 2x-3x the rate of GDP.
 A geographic entity delineated by the Office of Management and Budget for use by federal statistical agencies. Metropolitan statistical areas consist of the county or counties (or equivalent entities) associated with at least one urbanized area of at least 50,000 population, plus adjacent counties having a high degree of social and economic integration with the core as measured through commuting ties. Source: United States Census Bureau.
 From HBG’s inception (January 2016) through October 31, 2017. The global bank index is the KBW Global Bank Total Return Index (GBKXN), converted into Canadian dollars.
 Liability-sensitive banks in theory have liabilities, such as higher-interest bearing deposits, that reprice faster with moves in benchmark rates than do the rates on assets such as loans. In contrast, asset-sensitive banks are those where the rate on their assets reprice much faster than those on their liabilities.
 In late 2006, the OTC, FDIC and Fed put out joint guidance on growth and concentrations in commercial real estate. Specifically, the agencies indicated that banks experiencing rapid growth in CRE and/or considerable exposure to CRE (over 300% of capital for income-producing CRE and 100% of capital in construction and land) would be subject to additional oversight.