I’ve been watching – and profiting on – a ridiculously profitable wave I’ve seen developing over the years. It’s not exciting, but it’s the easiest money there is: bank consolidation.
The trend has its roots in the 1980s, when the interstate banking laws were changed to allow ownership across state lines.
Things got “interesting” in the aftermath of the savings and loan crisis, when the prices of great banks fell right alongside the dogs, overstuffed with junk bonds and dubious mortgages.
At the time, it was cheaper by far for any CEO worth their salt to just up and buy a smaller competitor rather than try and expand in a new state or region.
The consolidation continued right on through the Internet “dot-com” bubble and collapse, right up until the eve of the credit crisis in late 2007.
Consolidation went on a holiday of sorts until about 2011, when it started right back up where it had left off 34 years earlier.
That brings us up to speed.
The news is, bank consolidation will – I repeat, will – make you stinkin’ rich if you kick back and let it work for you. Maybe the easiest fortune ever made.
Why? Simple – there’s a lot more consolidating left to do. A whole lot more.
Each year, somewhere between 3% and 5% of American banks are taken over, and that’s going to continue until we get below 2,000 banks.
As you’ll see in a minute, we’re quite a ways from that milestone.
Making money off this trend is ridiculously easy. If you can sit around waiting for a package from Amazon, you have the specialist skillset required.
I’ve got two plays all lined up for you…
Here, I’ll Spill the Secret Right Up Front
In order to make money (and lots of it) off bank consolidation, we buy smaller banks that are underperforming but which possess strong balance sheets and pristine loan portfolios at less than the asset, or “book,” value of the business.
Of course, I like to cheat a little bit, stack the deck in my favor by making sure there is an investor in the bank who has demonstrated a willingness in the past to take an activist approach.
Sometimes management just needs a swift kick in the rear to motivate them to do the right thing, and there are a handful of bank activists who are good at delivering the blow.
Then, we just sit back and wait for a takeover.
Most people don’t have the patience to get rich from banking consolidation. You make all the money from banking consolidation by buying right and sitting very still for a long time.
There are no sexy stories. Nor will your banks will be mentioned on TV or in the press… until they sell at a price that can be several multiples of what you originally paid for your shares.
It is a boring way to get rich, and it seems most people would rather be broke than bored.
The bank consolidation trend is not going away anytime soon, and there are several excellent reasons for this.
Two Good Reasons Small Banks Are Up for Grabs Right Now
First… There are too damn many banks. As a country, we don’t need this many.
We have over 5,000 banks in the United States.
There are 86 in Canada. There are less than 500 in the United Kingdom – same as in France. There are less than 100 in Japan.
It’s the same all over the world, as other nations seem to get by okay with far fewer banks than we have in the United States.
There is a reason “we, the People” are overbanked.
See, once upon a time, owning a small bank was a fabulous business. You could earn as much as 15% a year on your investment investment, year in and year out.
Businesspeople all over the country would band together and form community banks and sit back and let their ownership stake grow their wealth at a much faster pace than most investment opportunities.
One of the drivers of consolidation is the fact that this is no longer the case.
Banking is a tough business in 2019. The regulatory environment since the credit crisis takes a lot more time and money to navigate. There is a lot more competition, not just from other banks but from technology-driven financial firms that offer all types of loans. Smaller banks are struggling as the costs of regulatory compliance and technology spending eat up much of the bottom line.
While it is tougher for the smaller banks, they are not the only ones that have a hard time with rising costs. When he announced the merger with SunTrust last week. BB&T Chair and Chief Executive Officer Kelly S. King said “This is a true merger of equals, combining the best of both companies to create the premier financial institution of the future. It’s an extraordinarily attractive financial proposition that provides the scale needed to compete and win in the rapidly evolving world of financial services.”
It is simple: More assets mean more profits are coming in the door. Higher profits mean you can more easily afford the costs of this changing world of banking. There is a reason JPMorgan Chase & Co. (NYSE: JPM) has such a massive lead in digital and mobile banking. They make an enormous amount of money because they have an enormous asset base. They have the money to spend.
That’s not the case for small banks and trusts. It often becomes a case of being too small to survive.
Second, the bankers themselves are getting older and have nowhere to go.
A lot of the bankers I talk with these days tell me that succession is becoming a driving force behind consolidation as well. Small banks have never really done a great job at succession planning to start with, but today they face an additional burden when deciding who takes the reigns from the older generation. The available talent pool is shrinking and will continue to shrink; no one wants to be a banker these days.
Why would they? Banking used to be easy and very profitable. Today, at the smaller banks, the returns are meager at best. The executives of community and smaller regional banks used to be admired in their communities.
Post–credit crisis, that’s not always the case. They have had to foreclose on people they went to high school with and deny loans to people they played Little League with decades ago. They have to entice deposits at ridiculously low interest rates. The examiners and regulators are a daily pain in the backside.
It is not fun, and it’s not very profitable.
Generation X, Y, and Z, especially millennials, are taking their talents to tech and high finance, not traditional banking. As banking executives and directors are getting older, all too often the only exit plan is to go ahead and sell the bank.
Here Are My Favorite Takeover Plays in This Space Right Now (There Will Be More)
There are lots of reasons for bankers to sell, and there is a compelling reason for larger banks to buy as well. We live in a slow-growth world, and there is a lot of competition for loans and deposits. The only way to grow at a reasonable pace is to buy other banks.
Shareholders want to see a higher stock price, and that requires earnings growth. To achieve that growth usually means you have to buy another bank and gain additional scale on costs.
Banking consolidation will continue for decades. The good news about this is that means we will continue to have the opportunity to make a ton of money buying and owning bank stocks. Buying financially strong banks at bargain prices is wildly profitable, and if you pay close attention to the loan portfolio and balance sheet, it’s actually kind of hard for patient investors to lose money.
Right now, as I look around the banking landscape, I see that Hope Bancorp Inc. (NASDAQ: HOPE) in Los Angeles has caught the eye of at least one successful bank activist investor. The stock trades at a small discount to book value and operates in one of the strongest markets in the country. It has plenty of capital on hand and the loan portfolio is pristine. To make a good thing better, the stock pays a generous dividend and yields 3.8% right now.
Another California bank has attracted attention from several known activists. One of these firms, Bancb, has a board seat and was instrumental in replacing the CEO last year. The bank specializes in business lending for the most part, and the loan portfolio is doing surprisingly well for a bank that has over 60% of its loan portfolio in business or multifamily real estate loans.
Banc of California Inc. (NYSE: BANC) is also well capitalized and should be more than capable of riding out any hiccups in the economy. It would also make a great target for any larger bank whose loan portfolio is heavily invested in single family homes.
Both of these jewels in waiting are trading for far, far below $20 a share right now. That’s just the cherry on top as far as I’m concerned.
— Tim Melvin
Source: Money Morning