We recently attended a U.S. financial services conference in New York City and had the opportunity to meet with executives from seven mid-cap banks. These meetings were of particular importance to us, as the Hamilton Capital Global Bank ETF (HBG) has ~46% of NAV invested in the U.S., with the majority of that in banks with less than US$50 bln in assets. Given the relatively low dividend yields of the sector, the Hamilton Capital Global Financials Yield ETF (HFY), which has a net underlying yield of ~4.8%, only has a ~5% allocation to U.S. banks.
The banks we met have median market caps of US$2.5 bln and median assets of ~$14 bln (averages of $2.8 bln and ~$15 bln, respectively). The banks are also geographically diversified and are headquartered in seven different states, including Florida and Texas (from a regional perspective, three in the Southeast, two in the Southwest, and one each from the Mid-Atlantic and Midwest). The discussions covered a wide range of topics, including the regulatory environment and tax reform, loan demand and economic growth, deposit costs, credit quality, and mergers and acquisitions. Below are our top takeaways from the meetings:
Declining Optimism around Financial Services Deregulation and Tax Reform
Bank stocks rose significantly in the wake of the U.S. elections, due in part to the view that burdensome regulations on the financial services industry will be rolled back. The market also began to price in material corporate tax reductions, and other pro-growth fiscal policies. Multiple CEOs on the trip stated that they are not counting on significant regulatory changes. One participant stated that regulators are “being nicer now, but the regulations are still there”. Another executive noted that he was previously anticipating tax reform to go through, but he now isn’t, given the difficultly this administration is having in passing legislation, noting that “Washington is Washington, it doesn’t matter who you are.”
Loan Growth Expected to Rise
Multiple meeting participants explained that loan growth started the year off slower than expected (one CEO stated that the economy is “muddling along”), but anticipate that things will pick up in the latter half of 2017. One executive, who is located in the South, blamed “chaos in Washington” for muted loan demand. He explained that when there is uncertainty around the economy, “clients just don’t spend money”, and refrain from making large capital expenditures. This view was not universal, as another CEO from a southern state noted that his bank is seeing strong loan demand, especially in commercial real estate (CRE).
Trying to Keep a Lid on Rising Deposit Costs
With the Federal Reserve raising interest rates in both December and March (and expected to increase another two times this year), we have been monitoring trends in deposit costs for U.S. banks for evidence of expanding net interest margins. No bank on the trip stated that they had passed along the recent Fed hikes to customers in the form of higher deposit rates. There were mixed responses among participants when asked about deposit pricing competition. One CEO noted that large banks have started to raise prices to gain deposits and conform with funding requirements, while another stated that slower asset growth is leading to less price competition on the deposit side.
Credit Quality Still Pristine, But CRE a Growing Concern
One meeting participant told us that his bank’s ratio of “30-days past-due” loans as a percent of total loans is so low, that if it doubled, it would still be a very good ratio from a historical perspective. The same executive noted that the current quality of borrowers is the best it’s been in his 38 years in the business (from a leverage perspective), giving him comfort should economic growth slow. Although he, and others, stated that there are no indications of a downturn, one CEO did note that “credit is too good right now”, and his bank needed to prepare for an economic slowdown. The same participant told us that his bank is seeing some “slippage” in credit discipline among competitors (e.g. lower covenants, better terms and pricing for borrowers), but nothing like what they saw pre-crisis. He noted that this is happening in commercial and industrial (C&I) lending, as banks are under pressure to provide loans in a category other than CRE.
Another executive at the conference noted that they had lowered their exposure to CRE, as they are seeing “aggressive” building in the multi-family and industrial warehouse segments, and that metro markets in their state are being overbuilt. Another CEO stated that they are seeing a “bit of a slowdown in most markets in the U.S.” in commercial real estate, but considered this “healthy”. Multiple executives told us that they are avoiding CRE associated with big-box retailers, with one meeting participant calling those borrowers “untouchable” at this time.
Current Valuations Weighing on M&A Activity
Multiple banks commented on how elevated public market valuations are impacting transactions. One CEO, who has completed over ten deals in the last seven years, noted that “prices are getting too high”. He told meeting participants that he looked at some deals in the first quarter on this year, but the potential accretion was too small to proceed (given stock price movements). Another senior executive noted that franchises are trading at levels “way above their intrinsic values” and that public market valuations just don’t make sense (“…the street is missing something”).