FJ Capital: Bank Consolidation a Profitable Trend

Oct 3 2017 | 4:12pm ET

FJ Capital released a white paper in mid-September titled "Booming M&A Cycle Creates Investment Opportunity." 

The paper examines the ongoing consolidation trend in the banking industry and the related investment opportunity. 

The paper points out that there almost 6,000 depository institutions in the United States, a figure that represents the largest of any developed nation on earth. 

In contrast, the United Kingdom has just 385 banks; Japan has 200, and Canada has just 30 banks. 

FJ Capital writes that they expect the number of banks in the United States to fall by half over the next 10 to 15 years, and feels this presents an enormous opportunity for investors.

The asset management firm cites many reasons for ongoing consolidation in the banking industry.

The first and most obvious is profitability challenges.

Given the higher capital requirements in a post-crisis world and rising regulatory and technology costs, it is hard for smaller banks to gain the scale needed to be consistently profitable.

Management and board fatigue is a significant factor as well in a bank's decision to sell. In a slow-growth economy with every growing regulatory and cyber challenges, banking has become a much harder business to navigate.

As boards and executives are aging, FJ Capital states that the average ages of public bank CEOs and Chairmans are 59 and 66, respectively. Due to this factor, these executives are less likely to be willing to face daily challenges and difficulties and are more open to selling the bank.

The paper also notes that small- and mid-cap banks are the most likely buyers as they seek to gain the scale needed to consistently grow profits. These banks have seen strong price appreciation since the election.

This trend creates a much stronger currency to use in buying the microcap banks who have not seen the same level of appreciation in their share price. 

As rates begin to move higher, there will be pressure on deposit costs and the small and mid-cap banks will be looking to buy smaller institutions with a strong deposit base.

As the smaller banks have looked to grow profits by making higher yielding commercial real estate loans, many are bumping up against the regulatory guidelines for CRE concentrations. They will be increasingly looking to partner with larger banks that have a more diversified loan portfolio.

FJ Capital is a SEC-registered investment advisory firm based in Arlington, Virginia that utilizes proprietary fundamental research to uncover and exploit value disparities in the small‐ and mid‐cap bank sector.

The whitepaper is available at this link.

[Tim Melvin]

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