Wall Street vs. Main Street – the discussion of the differences between the two is age-old. Throughout this COVID-19 Pandemic, OTC Markets Group has seen America’s community banks step up to support the small businesses in their local communities by providing loans and other much needed financial support.
Many community banks have been able to compete with America’s largest banks such as Wells Fargo, JP Morgan, and Bank of America in providing Payment Protection Plan (“PPP”) loans, part of the CARES Act. Collectively, they have lent a total of $510 Billion+ dollars to help protect jobs between both rounds of PPP Funding. According to the Wall Street Journal, banks with less than $1 billion in assets approved nearly 20% of total loan dollars. The SBA even allowed for an 8-hour window where only banks with less than $1 billion in assets could submit their loan requests.
Unlike in 2008, when the banks were considered “villains,” 2020 might be the year banks are characterized in the “heroes” category alongside frontline healthcare and essential workers. Seeing the work that has been accomplished in such a short period of time, what will come next, and what will the state of the market look like in 3, 6, or 12 months from now?
One of the biggest questions from the last few months has been, “What will happen to M&A?” According to Kirk Hovde, Managing Principal & Head of Investment Banking at Hovde Group, “M&A is expected to essentially remain on pause through at least 3Q in 2020. While we need to see a clearer picture on the credit front, there are other drivers that may cause M&A to pick back up. With discussions around board and management retirement/turnover becoming an ever more present topic due to C-Suite and Directors nearing retirement, how many want to stay in high stressed jobs? We saw peak pricing take about 10 years after the Great Recession, do these same boards and management teams want to potentially wait another 10 years? We may see sales simply due to it being the time to say, ‘this bank had a good run’.”
The press typically does not discuss what happens after a deal closes – there are system integrations, cultural changes, and new employees. For banks already working around the clock, and at capacity, how will there be time to do this on top of supporting local community businesses?
Another thought for bankers considering deals surrounds the current state of credit portfolios. If a bank can’t put a value on their own portfolio, how can they evaluate the loan book of another bank? Even though the M&A market is on pause, this does not mean that conversations between potential buy and sell candidates has halted. Ajay Asija, Senior Managing Director of Financial Institutions at B. Riley, commented, “M&A is essentially on pause till buyers and sellers understand the true nature of the impact of the shutdown and the trajectory of the losses through the banks’ balance sheet. Most bank CEO’s and Boards are not sure about their own credit situation, meaning they most certainly are not in the position to appropriately mark the loan book of a target bank. In addition, the depressed valuations of many acquirers are likely not going to produce acceptable shareholder results of the acquiring bank and its shareholders.”
Matt Veneri, Head of Investment Banking at Janney Montgomery Scott, added, “Strategic thinking will be accelerated, especially with smaller banks, as a result of COVID-19. We will see more sellers testing the waters, as they do not need to wait until the next market peak.” “This combination could result in a late 2020 spike in new deal conversations with activity increasing throughout 2021. However, expect to see a larger cash component in M&A deals than we have seen historically.”
A positive impact of the recent PPP program is that it showed local consumers the benefits of banking with their community bank. While the large banks are being sued for processing higher dollar amount loans first, instead of sticking with the “first come, first served” model that the government authorized, community banks dealt with their customers as partners rather than revenue drivers. This has opened the door for community banks to take market share and gain new deposits after the PPP experience.
Speaking with CEOs of community banks, many saw an increase of new accounts that were transferred from larger banks when the community banks were able to help facilitate PPP funding. Simply put, the big banks did not deliver and have lost deposits as a result. Moving accounts is tedious, which should help in retaining the new accounts. This ‘stickiness’ in new deposits will be something to look for in future earnings, as gaining deposits is always a challenge.
Capital raising in today’s environment is another key topic of conversation among community bankers. According to Veneri, “We expect to continue to see capital markets deals with debt and preferred stock. However, there will be minimal common equity raises until valuations return.”
Veneri also noted, “Banks have more offensive capital, better underwriting procedures and are better positioned now than they were pre-2008 cycle.” Even with rates being higher than they were 6 months ago, debt is still significantly less expensive than equity.
Ajay Asija commented, “As provision costs have gone up by orders of magnitude, even without CECL, banks are looking to shore up the balance sheet with non-common, less expensive capital instruments. However, it is quite possible that depending on the length of the shutdown and potential re-emergence of a second wave of the virus, banks may have to tap common equity markets to meet the needs of the shareholders and regulators.”
Bankers have been advising on equity raises since the last recession to ensure the banks were well capitalized when the time came for the next downturn. As the saying goes, “the best time to raise capital is when you don’t need it.” While no one thought the downturn would be related to a health pandemic, fortunately banks have been well-positioned for this scenario.
Bank stocks have been volatile throughout the market downturn, with some banks being reduced to 50% of their market value virtually overnight. Per Veneri, “The initial panic caused a flight to liquidity based on the market cap of banks. We saw a lot of investors trading out of smaller names into larger names because there was not much tangible book value differential.” Luckily, some of these bank stocks have rebounded, but we need more time to see how the bank stocks play out.
OTCQX Bank stocks have traded 21 million shares, totaling $336 million in dollar volume in the first five months of 2020. From March through May, the number of OTCQX Bank trades increased by 22% compared to the prior three months. The OTCQX Bank index has continued to outperform the SNL Bank index by 50% since 2015. Alternatively, the June 2020 rebalancing of the Russell Index has seen the market cap requirement for inclusion drop by nearly $50 million.
What Management Teams Should be Thinking About
Strategic planning by management teams has shifted since COVID-19 began. States across the country are issuing guidance of what businesses need to do in order to safely reopen. Some of these manuals are upwards of 50 pages long and will require significant spending that was not initially budgeted for.
Management teams will need to think about how to safely bring employees back to work while continuing to serve their customers. This includes ordering (and figuring out where to source) plexiglass partitions to keep customers 6 feet from staff / other consumers. Cleaning supplies are still hard to source in bulk so knowing when there will be enough hand sanitizer and other products available may impact opening dates of branches.
Furthermore, branch optimization will play a part in future planning. Employees of banks have stepped up to serve their customers while working remotely. The question that will be asked is, “Will there be a need for as many branches going forward?” Real estate is expensive, so if a bank can reduce the number of branches, they may be able to return the cost savings to their bottom line or shareholders.
Lastly, technology will be a big part of the conversation going forward. Asija, noted “The pandemic has forced digital delivery on the population across all age groups. As such, bank management teams need to fully adopt the digital delivery channel to provide banking services for its customers.” We may see an increase in mobile banking or other fintech initiatives from community banks.
Only time will tell how the market and economy plays out. What we do know, is that the need for community banks has been reaffirmed, and they will continue to serve the needs of their communities for years to come.