More banking M&A deals expected—How to play the financial sector

Market Domination anchors Julie Hyman and Josh Lipton explored how to navigate uncertainty in the financial sector on the Yahoo Finance Playbook. Mendon Capital senior portfolio manager Anton Schutz and Janney Montgomery Scott director of research Chris Marinac joined to discuss recent weakness in JPMorgan (JPM) and Ally Financial (ALLY) stocks as well as expected mergers and acquisition (M&A) activity in the sector.

After JPMorgan warned about its net interest income, the stock fell, though Schutz said investors' worries were overblown. The portfolio manager expects the company to beat its guidance given its "priced for greatness."

Marinac told the Market Domination team that another factor for JPMorgan investors is the timing of upcoming rate cuts. Ahead of expected rate cuts, the banking sector is “positioned very well because the cost of funds surged during the last 12 to 18 months, and so as interest rates fall, the cost of funds is going to improve.”

After comments from the Ally CFO on Tuesday raised concerns about credit quality, Schutz said this dynamic reflects the company's customer base rather than cause for concern about the banking market at large. “Ally's just seeing the pressure” from having a customer base of “subprime consumers,” Schutz said.

Schutz did note that credit quality is important given that banks' book values, a company’s assets versus liabilities, are “critical” as mergers and acquisitions (M&A) are expected “to pick up meaningfully.”

Marinac added that the expected uptick in M&A deals could come from mid-cap banks consolidating and acquiring regional banks to scale.

“We absolutely are at an inflection point on M&A,” and “the question is how much happens now and how much happens in the next six months,” Marinac said, highlighting that “the stocks haven't yet discounted that positive news,” leaving an opportunity for investors.

Schutz named First Horizon (FHN) and Veritex (VBTX) among his top picks, while Marinac called out Ameris Bancorp (ABCB), FB Financial (FBK), and Fifth Third (FITB).

For more expert insight and the latest market action, click here to watch this full episode of Market Domination.

This post was written by Naomi Buchanan.

Video Transcript

It has been a rough start to September for stocks and with the presidential election getting closer and closer.

Plus a new batch of economic data this week, the volatility does not seem likely to settle any time soon.

Specifically, we're looking at how to navigate the financial sector with the Yahoo finance playbook.

Joining us now, Anton Schutz Mending capital, senior portfolio manager along with Chris Marinac Jenny Montgomery Scott, Director of research and guys, we're also talking about financials because A we had the fed come out with new capital requirements for the banks and B we have been watching uh a financial services conference where some of these banks have been coming out and sort of spooking the market.

Anton, I'll get to you first here.

Um Do you think, you know when you hear the likes of a JP Morgan say the streets estimates for net interest income are too high?

How much does that worry you about the banks?

Doesn't?

I mean, JP Morgan has a unique balance sheet structure.

Uh They've benefited a great deal from the fed hikes.

They've done very, very well and you guiding higher.

I almost think that the de ahi much, you know, and beat this lower number.

Uh I almost have to say sandbagging.

They're a great company.

Uh the price for greatness.

So at the end of the day, um you know, no surprise they're guiding down.

I think they'll beat it.

Uh Chris, I wanna bring you in here on that same question because it made a lot of headlines.

Uh Chris, you know, JP Morgan EXEC comes out and says, listen, I think the analysts are just being too rosy here with their projections when you saw that, Chris, what, what did you make of that?

Well, some of it has to do with the timing of when interest rate cuts are happening.

And right now it's it, it's, it hasn't happened yet.

Number one, and I think also there's gonna be limited uh margin improvement and limited balance sheet growth for them.

So to some extent, it may just be a volume issue that the volume uh numbers were too high.

And so Chris S sort of broadening it out then and looking at the rest of the banks, um you know, as we're going into a rate cutting cycle, how are they positioned?

Well, the banks are positioned very well because the cost of funds surged during the last 12 to 18 months.

And so as interest rates fall, the cost of funds is going to improve.

I think there's a lag in how quickly loans are gonna reprice downward.

So banks should make a little bit more margin.

I also think in general, the investors are far more worried about credit quality than they should be.

The bank's net charge offs are very small right now.

They're not going to change a whole lot into the next 18 months.

So the amount of provision expense and reserve building the banks need to do is pretty limited.

So I think there's actually the opportunity for banks to make more money based on credit actually being much more stable.

And then you also have the idea that I think the banks are set up.

Well, for a positive mark from uh their unrealized security losses, it's gonna be pretty powerful.

We think book value may grow as much as 7 to 8% at certain companies uh this quarter alone.

All right, Anton, I wanna bring you here on that same issue, credit quality.

Now we did hear some talk this week.

I I think it was Ally Financial Anton speaking at the Barclays conference, certainly made, made some comments and maybe spooked some folks, but your, your thoughts on that dynamic.

Well, I mean, it's really subprime consumer at the end of the day, you know, they run out, run out of excess savings, you know, obviously jobs are no longer easy to find um out in the workplace.

So, you know, all I just seeing the pressure they have from the customer base, they have most, you know, community and regional banks do not, you know, have those customers so, you know, very, very different.

And here's a point I really want to make.

I think this is critical.

There's been a lot of people out in major media talking about thousands of banks failing from commercial real estate.

The question is how many have actually failed?

Yep, the silence is the answer.

It's zero, it's actually zero.

So Chris's point on, on credit quality is critical and his point on, on the book values going up is also critical for M and A because of the way accounting works very difficult to do M and A when banks have losses on their books because of higher rates on either loans or the securities with those losses turning into less losses or potential gains.

M and A math becomes much more compelling.

And if you look at the smaller banks, they traded a massive discount to the banks just above them which allows for very, very easy math to make a creative, you know, transactions happen for the buyers.

So I expect M and A to pick up meaningful Anton to be fair.

We've been talking a lot less about the risks for commercial real estate for the bank.

You've got it right, Chris, what do you think about what Anton is saying about M and A?

And if you think he's right, where do you think we could potentially see some consolidation?

Well, where does the consolidation?

A lot of midcap banks where, you know, they are sort of feeders for regional banks who want to get bigger, you know, regional banks that are near $100 billion or even higher.

They're gonna be making, uh, acquisitions to kind of strengthen some of their footprint.

You know, we have companies like Huntington Bank who are moving to the south to open branches, they'll eventually make an acquisition.

They're naming a stadium in Cleveland, not just for that region, but really to kind of think about more broadly.

I think all of the companies are going to find ways to get more scale.

There are a lot of mid-sized banks who would like to become closer to 80 or $90 billion and they'll do acquisitions to get there.

So we absolutely are at an deflection point on M and A Anton is 1000% correct.

The question is how much happens now and how much happens in the next six months, the next six months is probably more powerful and the stocks haven't yet discounted that positive news.

That's where the opportunity is for investors today.

Anton, you've been doing this a long time.

I think it's safe to say this.

Probably not, not, not much left Anton you haven't seen in this space.

Let's end here.

Give me some picks, Anton some names you like.

Sure.

I mean, I'll go to Florida, I'll talk about Amer and Bank.

Uh It's on sale, low tangible book value.

Uh, us Century Bank has done really, really well and it's one of the last banks of $2 billion of size in that market.

Uh I look bigger.

First Horizon Tennessee and then I look at Texas, uh companies like, uh be, it seems to be a or you're looking south, I'm looking south, I'm looking where there's growth.

Uh People are migrating south.

Companies are migrating south.

Those three states don't have any state income tax.

It's one of the reasons people are moving uh pro-business governments.

Um Yeah, so even if the economy slows down nationally, those states are going to have better growth than we're going to see in the rest of the country.

And Chris real quick, uh Give us your top picks also.

Sure.

I like a Marist Bank.

ABC B. I like FBK 1st, 1st Bank and uh Nashville as well.

Another Tennessee name uh Ocean first in New Jersey, OCFC and then Wintrust in Chicago, an excellent company.

WTFC.

If you have to look at a large cap name, Wintrust or uh excuse me, besides Wintrust 5th 3rd F I TB is my favorite regional bank.

Wow, that was a good lightning round.

There.

Really was Anton Chris.

Great discussion.

Great picks.

Thank you, gentlemen.

Great pleasure.