Listen: Street Talk | Episode 127: The 'knife fight' for deposits could spur more bank deals

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Nathan Stovall

Welcome to Street Talk, S&P Global Market Intelligence podcast that offers listeners a deep dive into issues facing financial institutions and the investment community.

I'm Nathan Stovall. And on this episode, we're talking about our annual Community Bankers Conference hosted on May 20 and May 21 in Dallas. The event attracted close to 100 bankers across the country and focused on ways banks can thrive through a challenging operating environment, where higher rates have pressured banks' deposits, margins and liquidity and raised concerns about their credit quality.

The outlook for deposits and liquidity came up numerous times during panel discussions at the event, and presenters agreed that competition for core funding remains fierce. Kelly Brown, Chairman and CEO of Ampersand Inc. and a senior adviser to Patriot Financial Partners, kick things off during a panel focused on deposits, noting that competition is unlikely to ease soon.

Kelly Brown

First of all, Ampersand is a customer-facing sales and service organization. Think of us as a deposit-gathering team of individuals that have 30 years of experience doing this, growing companies that aggregate deposits across the country as it pertains to -- and we work with banks everywhere, all sizes, all shapes, and we work with them on funding strategies for their organizations.

So we have our -- I would say, to your point, we have our finger on the pulse of deposits here in the country. And I don't see anything abating. Banks need deposits. They certainly need core deposits. It's getting tougher and tougher to find those deposits, especially when there's companies like ours that are working directly with depositors nationwide.

Nathan Stovall

Greg Muenzen, Director, Head of Treasury and Balance Sheet Management at Curinos, was also on the panel, and he noted that the environment has changed with deposit outflows abating. While that's true, and deposit growth has returned, growth has come at a cost.

Greg Muenzen

I think what we've seen moving from last year to this year is kind of a shift from worrying about liquidity to worrying about profitability. And I think last year, the headlines were a slow and steady bleed of deposits in terms of runoff and then a kind of acute heart attack moment for some around this time last year.

And I think that -- and to dig in a little bit there, big differences across your traditional consumer deposit where the headline was pretty stable, kind of balanced behavior versus the larger balance wealth, private banking and then the business in commercial, which saw significantly higher runoff and significantly higher volatility. So $1 of deposits is not really equal across all types of accounts. That was the story of last year.

This year, I'd say that it's stabilized. There's good news. The balance runoff has abated a bit, but we've essentially paid for that. Acquisition rates are up. As a result, portfolio rates are up and deposits are continuing to remix from kind of lower interest accounts to the higher rate accounts, including CDs.

Since the Fed plateaued last year, 4% of consumer balances industry wide have shifted to term deposits. 30% of those term deposit balances have just repriced up staying in terms. So there's going to be that pain on profitability now, I think, going forward. And as rates remain high, I think that, that continues to be a pain point for pretty much every bank.

Nathan Stovall

Many banks are simply leading on rate as they're going to compete for new deposits. And we asked the panel what unique deposit gathering strategies they had actually seen in the marketplace. Kelly Brown argued that banks have to find ways to compete without leading on rate. What unique deposit gathering strategies have you seen, Kelly?

Kelly Brown

To not lead on rate?

Nathan Stovall

To not lead on rate.

Kelly Brown

If that's all the bank has, they've got a lot of work to do because you're going to get your lunch eaten by credit unions and everyone else. You have to have a strategy around deposits and it can't be what every other bank has, and I'm going to tell you what those are: HOA, 1031, municipal. If I hear one more bank saying we're starting a strategy on one of these three industries, I swear I'm going to hang myself. They're the most expensive. They're the most competitive.

You have to have people that understand those industries. You have to have people that attend the GFOA conferences that know how to talk about bond proceeds and TANs and BANs. And most banks don't have a public finance group. So it's just -- it is imperative that you have a strategy.

What I would recommend to everyone in this room, and I've spoken on this nationally time and time again and I'm going to say it again today, every one of you need to prioritize depositors as you do deposit gatherers as you do your lenders. You should be entertaining those deposit customers, taking them golfing, taking them to a suite, doing all of the things that you would normally do with your best lending clients and rewarding your deposit gatherers the way that you reward lenders.

We know profitability is found with our cost of funds. So it's driving those relationships, getting people excited about finding deposits, finding strategies around deposits about things that people are interested in. For example, I have a bank that I work with here in Texas that has a big presence in Fort Worth. I said to their sales team, what are you guys -- what do people love, like get a flip chart out, and I want you guys to write down things that you're passionate about individually.

The repeated theme was rodeos. I'm from Wisconsin. We don't have rodeos in Wisconsin. We've got football and beer and cheese. So it's -- they're talking about rodeos, and it's like why aren't you then the bank of rodeos? Why don't you make an entire program of gathering deposits around every industry that touches rodeos in Fort Worth, Texas?

And they looked at me like I was an alien. They've now implemented some of these strategies and are bringing in noninterest-bearing deposits in a way that they've never done before. It's getting people excited about what they care about within the bank, and it becomes easy. I've done this for 27 years and had great success in finding deposits. And it's really not that tough, but you guys at your level at the bank need to do this from the top down and get people excited about it.

Nathan Stovall

Liquidity has remained top of mind for the regulatory community after the large bank failures that we saw in the spring of 2023. Josh Siegel, Managing Partner, Chairman and CEO of StoneCastle Partners, participated in our regulatory panel at the conference.

He said when it comes to exams, regulators want banks to show that they have diverse contingent liquidity options and that they can provide lots of detail on their deposit bases such as the geographic breakdowns, customer types and durations.

Josh Siegel

They want to see adherence to the actual guidelines, which is diversification by customer, by customer type, by geography, by duration, right? They want to see different sources, whether they're wholesale sources, right? Could be FHLB, could be deposit programs or networks. It could be the broker sweet market, if you're larger. They want to see as many different sources so that the risk of a large amount of liquidity walking out overnight goes away. That really didn't happen since the 1980s, the savings and loan crisis.

And so it wasn't on people's minds, but these risks never go away. I guess I come back to that same point. Banking is supposed to be boring, said that for years on panels. And that's a good thing, right? Getting a banking license. And the reason we all have this regulatory framework is it's a license to generate between a 9% and 12% ROE from now to kingdom come. That's what it is.

And if you do it carefully and patiently, you're built as a bank to survive cycles like this, right, where you might be -- have a strain on capital where you might have a strain on liquidity or you might have a strain on something, but making sure that you have enough of the counterbalancing asset, right, not a real asset, to withstand that cycle.

And that's what the regulators are really digging into, is to make sure that you're communicating to them and recognizing that you're generally, with one exception, aligned with the regulator. A field examiner or chief examiner has one goal, for you not to fail, that's it. They don't care about your ROE. That's where you guys will differ. But outside of the return on equity, they just don't want you to fail. And I'm sure that every banker in this room, you don't want to fail.

And so if you set the ground rule saying, okay, we're managing our bank with that goal in mind, to not fail. They don't want to hear about your profitability, that's not. They want it to be adequate, but not beyond. But have the dialogue with them of, well, here's what we're doing to diversify funding sources. Do you have any other ideas? Are you seeing any best practices elsewhere that you think we should institute?

Make that a dialogue and that will, again, back to alleviating some of their concern, but you definitely want to make sure that you have as many contingent funding sources in your arsenal as possible. You don't have to use them all the time, but you have to prove that you can use them.

Nathan Stovall

The message was pretty consistent. The intense focus on liquidity should keep banks firmly focused on building their core deposit bases, which in turn has put pressure on margins. Umrai Gill, a partner at Performance Trust Capital Partners, said that he expects those funding pressures to eventually lead to more M&A activity.

Umrai Gill

Definition of brand is why people do business with you for other reasons than price, right? So that's franchise, if you will, the difference between the wholesale rate and what you're able to attract money at. I do think that spread, notwithstanding -- by the way, not mutually exclusive to what Kelly said, is in secular -- under secular attack. So the ability to do all those things really, really well that you described, which is difficult, it takes commitment focus, is still not as potentially lucrative into the future.

When we talk to banks every single day, the ability to raise deposits 100 basis points out of the Fed funds rate would be like a miracle today. I'm not saying it can't be done. There's lots of reasons for that. So when you go back to where most banks, where their earnings streams are gummed up today, it's -- well, I really don't have a choice to wait for that 100 basis points. I've got to figure out how to fund my bank today.

When you have enough people saying that, that's also competing away what is the value of a bank, which is the funding advantage. So hopefully, over time, I actually think it's a when and not if the environment changes. But while we're going through this period of stress, the institutions that we're seeing create those survival adaptations really is what they are, will emerge competitive on the other side.

Those institutions that don't do that, we'll see their returns lag. And then ultimately, in our industry, as we know, that shows up in valuation. That shows up in Boards asking strategic questions, notwithstanding today's constraints around M&A. But it's going to drive consolidation. One last point on M&A. I know the panel yesterday talked about the low pulse of M&A. Yes, there's fewer announced transactions, but the pressure, because of the environment we're in, is building.

And if you have rates down 200 basis points, rates down 100, not saying we will, or if you have simply the passage of time where assets burn down and you're fighting this knife fight on the liability side, once you get through all of that, you may look at your earnings power and say, "Geez, I just went through a buzzsaw for the last two or three years, the hardest competitive environment we've been through. What are my options?" So all I'd to say is focusing on strategy, near term, intermediate term, long term is you're going to live through the near term to even get to the intermediate term.

Nathan Stovall

A number of other advisers at the event agreed that bank M&A will eventually pick up from the currently anemic levels as institutions look to break through earnings walls and seek scale. Advisers believe that plenty of sellers exist in the marketplace, but noted that there are many challenges to deals actually occurring, including the required rate marks buyers must take when acquiring a target, lower bank valuations and simply fewer buyers existing in the marketplace today because of the regulatory scrutiny over deals.

Scott Studwell, Head of U.S. Depositories and Co-Head of Equity Capital Markets at Stephens, was in that camp. He noted the event that recent policy statements from bank regulators suggest buyers will not be able to close deals as quickly as they once could. And the slower processes encourage acquirers to be more selective.

Scott Studwell

I think for the most accomplished buyers, those that are used to doing more than one deal every 18 months, I think the new statement of policy that both the FDIC and OCC put out makes them really think twice about if that's going to be possible. I think the new guidance suggests that not only do you get a deal closed, but you get it integrated for six months before you're on to the next one.

So I think buyers have to be really selective here around which of their top targets they want to pursue in light of some of the regulatory challenges and everything that Matt said around the interest rate marks. I mean that complicates it. So there are a lot of issues, I think, holding M&A back, but we're definitely beginning to see, I think, a lot of the companies that you would expect to go first are going first.

Nathan Stovall

Jonathan Hightower, a partner at Fenimore Kay Harrison, said at the event that the recent proposals from the regulatory agencies in some ways are just codifying what already existed. Buddy said the agencies have made it public that they are less likely to approve multiple acquisitions from the same buyer once. That means buyers are looking for targets that really move the needle.

Jonathan Hightower

When I first read them, I thought, well, okay, yes, this is my life, everyone. Now you all can see in black and white what I've been dealing with. But it is important that it is being codified. I think probably the strategy is the current staff under the current administration wants to grab as much turf as they can, not knowing how long they'll be in those seats so that if the winds change a bit, we're not going to reverse course overnight.

The new administration staff would spend the first, call it, year just undoing all of these new proclamations that have been put out before they could make any real progress. So that's really all I see it as. Having said that, when you see in black and white, we are less likely to approve a proposal from an acquirer that has overlapping deals. In other words, a serial acquirer, that's pretty troubling.

On one hand, you can see it. If someone's not experienced and they're sloppy and they're just moving from one deal to the next, maybe that's not a good scenario. On the other hand, if you have an expertise and you have teams within your bank that are really capable of onboarding a new bank, getting it integrated, why wouldn't you be able to use that team to your advantage?

And of course, there's nothing in these policy statements that says that's impossible, but it's sure causes concern in that regard. So to your question about appetite, the desire is still just as high as it ever was, right? And I think the longer we get into things, the more we're going to see sellers say, you know what, actually, it's my time.

The issue is, again, from the serial acquirer perspective, do I want to fire this bullet on this target? Because I know it's a serious matter when I go in front of the regulators and ask for approval for an M&A transaction. They may cause me to rewire the whole deal after I've announced it. They may place special conditions in place about matters that are completely extraneous to the M&A deal.

So do I want to do that for a target that maybe I'm kind of lukewarm about? So the conversations that we're having with big strategic planning, Board discussions are how far out do we want to go in finding a target that really moves the needle? Those things that we thought were sacred before, maybe we're willing to put on the table and negotiate around because the next time we do a deal, we want it to really move the needle for our institution.

Nathan Stovall

Scott Studwell and his fellow panelists, Matt Veneri, Head of Investment Banking at Janney Montgomery Scott, and Caspar Bentinck, Managing Director in the Financial Services Group at Piper Sandler, went on to say that the buyer landscape has now shifted and acquirers are targeting larger institutions. Scott Studwell was the first heard here, followed by Matt Veneri and then Caspar Bentinck.

Scott Studwell

Depending on what geography you go to the Southeast, Southwest, West Coast, you talk to banks in those markets and they all probably have on their upstream list the same one or two banks. And the reality is those one or two banks aren't doing all the deals. And so where we see it really playing out, the sellers don't fully appreciate that right now. They expect that when they're ready, those two plus the other eight banks in their mind are going to show up to the party. That is not happening.

I think banks are having to be sold right now. And if you're a buyer, you have to go buy the ones that you want. The sellers have to appreciate how much this landscape has changed. The buyers have just gotten meaningfully bigger over the last, call it, 15 years since the financial crisis. Not all of them want to do the $0.5 billion banks, the $2 billion banks anymore. In fact, most of them are thinking bigger.

And so when you look upstream, historically, you could envision a number of banks showing up to that potential auction or smaller negotiated deal. It's getting harder and harder to engage buyers on the smaller deals right now. Everyone's thinking strategic. Everyone's trying to do, as Caspar said, what is the most strategic deal for us to make us a better company right now. And all too often, that means some of these lower-tier targets really are going to be looking for another partner than the one they envisioned.

Matt Veneri

Yes. You might even see that today, SouthState, Independent, somebody who'd done smaller deals before. But if you're going to get that one shot, you go big. I don't know. If you go back 10 years ago, buried in that bank is probably eight or nine very aggressive acquirers across the Southeastern and Southern United States of America. So you've lost all of those buyers in the last probably since 2016, all in that one bank.

Nathan Stovall

Caspar, what do you think has been your experience? Is it similar there where the sellers are sort of expecting the normal process that maybe they've seen and they've not kind of come to terms with who's willing to court them?

Caspar Bentinck

I think if you go out to sell a bank, the dirty truth of it is, if we have three legitimate buyers put in a bid, we're pretty damn happy about the outcome. That's just the way it is today because all the things we just mentioned, you're going to -- you're not doing a shotgun approach. You're not going to look at buying five different banks in a year, and that was long gone now. I'm going to start dating myself.

But you're going to choose -- you have a list and it comes up. You're going to go, okay, well, absolutely lean in, and you've seen banks lean in on transactions. Even this year, you've seen when Fulton did Republic First, they were the strongest bidder. I mean the data is out there. They lent in, that was a strategic deal that they really wanted to get done.

And then -- and these are -- and there are stronger banks, obviously. I think Independent has had more performance challenges recently, but a great bank, I think a highly regarded bank. And so they -- SouthState lent in to get the -- make sure that deal got done but had to make sure that it worked financially.

But generally, there aren't -- you're not going to see a whole bunch of buyers turn up, and it's really hard to face that fact and we have to do that sort of balancing act of getting a competitive process, if that's what you're going through. It can be challenging. There aren't a lot of buyers out then. The one thing I would, and I think we're on the same path about challenges, pent-up. I think there's not a lot of huge amount of pent-up demand. There's certainly a lot of pent-up supply.

Nathan Stovall

Given that buyers are looking at larger institutions, we asked Matt Veneri, who would be the buyer of small banks since they drive many of the deals that come to market. A number of credit unions have purchased those small banks, and we asked Matt if he expects to see more of those deals. He does.

Matt Veneri

I think realistically, it does have to be. You look at the number -- the percentage of deals where you have a credit union involved, I think it's up in the 20s, 22%, 24%. That's double from where it was a year ago. They're starting to be a little bit bolder in the size of the companies. We were involved in the transaction at Pacific Northwest, where the seller, First Financial, was a $1.6 billion bank. Still got to close so there's a different process involved there.

But in markets where it is allowed from a regulatory standpoint, sometimes, particularly if you're a sub-$500 million bank, they are the most aggressive and provide the highest financial return for the shareholders. And so they also seem to cater to a little bit more on the social side of the equation.

One of their calling cards is to come in and say, "Hey, we're not going to get rid of any of your employees." They have ways to make sure that the membership ports over. So they're getting much more sophisticated and a little more creative in how they're doing these deals. So I think it's something until there's a regulatory party that steps in. It's going to be here to stay for smaller banks, and it will only grow from there.

Nathan Stovall

When it comes to M&A, capital is certainly part of the equation. In a number of recently announced transactions, particularly larger deals, have included capital raises in conjunction with the deal. That was the case in FirstSun Capital and HomeStreet's tie-up and UMB Financial and Heartland Financial's merger.

Kevin Stein, a Managing Director at Klaros Capital, said at the event that he expects more consolidation, but noted that regulators want to see that capital was not diluted by a transaction. He said regulators want to see that the combined institution has the same common equity Tier 1 capital ratio at closing that the buyer had when announcing the deal.

Kevin Stein

I think there will be consolidation. I think we need to understand consolidation needs to happen. Banks need scale to be able to compete with larger institutions to be able to pay for the compliance infrastructure, technology and innovation. What's changed, I think, is the amount of capital needed on day 1. Previously, you would put two banks together, you would have some dilution in the -- in capital and CET1 for example, and you'd earn it back relatively quickly.

Now what regulators are saying is, okay, whatever your CET1 -- essentially what your CET1 was on before the transaction, you need to have that same level of capital on day 1, which means that many transactions today are going to need additional capital. Not that it can't be raised. It's something we do on the investment side of our business. But it's required now and you can't earn it back. You will earn it back, but you need to have above your CET1. For example, your capital ratios need to be there on day 1. I think that's a change.

Attendee

Do you recommend banks when they're evaluating a deal and they go to regulators if they don't think that they need to raise capital that they come with that evaluation prepared?

Kevin Stein

Absolutely. I mean, all banks that are having conversations and want to participate in consolidation are having dialogue with their regulator. And they're running pro formas. They're having a conversation. This is what the combination looks like. Here's why it's good for the community. So there's all the qualitative aspects to the transaction. Here's the impact. Here's the pro forma financials. This is what our capital looks like on day 1, on day 365, so on and so forth. So absolutely, that dialogue is an important one.

Nathan Stovall

While capital might be tough to come by, seeing issuances close in the market is certainly a positive for the bank group. If more capital comes in the space, you can expect more M&A activity and more clearing trades for banks looking to clean up their balance sheets. We'll certainly stay tuned.