In recent months, the regional banking space has already experienced lots of change after several high-profile acquisitions. But there could still be lots more mergers and acquisitions (M&A) activity on the way, especially as the banking environment becomes more competitive and credit quality and earnings begin to stabilize. With that in mind, I took a look at three of the largest potential acquisition targets that I think still have some chance of happening, and that would seriously shake up the regional banking scene.
1. HSBC USA
Media outlets reported recently that HSBC Holdings (NYSE:HSBC) is planning to wind down its U.S. banking operations through a sale or closure, and it’s probably about time.
Everything about HSBC’s U.S. banking franchise stinks, at least on paper. Its returns in recent years are dismal under every metric. Its net interest margin, the difference between what the bank makes on interest-earning assets such as loans and what it pays out on interest-bearing possibilities such as deposits, ended 2020 at 1.16%. Even in the ultra-low-rate environment in 2020, this is terrible. The bank’s expense structure is also extremely bloated.
That said, any acquiring bank is likely to get a good deal on this fixer-upper, and if a bank is looking to grow, HSBC’s U.S. banking franchise is one of the largest opportunities out there with more than $196 billion in total assets. Plus, there are probably lots of cost-savings opportunities.
With more than $170 billion in total assets at the end of 2020, KeyCorp (NYSE:KEY) is the 20th largest bank with a presence in the U.S. That includes custodian banks, investment banks, and credit card companies. The Cleveland-based institution has a wonky retail presence in 15 different states including Alaska, as well as states in New England and on the West Coast.
Since the Great Recession, it’s been a long slog for KeyCorp and the bank still trades way down from levels it traded at prior to the Great Recession. In recent days, the bank has traded not too far off from its five-year high. However, as I mentioned, the banking environment only seems to be getting more competitive, so KeyCorp may be interested in exiting for the right price.
Prior to the pandemic, the bank didn’t have strong loan or deposit growth between 2016 and 2019, and while its returns are certainly not terrible, they are not superior or consistent through different interest rate environments in recent years.
KeyCorp could also be an attractive acquisition candidate because it offers an acquirer a great source of fee income. It has become tougher and tougher for banks to succeed just by relying on loans, and many tend to receive more favor from investors if they have a larger percentage of their revenue derived from fee income. This kind of income tends to fare better in an economic downturn or low-interest rate environment than net interest income from loans.
In 2020, fee income at KeyCorp made up 39% of its total revenue. Not only that, but the bulk of its fee income is from more sustainable streams of fee income such as investment banking, trust and investment services, and cards and payments income. KeyCorp recently traded at roughly 155% tangible book value.
3. Regions Financial
Regions Financial (NYSE:RF) is another bank that never recovered from the Great Recession, although it recently saw its stock trade at a new five-year high. The bank ended 2020 with more than $147 billion in assets. Similar to KeyCorp, its returns are not bad, but the bank has had very little loan growth over the last five years. Prior to the pandemic, Regions had seen its total deposit volume shrink between 2016 and 2019.
The good news is that the pandemic helped Regions grow its non-interest-bearing deposits, essentially a free funding source, by more than $17 billion in 2020. Non-interest-bearing deposits now make up nearly 42% of the bank’s total deposit base. So, if the bank can keep all those deposits around, it now has an infinitely more attractive and sticky deposit base than before the pandemic.
Regions also has a large presence in a lot of great banking markets. The bank has 289 branches in Florida and close to 100 branches in Texas. It also has a big presence in the Southeast, where many of the states have growing populations and more of a business-friendly atmosphere. Regions recently traded around 184% tangible book value, which means it is likely to command a more expensive purchase price in any acquisition right now.
Given the size of these regional banks, their list of suitors is limited because there are only so many banks that could swallow these whole, although a merger of equals is always a possibility. Three of the major U.S. banks — JPMorgan Chase (NYSE:JPM), Bank of America (NYSE:BAC), and Wells Fargo (NYSE:WFC) — already own close to or more than 10% of all U.S. deposits and therefore can’t acquire another depository institution by law. PNC Financial Services Group (NYSE:PNC), another big regional bank, also recently made a big purchase, so I would rule them out for now as well.
The bank that I think is likely in the best position to purchase HSBC, KeyCorp, or Regions is U.S. Bancorp (NYSE:USB), which currently trades for around 212% of tangible book value. Having a superior valuation like U.S. Bancorp is crucial in a bank deal because it makes the financials and eventual returns — especially in any sort of all-stock deal — much more appealing to investors.
Other potential banks that could be in the market for a deal are Providence, Rhode Island-based Citizens Financial Group (NYSE:CFG) and Cincinnati-based Fifth Third Bancorp (NASDAQ:FITB), but neither trade at superior multiples like U.S. Bancorp, and ultimately, high bank valuations could make KeyCorp and Regions too expensive. On the other hand, bank M&As can be hard to predict and valuations could come down as well, so you never know.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.
View more information: https://www.fool.com/investing/2021/03/12/3-acquisitions-that-could-shake-up-the-regional-ba/