Chatting With Chris Marinac Of FIG Partners: 2016's Top 5 Themes

Tim Melvin: We're on today with Chris Marinac of FIG Partners, a firm that specializes in the research and trading of community bank stocks. Chris recently put out a piece titled "Issues for Banking in 2016," so we want to go over that. Chris, thanks a lot for spending time with us. I know you're busy up there, getting ready for the holidays and closing out the year.

Chris Marinac: No worries, Tim. Glad to do it and appreciate the opportunity.

TM: You published this piece earlier this month, it was "5 Themes for 2016." Let's jump right in, because it's one that I had not honestly considered looking at banks. Issue #1 in your piece was "the possible Madam President." How does the election potentially change the community bank stock environment?

Issue #1

CM: I think the whole movement towards re-regulating banks has been underway for several years. It really began in the fall of 2008, when Wachovia technically failed, and we had the failures of AIG and Tarp and other regulatory intervention. So there's been new rules being written towards banking that we all know about, The Dodd-Franks rules, but there's also been an application of how bank examiners treat banks, and it's been a much more focused environment for several years.

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The question is, with a new leader in the White House, does he or she feel that the banking regulations should get tougher or should get easier or should stay the same? My point is that we don't really know. I think banking issues have not really been on the forefront of anyone's campaign platform for some time. It remains to be seen. I think as we get serious on the campaign trail and hearing how candidates feel about the situation and the industry, we're going to get a lot more clarity. That's not necessarily a positive or negative. We simply don't know.

It's possible that there is a very different view than the markets understand from either side of the platforms. It's not necessarily a black or white issue. It's more of a big uncertainty that I think the marketplace seems to me has been sort of ignorant about in the previous six months. The previous six months have been pretty healthy for bank stock valuations improving, and stocks doing well. It simply has been something that has been an unknown that has to get put back into the forefront.

TM: Now, if we get a president that wants more regulation on banks, or, lord help us, Mrs. Clinton gets elected and reaches out to Elizabeth Warren to really shut down the banks, that's going to accelerate M&A, isn't it?

CM: Yes. It should definitely accelerate M&A, and I think we were also alluding to that in our report a few weeks ago, because we think that how bank boards and chairmen and board members interpret how the regulatory tea leaves are being read is going to dictate whether or not they're interested in accelerating the M&A process. I think there are a lot of companies that I would say are on the bubble in the next 12 to 18 months, where they're healthy, they have good capital, they could very well stay independent for quite some time, but they have opportunities to sell the house, if you will, or sell their main asset, which is their company. If the opportunity is such that it's attractive to them, or, in some cases, easier, or a path of less resistance, then I think you're going to see more M&A transaction.

I think we've already seen that occur in the last 12 months. It's simply one of those chapters of the book or an act of the play that has not fully been viewed yet. I think it's an important distinction, and the perception about how tough or how the regulatory environment is going to change is going to dictate a lot of people's perceptions. If they feel like it's going to stay the same and be status quo, that's certainly one angle.

The other angle is it gets much harder under a certain candidate. The other idea is there's a real reform. I think there's a lot of skepticism about whether a real reform happens or any type of easing. I tend to be in the camp that I'll believe it when I see it. The regulatory environment tends to be a secular thing that tends to occur over many years, if not decades, and it took a long time to deregulate banking after the early 1990s. I think it'll take an equally long time for it to play itself out in the months ahead.

TM: A lot of the bankers I've talked to in the last two or three years, they're just tired. Since 2009, the regulators have just been wearing them out. It's been a difficult business. Issue #2, you say M&A gains speed and pricing altitude. So, you think that M&A picks up in 2016.

Issue #2

CM: I do. Frankly, we think it's been picking up for quite some time. It's really a question of whether it's going to accelerate to another level. I think it very well could. I think that there is a capacity for more transactions. I think the fact is that stock prices are strong for many companies, and it gives the opportunity for certain companies to consider transactions, whether they're buyers or sellers. I think what tends to happen in the M&A world is that banks are sold, they're not bought. Ideas get marketed from one bank to another. If you have an environment where stock prices are strong enough and the sellers are willing enough, then you'll see more transactions. 

I feel like that's a real possibility over this next year. It might be slow because of some of the logistics of having year-end close and having audited financials available come later in March, so it might be a slow first quarter. It typically is a slower first quarter. But what we tend to find is that transactions accelerate over the course of the year. I feel like come springtime and midyear, there'll be a lot of potential deals that'll start to be announced, if not others that are percolating for later in the year.

TM: Mark Olsen, the chairman of Trillium Risk Advisors, who used to be a Federal Reserve governor, told American Banker yesterday that he thinks there'll be over 400 unassisted deals in 2016. Now, we've had about 250 this year. Do you think he's off the mark, or he might be right on?

CM: It's possible. I get less caught up in the absolute number of transactions, and more about the direction of activity. To me, the direction of activity is clearly up. I mean, the pricing trends are clearly up. What we don't know is, will stock prices change? We had a setback in bank stock prices the last couple weeks because of the price of energy and a little bit of concern about whether the economy is slowing. I think that's passed through the system because the Fed did raise interest rates on the 16th, and that helped solidify the process that the Fed is now at a different place on interest rate policy. At least, they're leaning towards more rate hikes in the future, which is positive for bank stocks. I feel like the number is going to be higher. 

But whether we reach this magical number of 400 or 350, I don't know. I think, in general, we are going to see more and more institutions selling. I think the number is going to go up. The other thing to remember too, is, we're selling smaller institutions. Because they're smaller institutions, and those are the types of transactions that are happening, it does beg the question that if we're going to have an increase in activity and we're selling smaller institutions, of course you have a higher number. So, it's not impossible, is how I would phrase that.

TM: Most of the action as far as the merger activity is going to be in smaller banks in 2016, is pretty much what you put in your piece. Do you think that's the billion and under? Or should we be thinking even lower?

CM: I think it's still less than a billion in many cases. We looked at the average size being somewhere around 700. I think that average size is probably still going to hold around there. I do think there's another angle beyond just the billion-dollar mark. As you read about in our report, I think there are companies to get to that five or six billion-dollar size and they really consider how much do they want to spend to have the internal compliance controls to position them to be $10 billion in size. I think there are some companies who will spend to a point, but they won't spend the whole way. Or, they'll give themselves some latitude to grow, perhaps from 5 or 6 billion to 8 or 9, but they're not necessarily going to make the plan to be across 10, because the ideal is that's just a bigger expense than they really want to incur.

Issue #3

TM: That was your issue #3, mergers before the billion-dollar threshold. You and I deal with banks, so we talk about this stuff all the time, and we understand that some bad things happen from a regulatory point of view once you hit and cross that $10 billion mark. Can you explain what goes on when you cross $10 billion?

CM: Sure. First of all, banks lose the ability to charge inter-change transactions. I'm primarily thinking about debit card fees from the bank. They can earn a higher rate on that if they're less than $10 billion in size. When they climb above that, that rate goes down, and depending on how much transaction business you do in the debit card arena, it's a meaningful number. It's not catastrophic, but it's enough to care. It's certainly a few percentage points of revenue that a lot of these companies have fought hard to create over the years, and they have to give that back. It's a little bit, if you will, of an excise tax that is unfortunate and unfriendly, but it does occur. The way the banks have to work around that loss of revenue is to have more assets so that they grow by a meaningful amount above 10 billion to generate their additional earnings.

I feel that, most companies, when they look at the $10 billion mark, probably worried more about stress testing and compliance and the rigor and the depth which of those risk management procedures a lot more than the Durbin amendment, which is the loss of revenue. The Durbin Amendment is the official amendment that took away the debit card fees for banks above $10 billion. I think a lot of analysts talk about the lost revenue because that's a tangible thing that impacts the next year's earnings. But, to me, as a long-time analyst, what I really think is more of an issue for the managers is the increased stress testing and compliance. It's a going to the major leagues from a risk-management perspective.

It's a challenge. It's not impossible, and many banks tackle it with, not ease, but a good attitude and a very studious fashion that they execute. Companies like PacWest (PACW), who is grown right through the level and it hasn't bothered them at all. Iberia Bank (IBKC), the same way. Hancock Bank (HBHC) is another example. Hancock certainly has had its challenges with energy lending this past couple quarters, but in terms of being a bigger bank, hasn't been a problem. They've had a good regulatory relationship for many years, and it has not been a problem for them to be an 18, 19, now $21 billion dollar bank, it's not an issue. They certainly spend money on it, but it has not been an issue for them to execute that piece of the strategy. So, absolutely, positively, it can be done. 

The issue is one of focus. Some management teams simply do not want to spend the money, the time, the hardest to have a revved up compliance program that puts them over $10 billion. They want to do what is required of them to be less than $10 billion and not make that next step forward. They want to think awfully hard about, do they want to do it? I think you're going to see companies that are selling long before they become 10 billion, because there's just an easier ascension to make. They can maximize our profits at six to seven or eight billion, then sell, get a very good price, and that positions the next company, who is already decided to spend those dollars. 

It becomes more of a corporate philosophy than anything else. Do you want to run a company large enough that has to go through this vigorous compliance procedures? Some just simply don't want to do that. They have a bad taste in their mouth. So, they'll elect to sell their bank and cash their profits in.

TM: And most of that new regulation is coming from the Consumer Finance Protection Board, isn't it? Because at $10 billion, they become a much bigger part of the regulatory picture.

CM: They do. That's correct, and you definitely do get on the CFPB's radar much sooner. In theory, the CFPB can reach all the way down to much smaller banks, but they tend, from a practical standpoint, to focus on banks better at the $10 billion level. That they change, that's another position, because a new president can very well work with an agency like CFPB to encourage them to do more at the smaller end of the spectrum, or to do less. That's where the leader at 1600 Pennsylvania Avenue, he or she really does have a say in how that regulatory environment plays out.

TM: Right. If you get to the $6 or 7 billion mark, most of those are publicly-traded banks. So, just stopping there is not an option, is it? Your shareholder base is going to either want you to grow or sell. 

CM: Exactly. Grow or sell is exactly the answer. It's like they said in "The Shawshank Redemption," "Get busy living or get busy dying." If you're a bank, you really need to live and keep trying to grow. That's the name of the game. If you're going to get busy dying, you have to find yourself a good partner and get a maximized price.

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Issue #4

CM: First of all, obviously, the Fed has already officially increased. Now that they've spoken their piece, if you will, back on the 16th, we have a better understanding of this. I still feel that it's uncertain how often the Fed is going to increase. I think the question is not, is the Fed going to increase? Obviously, we know they will, they just did. But even before the 16th, it was not a question of whether they were. 

It was more about, are they going to increase multiple times, that there'll be another moment in history where you can look back and say, "Okay, over the next six or seven Fed board meetings, they increased rates every time." I'm not sure they have the economic cover or backdrop to do that. Now, there are some species that have occurred in the last couple of days that suggest that maybe it's every other time, the Fed is going to raise rates, and a lot of people cite the dots on the map, the dot chart that came out last Wednesday, the 16th of December, that suggested there was ample room to be well above well above 100 basis points, or a bigger number. 

I will just tell you, I think the Fed is still political. I think it's a political environment. I think the Fed has a big balance sheet they're trying to maintain, which has its own separate issues from what we're talking about, and I think it's going to really depend on how the economy and how the financial markets play out. I think there is concern, also, and we didn't address this too much in our report, but most companies we talked to, bank CFOs, treasurers, and CEOs are all worried about a flatter yield curve. A flatter yield curve is not healthy for banks. It's one of the reasons we feel like net interest  margins is going to be a challenge. We think the interest rates don't change enough to make a huge difference on revenue just yet, and we think the flatter yield curve creates issues in the securities book, and it does create a little bit of a pricing challenge on how new loans are priced. 

It's not an easy answer. It'd be easier if the Fed would come out and say, "We intend to raise rates aggressively, and we've got the first step movement," and then there would be a clarity for that. But there really isn't clarity. I think, for election year, it's going to be awfully hard for the Fed to increase rates in a serious way, particularly when people are campaigning to try to increase jobs and increase the economy and the whole economic base of the country.

TM:  I really get the feeling, when it comes to the economy -- although, the drive from Orlando to Atlanta in October for your conference makes a point, kind of. In Atlanta, there's cranes everywhere, there's building going on, much similar to here in downtown Orlando and New York City. But when you get outside of those beltways, it dies. And like you, I don't feel like the economy is strong enough to do three more interest rate hikes over the next year. But we'll see how all that plays out, I guess.

CM: Right. We have a global economy; we all know that. We have demand for global products such as oils and grains and other commodities that have decreased in the past year. You can't deny that there's less demand for oil today than there was a year ago. Same is true for corn, soybeans, wheat, and other commodities. That change in demand is a challenge for everybody globally. It's not just a U.S. issue.  That, of course, has implications for the U.S. dollar, on international companies. Those companies certainly have an impact on how many jobs are created, or not created, in the next year. 

This ties back to banking, because banking and banks are a mirror of the communities they serve. And we feel pretty strongly that economic activity is centered on how well the local communities do. If you are a bank in Greenville or Charleston or South Florida, you're pretty happy right now, because your local economy is doing well. Atlanta is a good example; Orlando is another good example. But if you're in other cities where it's not that strong, it is a challenge for you. We visited some banks in other states in the mid-South, like in Kentucky. It's not as robust in Kentucky as it is in Florida. That's, unfortunately, stating a fact that creates its own challenge for how banks grow in an area like that.

Issue #5

TM: Alright. Issue #5, this is one of my favorites. Credit issues seem quiet. Does this continue to be a non-event? As one of the speakers in your conference in October said, "Things are really good right now, but eventually, we're going to do something stupid because we're bankers, and that's what we do." Do you see any signs of that yet?

CM: Well, certainly, the energy market has an issue right now, because the price of oil has come down roughly to mid-30s during this fourth quarter, and is creating a little bit of havoc in terms of companies. Hancock Bank is one that's already made an announcement, there's the expectation that other banks have to build reserves in the fourth quarter, and I will tell you from past experience, investors are not going to be happy no matter what happens, because when you have issues with credit, there's always somebody else who worries that it's not enough. It's not enough reserves, not enough problem loan recognition, not enough write-down for charge off purposes, it's just never enough. 

We had to live through this in the financial crisis, and we're going to have to live through it again in 2016 as it pertains to energy. The question is, are other sectors going to follow energy's lead into the credit toilet. Unfortunately, what banks need to do right now is build reserves for the so-called rainy day that might just be sooner than we think. The best prescription for this is for banks to set aside reserves, to be careful. It seems to me that we are going to have low charge offs for a while, and that's the good news. The problem is, companies have to build reserves, and I think the regulators, at least, it feels to us that anybody that is growing their portfolio at a fast clip has to have stronger loan loss reserves. 

But even if you're not growing loans quickly, what is your pace of reserve growth? I think there are plenty of banks who can hide under low losses, and not build reserves. That's a short-term behavior that probably has to change, and the question is, which banks will be proactive in making that change sooner and building reserves, as we used to say, just because. The accountants don't like it, but the investors really would appreciate when banks build reserves just because.

TM:  I have to say, I really don't see any signs of that in a meaningful way at this point. If anything, everybody's still yanking a couple pennies' profit by reducing reserves. 

CM: Right. But it is year-end. We do tend to see some year-end cleanup that occurs at companies. I think a lot of companies probably have flexibility to increase their own allocated reserves, even if it's a little bit. I think we're going to see and hear more disclosure and more commentary from companies about what their unallocated reserve actually is. Some companies are very open about that, and discuss it in their 10Q, discuss it in investor calls and conferences, others are very shy, and I think that shyness probably has to change to some extent over the next year to at least open up a little bit more of a window into how the reserves are being done, and is there flexibility today for issues that are not yet recognized, but could develop in future quarters.

TM:  2015 has been a fantastic year to be a community bank stock investor, especially if you were pretty selective and tracked the activists and all that fun stuff. How does 2016 look?

CM: We think 2016 will be a positive year. Companies, in our opinion, are going to grow tangible book value in the neighborhood of 6-8 percebt per share per year from '15 to '16. We feel like stock prices can certainly make modest improvements. In our opinion, if we have, say, 6-8 percent tangible book growth, and if the valuations on price-to-book can improve modestly, let's say it's a 10 percent improvement, then you can see the stock going up 8 percent or 9 percent for the year, and then dividends go on top of that. 

There are plenty of community banks that do not pay dividends, because they're growth vehicles, but there's still some potential for a double-digit return in banks. Maybe it's more like high single digits, but we still feel like that is a reasonable return expectation, 8-10 percent total return in banks in 2016. Now, the icing on the cake is M&A. We think having a good, diverse portfolio that allows these companies to participate in some of these very solid fundamental stories of banks that are growing, but also have a few potential sale candidates, really is the best way to approach that from an investor standpoint.

TM:  By having that kind of mix, you could probably improve on that low double digits, I think. Would that be a correct statement?

CM: Absolutely. I think that's historically where the best portfolio performance has come, from a mixture of owning companies that are what I would call blocking and tackling, seeing their book value improve, seeing the valuations improve slightly. But then, you have one or two surprises where mergers more value. Now, there are times when companies create mergers as a buyer, and they create a lot of value. We've seen Ameris Bank (ABCB), Bank of North Carolina (BNCN), even United Community Banks (UCBI) and Seacoast (SBCF) make comebacks and create value in the course of 2015, because they're acting as a buyer. They didn't sell the company, they acted as a buyer to improve and increase their size.