Forecasts, Small Banks And Hot Stoves

The following originally appeared on the Community Bank Investor

Once again the forecasters got it all wrong. Hillary was supposed to win a huge Electoral College victory, and stocks would rally on the continuation of the status quo. If a miracle happened and Trump won, we would see a collapse of epic proportions.

We did see a very short-lived collapse Tuesday night, but it corrected quickly and the last two days have been a rally based on what everyone hopes will be the new administration's pro-business policies. Of course, he has not announced any actual policies yet, but that’s no reason to ruin a big rally.

One question I have gotten several times since the polls closed is if the trade of the decade will be ruined by a relaxing or repeal of Dodd-Frank. The short answer is no. Even a relief in the regulatory environment is not going to eliminate all the reason for banks to merge.

It is still a very low growth economy; net interest margins are low, and technology costs are rising quickly. There is also a chance the SIGI limits are raised which brings a whole new group of buyers into the market next year. Of course if I am wrong, and regulatory relief drops to the bottom line and the economy picks up under President Trump driving higher earnings for small banks, that is not going to hurt me as a small bank investor.

It is important to keep in mind that the consolidation trend began all the way back in the late 1980's when the interstate banking regulations changed. There have been several drivers of the trend, and the regulatory cost has been one of them. It still will be. Regulations may be reduced, but they will not be eliminated altogether.

The smaller banks will still find it a huge cost factor. The consolidation trend will continue for a long time even if Dodd-Frank is rolled back. That’s not a guarantee by the way, as banks are still pretty unloved institutions and freeing them up from regulatory oversight is not going to play well in Congress or with the public. There are still activists looking to unlock shareholder value at smaller banks trading below book value.

Don Lamson, counsel at Squire Patton Boggs in Washington and a former regulator at the Office of the Comptroller, told Deal.Com that he is hopeful that a regulatory rollback will allow private equity firms to buy smaller banks going forward. "You either are going to permit private equity to come in and buy small banks at realistic price levels or you are going to see them go into liquidation. These little banks can't make it. You need to find a way to permit small banks to exit the market."

The Trade of the Decade in small banks remains intact, and now we may have an earnings tailwind that drives takeover multiples a little higher to add to the return potential.