Tom Michaud, CEO of KBW – M&A and the Future of Community Banking

[Intro]: Helping community bankers grow themselves, their team, and their profits. This is the Community Bank Podcast.

Eric Bagwell: Welcome to the Community Bank Podcast I’m Eric Bagwell, Director of Sales and Marketing for the correspondent division of South State Bank, and joining me is Tom Fitzgerald Director of Strategy and research here at the corresponding division Tom, how are you today?

Tom Fitzgerald: I am good Eric, I hope you are as well.

Eric Bagwell: I am good, because it’s Thursday and tomorrow is Friday, and I’m playing golf on Saturday, so if we don’t get rain. I think we had a ton of rain lately, but I think the rain is going to be gone so the weekend is coming, so everybody’s good on a Thursday or Friday so. All right, we’ve got a great show today. We’re really excited to have Tom Michaud. Tom is the CEO of KBW, and he took time out of what I know is a very busy schedule to come on with us and just talk about the M&A environment kind of where we’re at where we’ve come from and, where we’re going in the future this is a great show, but Tom really quickly. You want to give us a little market update do that.

Tom Fitzgerald: I do. Today we received the May CPI numbers and you know of course inflation has been on everybody’s tips of their tongues for a month now since the April report came out. As far as what the report showed it was hotter than expected but it wasn’t quite as hot as the April numbers, and when you kind of dig into some of the details. Use cars again had a great month they were up 7% which is compared to up 10% Back in April, and that accounted for about Point 3% of the overall increase in the or third of the overall increase in the CPI. So you know what’s going on there is that obviously, the new car supply has been kind of crimped with the shortage of chips. That has kind of flowed back so that it also kind of compounding that is the rental car companies were selling fleets of their cars back in the summer last year. That’s kind of reverse now they’re kind of scrambling to get cars as people start to travel again.

And so they’ve kind of had a turn to the used car market so that’s kind of just forced up these used car prices. So when you kind again drill down, you know, some idiosyncratic areas that are driving a lot of the price increase. So again, that kind of goes back to the Feds, you know, transitory narrative, as far as that. So the Treasury market is kind of buying that for right now. So they’ve looked past that so you’re not seeing a lot of, you know backup in yields based on the CPI. So again I think the market is going to give the Fed time to kind of go work through these prices, you know constraints that we’re going to see over the next several months, and not really see a significant impact on treasuries, but as we get past the summer, then I think if you still continue to see some of those spikes and pricing, it could become an issue for the Fed, but for now, it’s sort of, you know, kind of shrug your shoulders and moves on.

Eric Bagwell: Alright Tom, thanks. So I get there whether people listen to the podcast that did just what I did, I looked up the definition of idiosyncratic, I’m not even going to read it but that’s a word that’s a new word. I’m going to try to use that again today on somebody and they’re going to look at me like I’m crazy because I don’t use words like that.

Tom Fitzgerald: It pays big in Scrabble, doesn’t it?

Eric Bagwell: That would be awesome and Scrabble, that’d be huge. Well, guys thanks again for listening. We’re getting a lot of feedback from listeners and saying you enjoy the podcast, and we were thrilled that you are. We’re just trying to bring value in, we appreciate you guys tuning in, so let’s go to the interview with Tom Michaud.

Joining us now on the podcast we’re excited to have Tom Michaud. Tom, CEO of KBW, he’s in New York City, Tom, thanks for coming on today, how are you?

Tom Michaud: I’m doing great. It’s great to be with you too today and talk about the outlook for the banking industry and community banks.

Eric Bagwell: That’s awesome. We’re glad to have you and we’re very thankful that you decided to come on and take some time out of what I know is a busy day for everybody, I guess. But it’s Thursday we’re close to the weekend. So we’ll get this done and this thing, we’re looking forward to it. So let’s talk obviously we’re going to talk about M&A and the outlook kind of for banks, there’s a wave of M&A pre-COVID. And then obviously it stopped its picked up recently and you always kind of hear Hey, you know, there’s, going to be this huge wave of M&A coming you’d like for 10 years or 12 years now. Maybe I’ve been in banking 20 years you’ve always kind of heard about that. What does the future look like? The kind of look into your crystal ball and let’s just talk about what the future looks like for this.

Tom Michaud: Well, what’s interesting is that the industry has been consolidating in one way or another since the mid-80s When all the laws were changed to allow it. So I think the way to look at it, post-COVID is to look at what was happening, pre-COVID. And generally, kind of compare it. So, pre-COVID Things were cooking in terms of the pace of consolidation. When I started in 1986 there were 18,000 banks. And so we used to measure consolidation, based on the number of banks that were merging, but now that we’re down to about 5000 banks and there are about a few more credit unions, but now we’ve been measuring it more as a percentage of the banking industry.

So we were seeing about 5% of the banking industry involved in merger activity pre-COVID. And that was probably the highest pace we’ve seen since consolidation started in the mid-80s. So I think you could say that the environment was pretty hot, coming into COVID. Then when the pandemic began, the consolidation essentially came to a stop. And then in the fall, it started to pick up again and we’re now back to a very healthy steady rate of consolidation. The drivers’ pre-COVID Were about scale. Were about making sure that there was enough scale to invest in technology and new investments required to grow. And I think succession is always present when banks are thinking about merging.

So post COVID We think the dynamics of the scale are still there. I’ve been doing this for 35 years and roughly the first 33 years, there was always taught that the bigger banks should be more profitable, would be more profitable because of their diversification and scale and it never really happened. In general, and then over the last couple of years, it’s been happening, the bigger banks were more profitable and had more diversification to their earnings, and so that was driving a lot of the scale argument. With regards to fintech and investments in technology, I sense that management teams thought it was important, pre-COVID.

I think post-COVID, they now think it’s essential because it’s incredible how much uptake there’s been, by the customer base. And we’re also seeing a lot of the energy about innovation, moving from the consumer side of the business over more towards the commercial side of the business. So I think that now, a lot of bank CEOs realize that they’re going to have to pay attention to what’s happening in the fintech world and digital engagement. I think a lot of CEOs pre-COVID thought that the competition was the bank across the street, and now I think many of the CEOs believe the competition’s the bank and technology companies. So I think the realm of competitors has changed. So I hope I didn’t start out by giving you a really long answer to that question, I promise I won’t take that long but I thought it was a great question. And so I really wanted to dig in a little bit on how I think about these things.

Tom Fitzgerald: No, those are all good points because we’ve done several shows with you know with fintech providers and, and those have always been some of our most listened to so obviously it hits a nerve. I think the community bankers anyway are getting that they can’t just kind of ignore it and hope it goes away, it’s going to be a part of the industry and they have to either embrace it or they’ll probably be left behind because of it. But kind of going back to the M&A question. We probably have, you know, a bunch of listeners that were contemplating M&A prior to the pandemic and of course, they put those thoughts, those ideas on hold. What would be your counsel to them now as far as kind of getting back into either looking, you know, it’s either the acquisition side or the sales side, is there an urgency, do you see for them to kind of move with that now, or would you still counsel, some patients on that?

Tom Michaud: I think there is urgency. But first of all, let’s talk about the patient’s part. The patient’s part and the reason why I think consolidation stops is there’s nothing scarier about not having your arms around credit quality at the time of consolidation. One thing that could really go wrong, is if you don’t if credit quality heads South while you’re trying to put together a merger. I think that since we’ve moved beyond the greatest concerns of credit quality due to this pandemic. I think that that concern moment is off the table. As far as urgency, we’re not only back on that pre COVID pace but I think even more so I think it’s more intense. And so I would encourage bankers to look at this now because we are in general still a benign credit quality environment. The economy is ramping in the recovery and is expected to ramp even more.

I think if you are thinking about doing a deal, have it consolidated before the economy really picks up or maybe even before the next cycle may start to get built. I think that makes sense and then the other thing is, there are fewer options. Having done merger work for several decades, the number of buyers or best buyers is shrinking as the industry shrinks. So sometimes if you’re thinking about buying a company, there are two or three targets that really stand out as great partners, if you’re thinking about selling, there maybe two or three buyers that stand out. And if those companies go and do strategic things with other banks, then you’ve permanently lost that buyer or partner, or target. And so I think you have to be proactive. And so I think there should be a sense of urgency. If you think consolidation is part of your plan, both as a buyer or seller, Tom.

Tom Fitzgerald: Tom, some pretty big deals have been done recently obviously last year or maybe the year before. End of the year before where BB&T and SunTrust, got together to form Truist. We were center state bank and merged with South State to form South State, but a lot of our listeners a lot of folks, listen to this podcast are community banks, what are the key challenges for these smaller banks, so you’ve hit on a few but what are the key challenges for these banks, as we go forward to remain profitable and independent?

Tom Michaud: So, it’s very interesting that you say that because we study that quite carefully and I’ve really looked carefully. At why bigger banks have been more profitable, more recently. And what I find is that their expense and efficiency ratios are better, and their non-interest income is better. Because, let’s face it, we’re in a really tough spread environment, the banking industry was not built for zero interest rates. So I find its banks that those are the I think some of the keys out attributes, and I think that’s driving it. So I think that’s one that you should think about you know, are you a one-trick pony or not. And if you are, is there a danger for disintermediation, because I also believe that right now, we earn as free and easy at deposit moment as one could imagine.

And I believe that that’s like, that’s going to change, we don’t know how long that’s going to happen and then once deposits become a little bit more scarce or more competed for. If you’re a one-trick pony or really one product bank and you need to become more of a ratepayer, boy, that can have some real impact on profitability. I also want some of the things I worry about for the smaller banks is to make sure you’re not getting disintermediated on the credit side, and that you find that you’re only competing in a couple of credit spots that maybe you don’t really want to be when I say that is, you know, over the course of the last year I met with a couple of banks who had somehow or another gotten too large exposure to the hotel industry, for example. And when that came under pressure during COVID, you know, it created a lot of concern now thankfully I think we’ve come out of it in better shape than we thought we might have. But I think banks that suddenly got over concentrated because there was some like getting disintermediated, put them in trouble.

But you asked a very broad question, those are some of the things I’m concerned about if you wanted to think about what it is I think you need to do because by the way, at every asset size in the banking industry there are exceptions, there’s no one single rule. When I say these things, I’m generally speaking to medium results for the industry. But I think the banks that really can control their own destiny, are the banks that can earn their cost of capital, have a reasonable return on equity, as well as do it consistently in businesses that are too risky. And then they’d have a consistent degree of growth, to their earnings. I think if you’re not growing, if you don’t think you have the capacity to grow your earnings, or you don’t have a capacity to earn an acceptable return on your equity, then I think you need to stand back, take a step back and really look at strategically where the bank has had. Yeah, I think those are the key elements.

Eric Bagwell: It’s like I talked to a friend, last week and he will remain unnamed in the location or remain unnamed, but he’s retired, and they just bought a bank in a rural market, he laughed, he said there are pine trees and lottery tickets. But they, believe in community banking, and he thinks that model will never die, and a very local level, and so it was interesting, it was good to hear. I’m glad and we’ve got, You know the de novo bank market obviously it’s slowed way down than where it was at one time, but it’s picked up just a little bit later you know some groups are forming and they’ve got some pretty good investors that just want a local bank, and so that was good to hear, especially for us because we deal with community banks, yeah.

Tom Michaud: Yeah, and I think to look, the bigger banks are going to treat many markets with the scale with 800 numbers, and I’ll tell you one dimension I always look for is that when you walk into a very large, I’ll say the banks right. When you walk into a bank American branch, I think this is their policy and you’ll notice it. Typically, they’re not allowed to have photos of their families or kids or whomever, in their office, I’ve just noticed that. And if you walk into a community bank now, they may have some rules about how you have to organize your office. But typically when you see the little league sign up or the local, some photos of the local community, or just a little bit more connectivity when you walk into some of these branches or these offices, you’ll feel a difference, and I think it’s that service and that high touch, but I do know that you know, I believe that COVID drove a lot of customers wouldn’t have been in the digital channel into the digital channel and these are some world customers, and I think that you know these community banks still need to be aware of that, but the personal touch I think still will have a place in the banking industry.

Tom Fitzgerald: And you had talked earlier Tom about, you know, bankers, probably should have a sense of urgency if they’re kind of thinking about, you know, the, in the M&A field. Are you seeing more from a community bank perspective, you know, Are you seeing that urgency kind of coming to you may be seeking out an inquiry saying hey, we know the time is right, let’s go ahead and pursue, you know, a sale or, you know, some other type of transaction.

Tom Michaud: We’re busy. We’re seeing consolidation, up and down the industry right now. And, and so we think consolidation is going to continue at a good pace, and what’s different is. If you went way back to the 80s, we went back, and study and I think Norwest in the 80s was the most prolific acquirer and they did a double-digit number of mergers in a year. And back then that was possible. Now if you’re a buyer, you’re probably going to do maybe two mergers, a year. So, and that just seems to be the practice. If you’re an aggressive buyer. Most do just one. So, so the fact that, it’ll be steady, is the point, it’ll be steady, and I think it’s going to continue to be steady, and we’ve also seen some credit union deals recently. And so I think this consolidation is going to be around and I think the number of banks in the United States is going to continue to shrink.

Eric Bagwell: Right, Tom, really quickly, you just mentioned something that I want to throw out there, you mentioned credit unions and what’s the future you know we’re talking about banks, what’s the future for credit unions I mean is it similar, I mean is there going to be consolidation there on a pretty wide scale, or what do you think there?

Tom Michaud: I think there’s going to have to be, and the dynamics are different there because the industry is just so dominated by the big ones, but I think that you know, I think that the credit unions are going to compete for that local touch and feel and customer and, you know, I sense that there will be continued consolidation there as well. But I think it’s going to be, I think it’s easier to happen and it’s a more proven path in the banking industry, so I think it’ll be a little bit stronger in the banking industry.

Tom Fitzgerald: Tom, I just wanted to circle back for a minute on kind of that credit risk component and this is just sort of getting your general sense of the banking industry but this time, obviously this time last year, there was a huge concern that the banks were going to suffer some credit, you know, some significant credit losses coming through this event. And really, you know, knock on wood that has not happened we haven’t seen the huge numbers as we did in the financial crisis. Are there’s some issues, kind of still out there on the horizon that you see looming that banks need to be aware of? Or is it,

Tom Michaud: I wouldn’t believe that where we are now is the way it’s going to be. And what’s unprecedented is I don’t think any of us really at the beginning, understood how big and powerful the government stimulus programs were going to be. And it’s really. And then also the forbearance measures that were allowed. So, those forbearance measures are going to go away. And the stimulus, at some point, will wane, and an interest rate point will go start to go up. And so we will see a return back to a more normal credit perspective so, I wouldn’t think that we’re in this period, permanently and I think, you know, over time, it’s going to start tracking back to a more typical, loss ratio, and I really do believe that the removal of forbear that the companies that are stressed, will be stressed and will need to be dealt with.

Tom Fitzgerald: Right. You make a good point. A lot of these, I guess crutches that were put in, you know, as fiscal stimulus measures at the beginning of the onset of this pandemic are slowly taken away. And so that you know the economy is going to have to stand on its own two feet and that’s kind of, you know, where how well does it do that is going to be an interesting question. Supplementary unemployment benefits are what you know, between now and September are solely going to be going away. Will those 15 million people that are collecting those benefits are they all going to turn around and show up you know at some of these jobs that are out there you know looking for employees. So, I think, like you said there’s going to be probably pretty material change and things as we move through the year, we kind of see a lot of that fiscal stimulus, you know those measures start to be slowly, you know, taken away.

Tom Michaud: Yeah, I think that’s right and look, the consumer even I mean consumer credit I think it’s really excelled expectations. And so, at some point you know the consumers are going to spend this excess liquidity that they have in some of these savings and, I would expect consumer credit to come back, I think, you know, in terms of the overtime, because it’s really exceeded expectations from a national perspective, I think retailing is a sector that we pay a lot of attention to in terms of real estate. I think retail has been changed by COVID. It probably won’t continue to the degree it has but I think it’s still going to be a pressured sector. And then I think continued watching what happens from my geographic but migration perspective, I mean we’re seeing real growth in banks in states where there’s just a lot in migration. And I think that’s going to be a driver and that and COVID had something to do with that. As well as the resulting tax policies by individual states. So, I think that these are some of the impacts that will affect credit going forward.

Eric Bagwell: Well Tom listen we appreciate the time is flown by, and we really appreciate your time coming on with us and this has been some great information. And we just, we’re thankful we think you guys are a partner of ours and we’re just very thankful for the relationship and for you coming on today. Thank you, man.

Tom Michaud: Well thank you and you know my firm, which is 59 years old has had a great relationship with both Center State and South State for many many years, and it’s two excellent banks coming together, and I’m delighted to be with you all today.

Tom Fitzgerald: Thank you, Tom. Awesome.

Eric Bagwell: Thank you, man. Have a great one.