By Jacob Sonenshine
Stocks of both investment banks and regional lenders stand to gain as several factors, including Donald Trump's election victory, bring a healthy flow of mergers and acquisitions.
That would mark a turnaround. U.S. deal activity dropped in 2023, as high interest rates and slowing economic growth discouraged companies from making purchases. Buyers often finance deals with debt, so when borrowing costs rise, they have to be confident that the earnings from the assets they are acquiring will at least offset the bill for interest.
While last year wasn't an appealing time to pull the trigger, given that the economy was weakening, a recovery was anticipated this year. The Federal Reserve was expected to cut interest rates, as it has done, and companies have continued to increase their profits. The overall result is that companies are in position to produce higher post-deal profits despite the borrowing cost involved in doing transactions funded with debt.
And there has been some growth. Banks such as JPMorgan Chase, Goldman Sachs, Morgan Stanley, and even smaller firms Lazard and Moelis have reported higher advisory fees this year than in 2023. Further deal activity will bring more gains.
But the rebound so far has been far from sharp. While nobody expected deals to reach the peak levels seen in 2021 yet, relatively large deals are going nowhere. The total dollar amount of U.S. deals worth over $5 billion is down 2% this year to $569 billion, according to London Stock Exchange Group. That is a touch above the 2022 level, but the road to full recovery is long: About $800 billion in such activity was recorded in 2021.
Companies have dropped hints about what is holding transactions back. Parker-Hannifin, an industrial manufacturer that makes acquisitions most years, said nothing to the contrary when an analyst said on the October earnings call that uncertainty over the election may have delayed agreements on deals.
Now that the election is over, M&A could take off in 2025. Trump is expected to pass much of his agenda, which includes deregulation, through Congress. It is a near certainty that antitrust regulators will take a more favorable view of deals than they are now.
At the same time, the tax cuts Trump has backed could spur even more growth in profits and the economy. If that weren't enough, the Fed could also cut rates a few more times.
All that is why, for some stock investors, "there's a strong focus on positioning for a possible surge in M&A activity," writes Megan Roach, co-head of equity portfolio management at Russell Investments. "The new administration might ease regulations on M&A, particularly in financials."
Regional banks are a key area. Their lending revenue and earnings would benefit from a growing economy, making them attractive to larger buyers. Trump's administration may reduce the amount of cash large banks are required to hold in reserve, making more capital available for M&A in a fragmented industry.
The U.S. has more than 4,000 regional banks, each an expert in their local markets. Many have market values of less than $1 billion, making it feasible for larger banks to finance acquisitions, especially if they want to move into new areas.
While the SPDR S&P Regional Banking exchange-traded fund is up 13% since just before Trump's win, it has more room to run. It has rallied partly because of expectations that other Trump policies will boost earnings, so a surge in banking M&A might well lift it further. Acquisitions tend to happen at significant premiums to market values.
The fund owns hundreds of banks, many of which are small, so a wave of deal activity in the industry could give it a boost.
Right now, the ETF is still trading cheaply, as 13 times the aggregate earnings analysts expect its component companies to produce over the next 12 months. The S&P 500 trades at 22, putting the fund's price/earnings ratio at a discount of 40%.
The average over the past decade is 29%, based on Barron's calculations using FactSet data. This just means the multiple is unlikely to move much lower, and that some combination of higher earnings or buyout activity can lift the fund.
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Write to Jacob Sonenshine at jacob.sonenshine@barrons.com
This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.
(END) Dow Jones Newswires
November 13, 2024 10:31 ET (15:31 GMT)
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