Tim Melvin reports from the 2020 Acquire or Be Acquired Conference.

The panel “Wall Street’s Perspective on Bank Deals” featured three noted bank investors. Jonathan Ashe, equity analyst at Wellington Management Company; John Eggemeyer, Founder & Managing Partner at Castle Creek Capital; and, Anton Schutz President at Mendon Capital, all spoke on Monday.

The three discussed current trends in bank merger and acquisition activity.

Ash noted that mergers of equals were trading lower after completion as the hoped-for earnings gains had not materialized so far. He suspects many of the banks that participated in an MOE transaction last year had overestimated cost savings and margin improvements and, as a result, presented earnings projections that were way too high.

He also thinks the most MOE deals are being done because bankers are looking out into the future of banking. The deals are being done in many cases to deal with the very high pace of technology spending that will need to be done over the next several years to remain competitive.

Eggemeyer noted that he had been at Jamie Dimon’s year-end gathering of the CEOs of the top 150 banks in the United States, and the general expectation was for a decrease in bank earnings this year. That was also limiting the ability of new MOE banks to hit their earnings expectation and would continue to be a problem for some of the banks that recently announced similar transactions.

He also reminded the bankers in attendance when you do an all-stock merger, you have not sold your bank. You have made an investment in the surviving bank, so it is critical to be diligent about selecting merger partners.

Shultz added that risk arb traders were also hurting the returns of the buyer in MOE transactions as they were aggressively shorting the deals. Banks that are buying back stock can sometimes push arbs out of the door, but in the short term, they have a substantial negative impact on merger returns.

All three investors expressed concerns about the valuation distortion being caused by passive investors. Passive funds and ETFs own a significant portion of the larger community and regional banks and that buying is done without any regard to the actual value or condition of the bank.

In particular, banks that complete deals that significantly change their market cap could see massive buying by these passive funds that push the stock higher than it should be based on fundamentals.

The price distortion caused by both risk arbs and passive investing makes a compelling case for preferring the smear calp funds where arbitrage traders and passive funds cannot trade.