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One important way Gator Capital is different from other investment managers that specialize in the Financials sector is that our portfolio has a much smaller position in mid‐sized regional banks. The difference in our view is that we are negative on the prospect for widespread banking M&A.
Despite more than 7,000 banks still existing in the U.S., M&A activity among banks has been subdued. Through Q1 2013, there were only 44 bank M&A deals valued at a total of $1.8 billion. If this run‐rate continues, full year 2013 M&A activity will only total 176 deals valued at $7.2 billion. This would mean a decline in the number of deals by 25% and a decline in total transaction value of 57%. I believe this current low rate of M&A activity will persist for a number of reasons.
b. Often a banker’s most valuable asset is his paycheck: Many bank stocks are nowhere near the levels of 2005 to 2007, so bank executives have seen their personal balance sheets decimated. Their paychecks may be their most valuable assets. If they were to sell and not secure a position with the acquiring bank, they may be out of work. It is better to control their own destiny by not selling their bank.
c. Can’t start a new bank after selling: A bank executive who sells his bank is probably not able to start a de novo bank. Bank regulators have granted just a handful of new banking licenses since 2011, so it is unlikely a bank executive can sell their current bank and get a license to start a new bank.
b. Trickledown effect makes MidCap banks less enthusiastic about buying: Midcap banks are less likely to make acquisitions because they understand their end game is not selling to one of the larger banks. Instead, they are going to have to stand‐alone on their ability to grow and generate high returns on capital. Therefore, they appear to be more judicious in making acquisitions.
c. Would‐be acquirers seem to be price anchoring: The average Price‐to‐Tangible Book paid for banks since 2009 is only 113%. From 2004 to 2007, the average Price‐to‐Tangible Book paid for banks was 232%. It appears the only deals getting done in the current environment are the low priced deals. Bank executives haven’t shown a willingness to pay‐up for healthy bank deals so far in this cycle.
The Fund’s portfolio has a variety of both long and short positions in different banks. Our long positions are mainly in two areas: 1) in the TARP warrants on the cheapest large banks and 2) in microcap banks with recovering credit quality. Our short positions in banks are in 1) mid‐sized regional banks with high valuations facing headwinds of loan growth and spread compression and 2) thrifts that are at risk to a flat yield curve and low rates. We do not own banks in hopes of a stronger M&A environment. We think owning many banks with lackluster loan growth and mediocre returns on capital with the hope of a stronger M&A environment will produce disappointing returns. This belief is different from those of our peers.
Disclaimer: The discussion of any security is meant solely as an illustration of our investment and thought process and should NOT be considered as a recommendation or suggestion to buy or sell any securities. Before you make any investment, do your own research and talk to your own financial adviser. Information in this report is received from external sources. Therefore, we can make no guarantee as to the completeness or accuracy of the information provided.