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While many banks are being unfairly painted with a broad brush, institutions will face tougher regulations, and that could ultimately lead to a strong rebound in bank M&A activity.

That was the message delivered by experts during two panel discussions focused on bank liquidity that S&P Global Market Intelligence hosted on May 18. The latest "Street Talk" podcast featured highlights from those sessions, including the panelists' view of bank stocks, how institutions should react to liquidity pressures in the marketplace, and the outlook for bank M&A activity and future regulation in the aftermath of recent bank failures.

Since liquidity pressures accelerated in March, bank stocks have come under considerable pressure, leaving the group down more than 30% this year. Greg Hertrich, head of US depository strategies at Nomura Securities, said investors were painting all banks with a broad brush.

"I do think that where we are right now is very similar to a Bob Ross painting so far as he's got his big brush out and everybody is sort of swiping all the banks to the side. And I think that that is a) irrational and b) probably not how this all ends," Hertrich said.

Jonah Marcus, partner and portfolio manager at Endeavour Capital, agreed with that analogy and noted that any investor that can take a long-term horizon should buy bank stocks at current levels.

"The question is, can you get a better deal and [in] three months or in six months? But generally, in this period of time, I think you want to be not just contrarian for the sake of being contrarian, but I think it's contrarian and right if you own the right balance sheet management teams and revenue streams," Marcus said.

Chris McGratty, head of US bank research at KBW, a Stifel company, noted that bank stocks bottomed around 4x to 5x pre-provision earnings during the height of the pandemic and the aftermath of the great financial crisis. More recently, he said the group was trading around 4.8x pre-provision earnings, putting it in the window of "trough valuations." However, he noted that it is challenging to assess bank earnings in the current environment, where deposits are moving quickly from noninterest-bearing accounts into higher-cost deposit products.

Banks also face earnings headwinds from lower-yielding assets, particularly bonds, remaining on their books. A handful of institutions took actions to reposition their securities portfolios in the first quarter by selling bonds at a loss and using the proceeds to either build cash levels or pay down higher-cost borrowings.

Several panelists at the liquidity briefing agreed that repositioning securities portfolios makes sense but noted that banks need to have adequate capital on hand to take the hit when purging underwater bonds. Endeavour's Marcus said if a bank has regulatory capital on hand to take the capital hit associated with repositioning their bond portfolios, they should probably consider doing so. However, he did not think that any banks should sell portions of their bond book if they would have to raise capital on the back end.

The panelists also believed that new regulations could surface in the aftermath of recent bank failures. While new rulemaking is eventually expected, Isaac Boltansky, managing director and director of policy research at BTIG, noted that changes in Washington, DC, do not come quickly.

"Look, DC does two things well: nothing and overreact. And I think that's exactly what we're going to see here," Boltansky said.

He said that new rules are likely to come from regulators rather than Congress and noted that regulators had already begun working on imposing stricter regulations on regional banks before the series of recent bank failures. For instance, he noted that regulators had already considered subjecting regional banks to the liquidity coverage ratio as well as having to hold more loss-absorbing capital in the form of long-term debt.

Other panelists said they have already seen changes during regulatory exams. Bill Burgess, co-head of financial services investment banking at Piper Sandler, said regulators have begun testing banks against new liquidity ratios.

"The [Office of the Comptroller of the Currency] was sitting down with national banks in early April, like the first week of April, with a new ratio of liquidity and cash as a percentage of uninsured deposits. That ratio didn't exist on March 1, and they want that ratio at 100%," Burgess said.

Ben Azoff, partner at Luse Gorman, said he has seen examiners subject banks to more matters requiring attention (MRAs) and has even seen them subject banks to more serious orders, like memorandums of understanding, or higher capital requirements.

"One thing that's happened over the last month, we've seen regulators coming asking, particularly in the community bank space, ... for daily liquidity reports," Azoff said.

Panelists believed that increased regulation would eventually spur more M&A activity. M&A activity is almost dormant right now, but Marcus said consolidation would eventually be huge as bankers and their boards are already fatigued.

"We saw it on the back of COVID and the stress that people were under and you saw a huge increase of M&A in 2021. I think this is more dramatic psychologically on boards and management teams," Marcus said.

Burgess, whose firm was hired by the Federal Deposit Insurance Corp. to help shop the bridge banks created in the aftermath of bank failures, said he was surprised how difficult it was to get regional banks to pay attention to the bidding for the failed institutions, particularly since larger bank deals have faced greater regulatory scrutiny and longer closing timelines.

"I'm talking to these same large banks saying, 'I can have this close for you on Sunday. Sunday,'" Burgess said. "It can close in days, and we really didn't have anyone who's paying attention."

Burgess does believe that the M&A dam will ultimately break, as smaller institutions in particular will face pressure on returns as regulatory scrutiny grows.

"I think that all of this is just terrible in terms of bank profitability. All of this is going to be more liquidity, more capital, more expenses, lower returns. As an M&A banker, I think that's absolutely fantastic because it's going to mean that all the smaller banks that were earning 12% on capital are earning 10% on capital, and they're going to be forced to run for the exits."

^{This article was published by S&P Global Market Intelligence and not by S&P Global Ratings, which is a separately managed division of S&P Global.}