Russell-ensnared bank stocks have now underperformed by about 15% year-to-date. Wednesday morning, analysts at KBW published a report indicating the market cap cut-off could be as high as $249 mil., ~25% higher than the prior consensus forecast. The stock price reaction during Wednesday’s trading session was immediate, as most bank stocks with market caps ranging from ~$200 mil. to ~$275 mil. generally underperformed. There are now, by my estimation, about 80 banks (give or take) that seem to be ensnared in this Russell situation, and these stocks on average have now underperformed the index by about 15% since the start of the year.
Compared to a few weeks ago, most market participants – analysts, investors, community bankers, etc. – now seem laser-focused on this issue, as it truly presents a conundrum for just about all sector constituents.
- For analysts, the inclination is understandably to gravitate toward stocks in the Russell subset that do not appear to have any glaring fundamental flaws on a relative basis, have not participated in the recent rally, and could be attractive acquisition candidates as the pace of M&A picks up in the coming months. The caveat is these stocks could materially underperform on a relative basis, and could move lower still on an absolute basis, over the next several months.
- For investors that already own these stocks, the lack of liquidity within this subset is such that an exit would be challenging to say the least, not to mention difficult to justify given in some cases valuations that are already 15%+ lower than comparable peers outside of the Russell subset. Moreover, investors would likely kick themselves if they spent the next month or two exiting a stock (and likely driving it lower in the process), only to see it acquired later this year at a sizeable premium from the depressed level at which they sold. But on the other hand, amidst a straight upward move in the bank index so far this year (save for a couple of weeks in late January), an over-concentration in these names would likely lead to significant underperformance for most of the first half of the year, particularly if the rally in bank stocks were to continue in the months ahead, which is certainly possible.
- For community bankers, there is likely considerable frustration over the fact that strategic planning is likely to be disrupted, and in the meantime, there really isn’t anything that one can do to influence the situation one way or the other. Bankers that were hoping to be acquisitive as we emerged from the pandemic could be sidelined well into the second half of the year, given depressed stock currency. Moreover, for those looking to be acquisitive, large scale stock buybacks, while undoubtedly attractive from a financial perspective, obviously limit available dry powder for future deals. On the flip side, bankers that may have been looking to sell their company in the early stages of the economic recovery are likely in a difficult negotiating position, particularly if the number of interested parties is limited, as buyers may be reluctant to pay a sizeable “Day 1” market premium, no matter the perceived fair value of the target. To that point, potential buyers of the Russell subset group are likely the best positioned of all sector constituents right about now, with many of these stocks having already appreciated meaningfully over the past several months, resulting in “deal math” that is undoubtedly quite compelling at this point.
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