Revival of the Bank IPO

May 28th, 2014

5-28-14-Hovde.pngAs U.S. equity markets climb higher—the S&P 500 has set a new record 10 times already this year—initial public offering (IPO) activity has returned to levels last witnessed during the tech boom. In 2013, 222 U.S. companies went public, raising $55 billion—the most activity since 2000. This IPO momentum has continued into 2014.

Now that the banking industry has returned to health and equity markets are on fire, IPOs have become viable options again for banks seeking fresh capital.

Disregarding mutual-to-thrift conversions, four banks completed IPOs in 2013, raising $335 million. Seven banks have already filed for IPOs in 2014, four of which have completed offerings and raised $254 million. As a result, 2014 is shaping up to be the most active year for bank IPOs in a decade.

What’s contributing to the revival of bank IPOs?
The banking industry is as healthy as it has been post-recession, but the extended low interest rate environment has changed the industry’s profitability playbook. Most banks have improved asset quality, returned to profitability and boosted capital ratios; however, net interest margin compression is overpowering those banks that lack sufficient loan growth. As a result, opportunistic banks capable of growing loans through acquisition or market expansion are attracting the most investor interest. Given the current market appetite for growth, access to capital is becoming a larger consideration for management and boards, especially if it gives them a public currency with which to acquire and expand. A bank’s ability to articulate its growth story remains critical to completing a successful IPO.

The same factors that are fueling IPOs in other industries are at play in the banking industry. Equity markets have recovered from the recession, and valuations have improved sufficiently for banks to consider an IPO. The SNL Bank & Thrift Index now trades at approximately 165 percent of tangible book value and 15 times trailing earnings.

Furthermore, many banks that recently completed IPOs have since outperformed the market. The four banks that went public in 2013 have returned 49 percent, on average, since their IPO dates, compared to 20 percent for the SNL Bank & Thrift Index and 21 percent for the S&P 500.

Private equity (PE) firms are also playing a pivotal role in the revival of bank IPOs. PE firms that entered the banking industry during the downturn now view the market as ripe for an exit. Valuations have increased and firms are nearing the end of their typical investment horizons. Five of the last six banks that went public were owned by PE firms. Private equity’s business model depends upon a successful investment exit, and an IPO exit may be preferable for those investors who want to take some money off the table, but still believe in the growth opportunities of their franchises.

Additionally, certain regulatory changes under the JOBS Act have made it less burdensome for companies to raise capital publicly. In particular, new issuers that qualify as “emerging growth companies” (i.e., those with less than $1 billion in gross revenues) can submit a draft registration statement to the SEC for confidential review, thus avoiding any public stigma associated with a failed IPO if they decide not to complete the offering. These changes may result in more IPOs in the pipeline than are publicly reported.

The confluence of factors leading to the revival of bank IPOs could also warrant investor caution. Banks that have completed IPOs in 2014 saw their stock drop 1.5 percent, on average, since their IPOs. The two most recent bank IPOs in 2014 had stock price declines of 6.6 percent and 2.2 percent, respectively, on their first trading days.

The market’s upward trajectory—fueled, in part, by the Federal Reserve—will not last forever. The S&P 500 now trades at about 25 times earnings—a level rarely reached over the past century. And while bank stocks trade at more reasonable multiples, a steep macro correction would stall the recent bank IPO momentum.

Furthermore, since loan growth is critical to shareholder returns in the current low interest rate environment, banks must remain prudent while executing their growth plans. Interest rate and credit risk monitoring is paramount to sustained, profitable growth—particularly at a time when it’s tempting to chase yield. PE firms have had mixed success investing in banks, and their aggressive roll-up strategies have not been time-tested in the banking sector.

Despite some warning signs on the horizon, the IPO window remains open, and bank investors are still captivated by unique growth stories. If the trend continues, 2014 should remain on pace as the most active year for bank IPOs in a decade.

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Andrew J. Fitzgerald is a managing director at Hovde Group, LLC, and a bank director at Farmers Savings Bank in Mineral Point, Wisconsin.