The Long and the Short of It: Profit on the Lucrative Banking M&A Boom

There's real potential for runaway profits right now in a surging trend that you're not hearing about in the news: a looming deal boom in the banking industry.

I get it: Banks are boring. They don't make high-tech gadgets and new, must-have apps. They're not known for flash.

But there are a heckuvalot of 'em here in the United States. Around 5,000 or so - compare that to Canada, with just six banks.

That U.S. total is down from 15,000 in the 1980s, thanks to a decades-long tendency for big banks to buy smaller ones and consolidate.

In the case of banks, consolidation is a proven trend that will only accelerate in the years ahead. The recent uptick in the market gives public banking companies more capital to grow through acquisition.

As our Chief Investment Strategist, Shah Gilani, would tell you: It's all about where the money is going. Shah is always looking for places where massive waves of capital are heading in the future and buys into companies before they reap the rewards of a massive economic trend.

And as I'll show you, the money is going into banking M&A...

Why Banks Buy Other Banks

Ultimately, acquisition is really the only way that financial organizations can increase their deposit levels.

Take a quick step back and think about it.

Banks operate on the capital that they have in their vaults. They can only lend based on a percentage of the deposits they hold from customers.

The ways to grow your deposits are organically - your customers get richer or you operate in a part of the country that is seeing population growth.

Or you have to build through acquisition - the purchase of another, smaller bank.

Why Banks Sell Themselves

There are lots of reasons for a bank to, in essence, sell itself.

Right now, it's extremely difficult to operate a handful of banks in a small town and compete against behemoths like JPMorgan Chase & Co. (NYSE: JPM) or Bank of America Corp. (NYSE: BAC). Those institutions have branches around the country, access to ATMs everywhere, and far greater advantages in terms of cost structure and the ability to provide other services like business loans or mortgages.

In addition, bigger banks have deeper pockets for cybersecurity protections to ensure their additional offerings around mobile banking. Cybersecurity is actually the number one concern among banking executives, and it's an extremely expensive solution to a growing threat. But there are additional drivers in M&A that are outside the quantitative fold.

For example, retail and community banking isn't an industry rife with new talent. Today, boards of directors at these little banks are largely run by older executives who are eyeing retirement. Without a proper succession plan in place, I'm seeing more and more boards heading for the exits.

In fact, I'm expecting that the banking space will consolidate at a rate of 3% to 5% over the next decade. Banks that can engage in intelligent acquisitions of smaller banks will grow earnings much faster than the competitors, which should lead to the shares trading at a premium multiple. Banks that are targets of potential takeover offers often see huge premiums in their shares when a deal is announced.

So, here are two moves I like right now - one is a long-term bet, the other could pay you handsomely in six months or less...

Make This a Long-Term Investment

Investors with 12- to 24-month time horizons can't go wrong with buying shares of Prosperity Bancshares Inc. (NYSE: PB), a bank holding company based in Houston. This stock sports an unbelievably low P/E of 11.29, and its board is paying shareholders an attractive 3.9% right now.

The stock is off about 20% since the onset of the COVID-19 crisis, but this is a company that will use weakness in the banking sector today to grow for tomorrow. The bank has grown by acquisition over the past decade, using smart deal-making to grow the bank to $32 billion in assets.

CEO David Zalman has said that he intends to reach the $50 billion mark by 2024, and he's well on pace to do it. Prosperity has seen some exposure to weakness in the oil markets over the last few months, but a return to normalcy in the economy complemented by demographic shifts that favor Texas and most of its markets will make the company a winner - a big one - in the long run.

There Are Juicy Short-Term Profits to Take, Too

Now, let's look for a way to tap into the consolidation trend over the next six months or less.

Today, I want to focus on Cadence Bancorp (NYSE: CADE), a Houston-based bank with 98 branches across the Southeastern United States. The company operates in higher-growth markets like Texas and Florida, which continue to generate steady growth in population.

However, I will note that COVID-19 has generated a new real estate boom for the Sun Belt region, particularly its suburbs and exurbs. It's simple: With more people likely to work remotely in the future, look for Cadence's markets to benefit from the massive escape from the city.

This bank has "acquisition target" written all over it. I anticipate that may happen in the next six to 12 months, so we want to find a way to accept a steady amount of risk and reward in this scenario.

I recommend that you look at the CADE Dec. 18, 2020 $10 calls (CADE201218C00010000), These are just out of the money, hovering around $1. Put an order in there and wait.

Your downside potential is limited; if things don't pan out, you'd lose $100 should a takeover deal not materialize, but there is the possibility that you can roll over that contract to the last dated contract on the options chain.

Shares of CADE are off nearly 50% since the onset of the COVID-19 crisis, but I think the situation on the ground is likely to lead to a rebound to at least $10, if not much more.

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About the Author

Garrett Baldwin is a globally recognized research economist, financial writer, consultant, and political risk analyst with decades of trading experience and degrees in economics, cybersecurity, and business from Johns Hopkins, Purdue, Indiana University, and Northwestern.

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