What Makes Mid-Size Banks So Interesting?

Speaker 1:
Welcome to TD Cowen Insights, a space that brings leading thinkers together to share insights and ideas shaping the world around us. Join us as we converse with the top minds who are influencing our global sectors.
Jaret Seiberg:
Welcome to Two Cents, the financials podcast at TD Cowen. I'm Jaret Seiberg, managing director and financial services policy analyst at TD Cowen Washington Research Group. Today, we're going to dig into the world of the mid-size banks with TD Cowen equity analyst, Janet Lee. But first, as always, my partner in podcast, Scott Smith, who is TD Cowen's specialty salesperson for financials. Scott, what's going on in the market these days? It certainly seems to be pretty chaotic.
Scott Smith:
Well, Jaret, as you know, April was earnings month. And as of today, we only have about 10% of the XLF stills to report. So quite a bit is known at this point. For the month of April, when earnings really rolled off, the XLF was up 5.6%, but to some real divergence in performance on the financial sub-sectors, with large-cap banks represented by BKX up over 10%, mostly on capital market strength, which was just a little bit under the S&P 500, up 10.4%. Regional banks using KRE's approximate were up 7.2%, but there was notable variability there in terms of earnings revisions. More on that in a second.
Insurance was the weakest of the financial sub-sectors, just up 90 basis points. As commentary in the P&T space weighed on the sector, with managements being as direct as calling out some of the pricing, if I air quote, just dumb. It's worth noting that a lot of the positive action for the financials in the quarter was short covering, driven in particular, if I look at the performance of the TD coverage list, the biggest gainers on the month were overwhelmingly the more shorted names.
Alternative asset managers did perform better around earnings. And while the software ATF rallied over 12% from the mid-April low, which helped that sector, there are still some questions around that. AI does remain a super hot topic, but does seem a little bit more right now, like companies are able to speak to the benefit of AI deployments, whereas previously they were defending them from AI-distinct remediation. At least that seems to be the case for the moment.
I did think a couple of other things were interesting, looking forward. 45 of the 76 XLF names have had positive 2026 EPS revisions. Largest revisions were in trust banks, exchanges, and the large banks. Largest negative revisions were a mix, but had some of the alternative asset managers and traditional asset managers for the alts. I think it's really people starting to add in stock-based compensation. Looking more broadly across the TD coverage universe, only about 34% of the covered names had positive EPS revisions.
That's despite a generally constructive view in the quarter in terms of the economy and credit. The negative revisions were... Actually in the negative revision side, there were a bunch of mid-cap banks there, but that space clearly highly divergent, and I'm sure Janet will get to that in a minute. I will say, right now, investors remain glued to Iran headlines, of course, and the potential inflation impact. But for now, the view is the economy remains strong. Credit is generally benign, so it's okay.
Jaret Seiberg:
All right, Scott, I can't let you get away with a couple of questions here. So you brought up Iran. As we think about the financial space relative to the broader market, is the uncertainty on the geopolitical front more impacting financials, less impacting, are we moving in step with the market? How does one kind of view all of that?
Scott Smith:
It's a sector-by-sector thing to some degree. For sure, we move bank stocks around quite a bit on Iran headlines because it moves interest rates. You get a little bit less movement in alternative asset managers, and the P&C insurance space do get decent amount of move and most of it to the upside in the exchanges as that volatility comes and goes. But I'd say there's probably other sectors of the market that are a little bit more impacted, but I'd say where investors are more focused on those headlines within financials is banks.
Jaret Seiberg:
Okay. So let's talk about the other area where banks certainly were in the news and that's on exposure to private credit. It's a topic we've discussed in our last several podcasts. What's the latest on private credit and its broader impact?
Scott Smith:
From a trading perspective, because obviously Janet will be able to dig into that a lot more with respect to the banks themselves, it does seem like people have largely gotten over that concern. It does help, like I said, that IGV rallied kind of 12% off the low, and so people are a little less worried about it impacting the space right now. There have been a couple of very specific episodic stories around credit. But in general, we got through earning season without a lot of exposure to private credit cropping up as an issue.
Jaret Seiberg:
And so does that mean you think that this ship has sailed, or do we need to be prepared for it to come roaring back some point this year?
Scott Smith:
Well, I guess I would say that they've pulled up the anchor and are preparing to leave port, but it's not entirely clear that they've cleared the jetty yet.
Jaret Seiberg:
All right. Well, Captain, I think we will leave our boating analogies there. Scott, thank you as always for your participation on the pod. And let's now turn to the main event, which is my colleague Janet Lee, who is our mid-size bank equity analyst. Janet, welcome to the podcast. Let's just dig right in.
Janet Lee:
Sounds good. Happy to be here.
Jaret Seiberg:
Awesome. So let's go really basic. What makes a bank mid-size, and why do we have mid-size banks?
Janet Lee:
Yeah. So at a high level, when we say mid-size, we're usually talking about banks in that roughly 10 billion to 100 million asset size. If you include those super regionals, you could certainly go up to 250 billion in assets, but I want to say it's less about the exact number or the asset size itself, but more about what they do.
These are the banks that are big enough to offer a full product set, whether that's lending, treasury, and some capital markets to an extent, but still operate with the regional relationship-driven models. So in terms of your question around why they exist, it's pretty simple.
They just fill a gap. A lot of mid-size banks are middle-market companies. They're not necessarily always the core for mega banks, and for smaller community banks and credit unions, they are very local, but they may not have the technology or product set. So, my mid-size banks and right in the middle. They bring both service and scale.
Jaret Seiberg:
Okay. So not everybody who listens to the podcast is an expert on financials. Can you give us maybe some examples from around the country of mid-size banks? What are some of the brand names out there?
Janet Lee:
Yeah. So on the super regional side, think of names like Fifth Third, Citizens, M&T, Key, Huntington. Those are kind of classic super regionals that operate more nationally, a little bit.
But then, if you go down the ladder a bit to our mid-cap banks below 100 billion in assets, you come across names like East Western California, Wintrust in Chicago, Value National in the Northeast, Colin Frost in Texas, Pinnacle and South State and the Southeast Western Alliance Customers Bank.
I can probably spend all day going through them, but what you'll notice is that each one tends to have a regional or sector focus. So they're not just defined by size, but by where and how they compete.
Jaret Seiberg:
And so how are they able to compete against their mega-bank rivals, the JPMorgans and the Bank of Americas of the world?
Janet Lee:
Yeah. So it's really their core advantage. Against mega banks, they tend to win on relationships, speed, and service. Decisions usually happen locally for these mid-cap banks, and clients tend to get more attention by their bankers.
And against the smaller banks, they win on capabilities and sometimes on technology, oftentimes broader product and more lending and fee capabilities. So I do want to say their sweet spot is being big enough to matter and small enough to care, which actually resonate quite a bit with middle-market clients. So I would say those are sort of their core advantage against competing with those larger cohorts and versus smaller cohorts.
Jaret Seiberg:
You mentioned that they're big enough to be able to fully serve some of these customers. How much specialization do we see among these mid-size banks? And could you give us an example of what specialization could look like?
Janet Lee:
You could almost divide up those regional banks or mid-size banks into regional-focused and specialization. So on the specialization part, you could think of banks like I mentioned, Western Alliance and Customers Bancorp and First Citizens of the world. So some of these banks, take First Citizens as an example. This is probably the largest bank that I cover, with 200 billion in assets.
They bought Silicon Valley Bank, which used to and still does bank the innovation economy. They provide those banking services to startups and the venture capitalists and the innovation economy. So that's how they're known in that specific space. SVB might actually be better at serving those specific clients because that's the bread and butter of what they do.
And for these shift to Western Alliance or Customer Bank or even the bankers are industry experts in specific areas, whether that's healthcare, mortgage warehouse, or some other areas where... or hotel franchise lending, where typical regional banks or even bigger banks may not be an expert, so to say. So it really differs. And I do think that the specialization method is really one of the ways that regional banks will continue to flourish as a business model.
Jaret Seiberg:
So, as somebody who follows this space, then what do you think are the biggest challenges that the regional banks are confronting right now?
Janet Lee:
One of the biggest challenges for regional banks has always been the funding. They don't necessarily have the same low-cost deposit base as the mega banks do. So I just want to give you quick stats. For larger-cap banks, their interest bearing deposit cost is around two, like low 2%, 2.1% in the first quarter. From our banks, on average, it's about 2.7, close to 3%. So we don't have that granular consumer deposits that are lower cost.
So a lot of these banks are always trying to get the higher better mix of funding, which is their biggest challenge that they've always been working through. Another one would be, I want to say AI. The thing is, we do think there's going to be a lot of divergence between AI deployment and readiness when it comes to the mid-size banks. And for those that are behind versus the ones that are ahead, I don't think the laggers are going to be able to compete in terms of operationally, as well as pricing products competitively versus the ones that are much ahead.
Jaret Seiberg:
Okay. So if they're not able to compete, perhaps that leads nicely into the next question, which is bank M&A has always been a feature in my experience in the mid-size bank space. Are we expecting an uptick in M&A? It seems to have been less in the last decade than what we saw in the prior 20 years. And what are some of the hurdles to bank consolidation in your space?
Janet Lee:
Yeah, I do think that it will accelerate. I mean, if you look at 2025 just as a whole last year, there were about 180 bank M&A deals that were announced, which is almost a 50% year-over-year increase. So we saw the momentum picking up. So far, year-to-date, we've seen about 50 deals.
So it's going, but you could say it's been slowed down a little bit, just obviously because what's going on in I think the geopolitical uncertainty that we're dealing with is certainly a factor there. But if you look at the regulatory factor, I know, Jaret, you will have much more to say, but the regulatory environment for banks overall, including bank M&A, cannot be better. So I do think there will be more bank M&As to come while the window, the regulatory window, is open.
So that's what we're expecting in terms of just the sheer amount of M&A activities to pick up in the quarters to come. Another hurdle, I want to say, besides the geopolitical uncertainty that we're dealing with right now, is just the gap, the valuation gap between the larger banks and the mid-size banks, is not wide enough in order for the deal metrics to look very accretively from the standpoint of the bank investors.
So that's one another hurdle. But once we gain those valuation back for the banks in general, I do think there will be a time where bank M&A will just continue to pick up in the quarters to come. Probably not this quarter, just because we're still dealing with that uncertainty. As that uncertainty unwinds a little bit, and once we have a period of some calmness, then I do think the M&A will pick up in general.
Jaret Seiberg:
And do you think that M&A is going to be focused on more mergers of equals, or is it going to be these regional banks looking for kind of community banks, super community banks, banks that might be active in just a single city or narrow geography? What might it look like?
Janet Lee:
I do think it's more of the latter in terms of our banks, mid-cap banks being the acquirer. I mean, some of the super regionals are definitely going to be interested by my banks, the mid-size banks. But I think it's more of mid-size banks also acquiring smaller size regional banks, less so of merger of equals.
I mean, we saw what... the merger between Pinnacle and Synovus and the market reaction to merger of equals. It's very difficult to come by. So there will be a much higher threshold for M&A... for merger of equals to work and received favorably by the investor community. So I do think more of the latter.
Jaret Seiberg:
All right. So you had mentioned one of my most favorite words earlier, which is regulatory. As the guy in Washington, I got to deal with all the regulators, and they have definitely been active as you suggested. One of the biggest things that we've seen move forward is an overhaul of bank capital rules. Now this is just a proposal, and more changes are expected, but what's your early read on how it could impact the regional or the mid-size banks?
Janet Lee:
It's definitely positive. When it first came out, I thought that, "Oh, this is definitely a favorable outcome for my banks as well, for the mid-size banks as well." But initially, I thought it was going to be just marginally beneficial.
But when a lot of banks came out with the first quarter earnings, a bunch of our banks in the mid-cap space pointed out that these preliminary Basel III Endgame estimates imply about somewhere between 60 basis points, 100 basis points plus Lyft to CET1, which is actually better than I thought.
So we do think that then continues to provide a strong setup for continued capital returns in the form of buyback for many quarters to come, and also provide more capital for these banks to engage in loan growth and lending activities. So I do think that what's coming out on the bank capital rules front is beneficial for the entire sector, including our mid-cap banks.
Jaret Seiberg:
So part of this proposal would require more banks to count unrealized losses and gains unavailable for sales securities against capital. Are the mid-size banks prepared for this, and what would it mean for them?
Janet Lee:
I want to say that's probably the one thing that has largely been expected by bank managements in terms of including available for sale secure of... accounting unrealized losses and gains unavailable for sales securities. So I do think that a lot of our brands will be very well positioned to weather this change.
If you look at CET1 on a reported basis for my banks, it's about 11.5%. If we take out AOCI, excluding AOCI adjustments, it's going to be 10.8%, which is still high... well above the well-capitalized threshold. I do think it's a problem or an issue that our bank managements, overall, from the mid-cap bank space, are going to manage.
Jaret Seiberg:
All right, Janet, I want to wrap things up. Big picture. As we think a decade out, what are your expectations for what the mid-size bank sector is going to look like?
Janet Lee:
I certainly do think there will be fewer banks in the next decade. I really don't think there should be 4,000 banks in the United States. So I do think there will be continued consolidation in the bank space overall. And honestly, because of the potential for what... for what AI could do, I do formally believe that the laggards when it comes to AI will be absorbed by the ones that are ahead on technology, including AI, because they're just simply not going to be able to compete in the next five or 10 years.
So there will be more consolidations to come. I do think more mid-size banks will exist, but I do also believe there will be more specialization and regional focus as opposed to one mid-size bank just serving the whole nation, but with smaller scale. I don't think that has a lot of differentiation to it. So I continue to see mid-size bank sector flourishing, but with the caveat that there still will be more and more consolidations to come, where the technology... technologically advanced or the ones that are leading on service as a way to drive that market share and gain that revenues to be the ones to be the ultimate survivors.
Jaret Seiberg:
All right. Janet, I think we're going to leave it there. Thank you so much for joining the Two Cents Podcast this month. We'll be sure to get you back in a couple of months from now to catch up on where the regional banks are.
Janet Lee:
Thank you very much.
Jaret Seiberg:
All right. And that brings us to our final segment, which looks at the major financial policy issues from the last few weeks and previews what's coming up in the next few months. So what happened in the last month? Well, we're having the final push to get the Clarity Act on crypto market structure enacted into law. Senators Alsobrooke and Tillis propose compromise language dealing with yield or rewards on stablecoins. The banks are not happy with this language, and so the fight certainly continues.
We think the window to get this done is the August recess, which historically begins in late July, and so our friends on Capitol Hill still have a couple more months to try to get to the finish line on crypto market structure. We also had an interesting hearing in the House Financial Services Committee on that bank capital proposal that we were discussing earlier with Janet. What surprised me most was the lack of strong democratic opposition to the capital reforms, and it reinforces what I think is perhaps most important about this capital proposal, which is that it is sustainable.
And by sustainable, I mean, even if there is a change in party control of the White House in 2028, we're likely to still see these capital rules remain in effect. To me, sustainability is critical because it allows banks to plan for the future. It's why I took this hearing to be especially positive for the sector. All right. Kevin Warsh is going to become the chair of the Federal Reserve. He should be confirmed into that job by the middle of May, but Jerome Powell, the current chair, is staying as a Fed governor.
The other big news we're waiting for on the Fed front is for the Supreme Court to decide if Lisa Cook gets to remain a Fed governor while the courts decide if the president has the ability to fire her for cause. And then lastly, one of the latest developments is perhaps new life for housing legislation. This bill would eliminate the permanent chassis requirement for manufactured housing. That would be a big plus for that sector. It also includes some recommended local zoning reforms, which could help on the construction side.
The bill has been held up due to disagreements in the House and the Senate on built for rental single-family homes and whether institutional investors would be allowed both to build those properties and then retain those rentals. It looks like we're going to find a middle ground there, and that could clear the way for this legislation to move sometime this summer. In terms of other actions and events coming up in the next several weeks, just a couple that I want to flag here. On May 20th, we're going to have a House Financial Services hearing on equity markets.
It's been a while since we've had a real in-depth congressional hearing on this topic and so that should be insightful. We also have SEC Chair Paul Atkins speaking that day in Washington. I expect he also will be focused on equity market structure as well as crypto. Speaking of crypto, we're still waiting for more action from the SEC on tokenization. Our friends on Capitol Hill are working on a reconciliation bill to fund immigration enforcement. That has to get done. The self-imposed deadline is June 1st.
And then in late June, we are looking for the results of the 2026 stress test of the big banks. And so certainly not a slowdown here in Washington, and that means that we will have lots to talk about when we record the June edition of the TD Cowen Two Cents Podcast. With that, let me thank Janet and Scott for being our guests this month. This wraps up the May edition of TD Cowen's Two Cents Podcast. I look forward to having everyone tuned in next month, and I'm Jaret Seiberg with TD Cowen. Thanks, everyone.
Speaker 1:
Thanks for joining us. Stay tuned for the next episode of TD Cowen Insights.