The SPDR S&P Regional Banking ETF (KRE ), the largest ETF dedicated to regional bank equities, gained 27.4% last year. While that lagged broader benchmarks, the performance was still impressive when considering the Federal Reserve cut interest rates three times.
Rising interest rates historically benefit regional banks. Higher interest rates would help widen the difference between what banks charge on loans and pay on deposits, which would boost earnings for the financial sector. Regional banks are among the stocks most positively correlated to rising interest rates because higher rates improve net interest margins.
As 2020 unfolds, KRE and other regional banks ETFs could have a tailwind: increased mergers and acquisitions activity. That after last year’s pace of deal-making in the industry was the best in two decades.
“Regional bank deals hit a 20-year high in 2019. Regional banks — defined as having between $10 billion and $50 billion in assets — were involved in 35 deals, the highest number since 1999,” reports S&P Global Market Intelligence. “The 2019 activity included five transformative deals that reshaped the regional bank space and laid the groundwork for a potential slew of multibillion-dollar mergers-of-equals.”
An important to the regional banking consolidation thesis is speculation that the bulk of transactions could be front-loaded in the first half of this year.
“Bankers might have a short window to get those deals done. Regional bank M&A is experiencing something of a sweet spot after regulators lifted a key asset threshold,” notes S&P. “But that could change after the 2020 elections, leading to some predictions that large deals will be front-loaded in the year ahead. Meanwhile, the market dynamics driving regional bank M&A remain very much in place, as analysts and investors point to a tough operating environment and the imperative to invest in technology as key drivers of regional bank consolidation.”
The weighted average market value of KRE’s 122 member firms is $10.8 billion, indicating suitors can potentially avoid large premiums to bring targets to the negotiating table.
“The market has reacted negatively to high-premium transactions where a large bank buys a smaller one at a price above market value,” according to S&P Global Market Intelligence. “The market has made it clear that expensive deals will lead to sell-offs.”
This article originally appeared on ETFTrends.com.