An important piece of banking's M&A puzzle may have just fallen into place.
The Federal Reserve's stress test results of the largest banks were broadly good for deal-making. And even if they did not necessarily change the M&A outlook for those large banks, it could help prompt more community banks to change hands, experts say.
Indeed, while the Fed's latest gauge of capital strength focused on the country's largest 19 banks, the smaller institutions below that threshold will be able to use it as their own learning experience from observation.
The issue of capital clarity has joined healthy share prices and rising profits as gathering forces of a bank merger wave that experts have been predicting for years.
"Everyone, from No. 20 to 100 [of the largest banks], is watching this, looking at this and learning about how the Fed views capital," said Robert Albertson, principal and chief strategist at Sandler O'Neill & Partners LP. "Therefore it does remove some of the uncertainty and probably adds a bit to the momentum for consolidation. But not directly with the Top 19."
When banks know how much of their profits they can use to hike dividends and repurchase shares, they can figure out how much they need to set aside to take over a rival.
The capital guidance the Fed just broadcast to the market? If a bank is in good shape, regulators may not want it to dole out more than roughly 70% of profits through dividends and share repurchases.
That is the median payout ratio for a half-dozen institutions that said they now plan to increase dividends or share repurchases. That should leave would-be buyers with plenty of extra cash for deal-making, experts say.
"The capital at these banks is going to continue to build. Nobody is paying back more than their earnings," said Frederick Cannon, managing director of research at Keefe, Bruyette & Woods. "On the margin it does kind of support the banks looking toward consolidation."
The stress tests largely reinforce the M&A dynamics among the largest banks. Those already viewed by Wall Street as buyers received a similar stamp from the government: U.S. Bancorp, Wells Fargo and JPMorgan Chase-in announcing larger than expected share repurchases-solidified their standings as top banks with deep pockets.
Banks striving to prove they deserve to stay independent, such as Regions Financial Corp. and SunTrust Banks Inc., will have to continue to do so.
The results may offer clues into exactly how much buying power top acquirers have, Cannon said. U.S. Bancorp-long pegged as a potential buyer of either Regions or SunTrust should they come to market-was allowed to repurchase up to 100 million shares, or $3.1 billion at their current market value. It is now likely to get the nod from regulators to spend at least that much buying another bank, Cannon said.
"The dollar amount of the share repurchase announcements should be available for M&A," Cannon said. "The Fed would almost prefer that. More capital in the system tends to be a good thing."
Share repurchases remove capital from the system, and acquisitions keep it in the system, he added.
The Fed tested banks' ability to withstand severe increases in unemployment and decreases in stock prices and home prices. It estimated how much such hits would weaken capital or earnings power measures like pre-provision net revenue. Other buyers validated by the results: PNC Financial Services Group, KeyCorp and BB&T, which all got permission to either increase dividends or repurchase more shares as they integrate recent major acquisitions.
Huntington Bancshares, in being allowed to maintain its dividend and repurchase as much as $182 million in common stock, affirmed a view among investors and analysts that it is an institution well past its problems and able to buy, should it want to.
"It is a significant stamp of approval to get," said Stephen Steinour, Huntington's chairman, president and chief executive. "It doesn't change our strategy."
That strategy is to grow profits by taking market share one customer at a time by keeping branches open longer than rivals, and keeping fees and prices customer friendly. Huntington will consider deals cautiously, Steinour said.
"We're only looking at things in our region. Our first priority is organic growth," he said.
Matthew Monks is a reporter for American Banker, a sister publication to BIC.