KBW CEO Tom Michaud: Big bank fundamental story is very good, credit remains solid

Here's a summary of the provided YouTube transcript:

Key Concepts

• Bank Valuations: Discussion on whether bank stocks are fully valued or deserve a rerating, especially given record stock prices.
• Credit Concerns: Underlying worries about credit quality, particularly in consumer subprime and private credit, despite current benign credit costs.
• Deregulation: The potential impact of reduced regulatory oversight on bank operations and profitability.
• Mergers & Acquisitions (M&A): The expectation of increased M&A activity in the banking sector, driven by economic conditions, stock prices, and the benefits of scale.
• Return on Tangible Common Equity (ROTE): Identified as a key driver for bank valuation relative to book value.
• Private Credit: Highlighted as a potential area of risk due to rapid growth.

Bank Valuations and Fundamental Story

The fundamental story for banks is described as "very good." There's an expectation that earnings per share (EPS) will be 13% higher next year, with estimates being raised for most banks. This positive outlook is attributed to strong performance on the revenue side, efficient expense management, and a robust pipeline of business.

Credit Concerns and Realities

Despite the positive fundamental outlook, there are underlying credit concerns. The transcript mentions the bankruptcies of First Brands and Tricolore, and general worries about consumer subprime credit. However, the numbers seen so far suggest "benign credit costs," and the industry is currently "over earning on credit." While credit costs are expected to rise from current provision expectations of around 26-25 basis points (which are considered too low), the key question is whether this increase will be "manageable." The speaker states they haven't seen anything "scary" on the credit side, but acknowledges that credit challenges will persist in financial services.

Areas of Potential Risk: Private Credit

A specific area identified for potential risk is "private credit." The transcript notes the "huge run" in this sector and suggests that financial institutions that have grown the fastest in private credit over the last four and a half years might be the places with the most risk. This is not an indictment of the entire sector but a cautionary note based on rapid growth rates.

M&A Activity and Drivers

Mergers and acquisitions (M&A) are expected to continue into 2026, forming part of the "bull case" for the banking sector. Several forces support this trend:

• Economic Health: The economy is in good shape.
• Stock Prices: Stock prices are also in good shape, providing a favorable environment for deals.
• Consolidation Benefits: Generally, consolidation has led to more profitable banks that are more highly valued by investors.

Regulatory Environment and M&A Speed

A significant shift in the regulatory environment for M&A is noted. Previously, mergers could take up to 16 months to receive an answer from regulators. Now, decisions are being made within a six-month timeframe, representing a return to a more traditional approach. This speed is attributed to a "pro-growth administration," and the industry is perceived to be "on the clock" to act now, as a future administration might have a different stance.

Rerating and Valuation Multiples

The discussion touches upon the rerating of bank stocks, using Bank of America's results as an example. While Bank of America's results were strong across M&A, capital markets, and credit quality, the stock is trading at 14 times earnings. This is considered high for the banking sector, especially when compared to the broader market's P/E of 24 times earnings. The transcript highlights a historical discount between bank multiples and S&P multiples.

Key Driver for Valuation: ROTE

The primary driver for bank valuation relative to book value is identified as "return on tangible common equity" (ROTE). Bank of America is expected to reset its ROTE target, and other major banks like Citigroup and Wells Fargo are holding investor days. These events are seen as positive indicators, suggesting that these institutions believe their business models will drive increased profitability. The speaker believes that improving ROTE is the path to rerating bank multiples.

Current Valuation Discount

Despite the positive outlook and potential for rerating, the transcript concludes that banks are still trading at a significant discount to the broader market. Specifically, they are noted to be "30% cheap" relative to the market's P/E multiple.

Synthesis/Conclusion

The banking sector is currently experiencing a strong fundamental story with expected EPS growth driven by revenue, expenses, and pipeline. While credit costs are benign, there's an acknowledgment of potential future challenges, particularly in rapidly growing areas like private credit. The regulatory environment has become more conducive to M&A, which is expected to increase due to economic strength and the benefits of scale. The key to unlocking higher valuations for banks lies in improving their Return on Tangible Common Equity (ROTE), as demonstrated by upcoming investor days from major institutions. Despite these positive developments, banks continue to trade at a notable discount compared to the broader market.