Bank Valuations — Is an Estate Planning Window of Opportunity Closing?

Bank stock valuations continue to face headwinds, particularly community banks relying on net interest margin (NIM) to drive profitability.

Community bank investors may be experiencing negative earnings due to the current economic conditions.

Investors may have a golden opportunity to benefit from the current environment through proactive estate planning.

The Recent Banking Landscape: Rate Hikes, Losses, and M&A Activity

The banking industry experienced significant volatility throughout 2023 as the Federal Reserve rate hikes challenged bank balance sheets, drove funding costs higher, and created liquidity challenges — ultimately leading to three of the largest bank failures in U.S. history.

In early 2024, the banking industry continued to be affected by uncertainty around interest rates, funding costs, liquidity, and unrealized securities losses. Concerns about future earnings, legacy loans, and securities added to balance sheets during the pandemic also weighed on bank stock values and M&A activity.

The charts below show that the Federal Reserve’s interest rate hikes in 2022 and 2023 have sharply reduced the Yield/Cost Spread (yield on earning assets minus the cost of interest-bearing liabilities) for community banks ($10 billion or less in assets). This is because the cost of funds increased faster than the interest earned on assets, leading to lower profitability.

Additionally, community banks faced nearly $97 billion in unrealized losses from their investment securities portfolios in Q3 2023. These losses, combined with low yields from legacy loans, have made M&A activity less appealing. As a result, both profitability and bank transaction values have dropped.

*Represents average price to tangible book value on whole acquisitions of banks and thrifts.

Opportunities in an Evolving Economic Landscape

As we move into the second half of 2024, inflation has decreased significantly, and the market is anticipating interest rate cuts by December 31, 2024.

With these anticipated rate cuts, banks will likely experience reduced pressure on net interest margin (NIM) as funding costs stabilize. This could increase net interest income, enhancing bank valuations as future earnings become more apparent. Lower rates could also help reduce unrealized securities losses, making mergers and acquisitions more feasible.

The opportunity to benefit from the current economic conditions might close soon.

In addition to the current economic conditions, the following factors should also be considered:

Favorable Tax Laws and Potential Changes Ahead

Under the Tax Cuts and Jobs Act of 2017, current federal estate and gift tax exemptions are at historic highs. As of 2024, individuals can utilize the estate and gift tax exemption up to $13.61 million without incurring federal estate taxes, and married couples can shield up to $27.22 million. These exemptions are scheduled to revert to lower levels after December 31, 2025, unless Congress extends them.

• We dive into further detail about what this means for estate planning here.

Valuation Discounts

Estate planning strategies often involve transferring ownership interests in a bank to family members or into trusts. Since these interests in community banks are typically illiquid due to their private and closely held nature, they may be transferred at a discount that reflects their limited marketability and lack of control. These discounts, when combined with the current economic conditions noted above, present a potential opportunity to further reduce the taxable value of transferred assets.

Proactive Planning and Availability of Advisors

Estate planning involving bank ownership interests is inherently complex. A collaborative and coordinated team of tax, legal, banking, and financial planning advisors can develop a comprehensive estate plan that minimizes tax liabilities and supports the institution’s long-term success for future generations.

Now is the Time to Act

Given the current economic conditions, favorable tax laws, potential discounts, and availability of advisors, now is an ideal time for bank owners to engage in estate planning. Working with experienced professionals can help you successfully navigate the challenges and complexities of transferring bank ownership interests.