While I generally write only about the nation's biggest banks, that isn't where the action is in the bank industry right now. For that, you have to look at smaller banks -- those with between $10 billion and $50 billion in assets.
There's one bank in particular that's worth watching in this space: Pinnacle Financial Partners (NASDAQ:PNFP). I'll write more about Pinnacle in the future, but I wanted to share one point about the Tennessee-based bank to help orient investors' perspective on it.
But before getting to that point, here's a taste of Pinnacle's stock performance over the past 17 years:
The point is about growth
As a consequence of how the bank industry has evolved since the Civil War, when the modern American financial system began to take shape, the country has ended up with a highly fragmented industry with an over-abundance of banks.
There are more than 6,000 of them today.
That may not seem like a lot given the size of the United States and its economy, but in an industry that's as heavily commoditized as banking is -- there's no truer commodity than money itself -- this leads to stiff competition among lenders. This is one reason banks get into trouble so frequently, as competition for customers has led banks in the past to lower underwriting standards in order to compete with less prudent peers.
This is what Warren Buffett is talking about when he expounded on his thoughts about banking in his 1990 shareholder letter (emphasis added):
The banking business is no favorite of ours. When assets are twenty times equity -- a common ratio in this industry -- mistakes that involve only a small portion of assets can destroy a major portion of equity. And mistakes have been the rule rather than the exception at many major banks. Most have resulted from a managerial failing that we described last year when discussing the "institutional imperative:" the tendency of executives to mindlessly imitate the behavior of their peers, no matter how foolish it may be to do so.
Another consequence of the stiff competition in the bank industry, and the related race to the bottom that Buffett alludes to, is that there's little opportunity for a bank to grow organically in a way that's both rapid and prudent. Generally speaking, to grow responsibly at a pace faster than the economy in a bank's footprint, it must instead use mergers and acquisitions.
Growth through acquisitions
Growing through mergers and acquisitions is a tried and true strategy in the bank industry. Few banks prove this better than M&T Bank (NYSE:MTB), which has produced some of the best shareholder returns among publicly traded banks over the past three and a half decades. And it's done so by making smart acquisitions -- buying less prudent peers for pennies on the dollar in times of crisis.
The problem with growing through mergers and acquisitions, however, is that it too is hard to do responsibly. As was the case with Bank of America (NYSE:BAC) in the lead-up to the financial crisis, most banks tend to pay too much for acquisitions and cut corners on due diligence, leading to large losses later on down the road.
In the best-case scenario, this exposes investors in the acquiring bank to dilution. In the worst-case scenario, as with Bank of America's purchase of Countrywide Financial, it can blossom into an existential issue. Over the past decade, due in large part to that deal, Bank of America has incurred upwards of $200 billion in crisis-related costs.
The key is bank management. Robert Wilmers has led M&T Bank since 1983. He's basically the Buffett of banking -- an iconoclast who's patient, prudent, and analytical. It's no coincidence that Buffett has long been one of M&T Bank's biggest shareholders. Bank of America by contrast was led by Ken Lewis prior to the crisis, whose principal objective seemed to have been to grow for the sake of growth.
The growth of Pinnacle Financial Partners
This is where Pinnacle Financial Partners comes into play. Few banks have grown as fast as Pinnacle has over the past decade. It went into the financial crisis with around $2.5 billion in assets. Today, after its latest deal, it has approximately $20 billion in assets on its balance sheet.
Most of Pinnacle's growth has come by way of mergers and acquisitions. Just this month, it closed on a merger with BNC Bancorp, which nearly doubled the size of Pinnacle. This comes on top of a half dozen other deals that Pinnacle has completed since it began operations in a single location in downtown Nashville, Tennessee in 2000.
The question for enterprising investors, in turn, is this: Is Pinnacle's approach to mergers and acquisitions more akin to M&T Bank's or to Bank of America's? If it's the former, then this could end up being one of the biggest winners in the bank industry over the next few decades.
I don't know enough yet about Pinnacle to opine on the answer to this either way. But what I can tell you is that multiple highly respected bank analysts and institutional investors have told me in recent days that Pinnacle's CEO Terry Turner is the real deal, and that this is a story to watch. He's an excellent operator with a stellar track record, they say, not unlike Wilmers. And his bank could soon be on the verge of evolving from a community bank into a regional banking powerhouse -- again, not unlike M&T Bank.
Pinnacle's stock isn't cheap, trading for nearly three times its tangible book value per share. But if its success continues, this could very well be, in the words of Peter Lynch, a multibagger for investors with long time horizons.