For those readers unable to escape the cold to attend Bank Director’s Acquire or Be Acquired (AOBA) conference in Scottsdale, AZ, we reflect on the major themes: bank M&A and scarcity, tax reform and valuation, and FinTech. For those unfamiliar with the three-day event, over 1,000 bankers, directors, and advisors gather to discuss pertinent industry issues.
There are fewer than 5,500 banks today, which is roughly half from only 10 years ago when we first attended AOBA. This scarcity was top-of-mind for several panelists who noted variations on the same theme: Scarcity matters to both buyers and sellers as the number of banks dwindles at a rate of 3-4% per annum.
Unlike the 1990s and even the pre-crisis years when a seller could expect multiple offers, banks that sell today often have just one or two legitimate suitors. In our view, this means that sellers need to think more strategically about their valuation today and prospectively if their most logical suitor(s) is acquired. Even if the logical acquirer is unlikely to be acquired, board planning for some institutions should consider the potential to strike a (cash) deal with a credit union. For buyers, scarcity may translate into less desirable banks in targeted markets. If so, scarcity may mean greater emphasis on expansion through lift-outs from other banks, or even a push into non-traditional bank acquisitions/investments such as wealth management that could serve as a nucleus around which traditional banking services are bolted. One key question to watch: Will scarcity impact the pace of consolidation and the valuation of transactions? The short answer is seemingly “yes,” but rising acquisition valuations over the past couple of years correspond to the rising value of acquirers’ publicly traded shares.
The banking sector was revalued higher in the public markets following the November 2016 elections, reflecting four attributes that would favor banks: regulatory reform, tax reform, faster GDP growth, and therefore, higher interest rates. While the impact (thus far) of regulatory reform and higher interest rates is limited, passage of the Tax Cuts and Jobs Act of 2017 is a highly tangible benefit for banks and customers. With the stroke of a pen, ROE for many banks will rise to or above the institution’s cost of capital, returning to pre-financial crisis levels. However, tax reform is not a cure for strategic issues such as whether FinTech may radically disrupt the “core” in the deposit relationship between customers and their banks.
One panelist summed up the debate by noting that management teams who achieve a 10-15% increase in earnings and ROE in 2018 from tax reform are not geniuses; rather, they are around to cash the check. The real winners, as it relates to tax reform, will be banks that leverage the enhanced cash flows to make optimal capital budgeting and strategic decisions. Bankers will have to allocate the additional earnings before some of it is competed away among investments in staff, technology and/or higher dividends, share repurchases and acquisitions. Perhaps in the ideal world, the incremental capital to be created would be used to support faster loan growth, but few at the conference indicated their institution had seen an increase in loan growth as a result of tax reform.
A related theme that emerged in several sessions was the dichotomy in valuations between the “haves” and “have-nots” along key metrics such as size, profitability, core deposits, location, management team, and operating strategy/niche. This divergence could widen further following tax reform as the “haves” effectively take their higher cash flows and reinvest/deploy them more profitably than the “have-nots.” Ultimately, these strategic decisions and the trajectory of the bank’s performance will drive whether tax reform leads to sustainably higher bank valuations, likely varying case-by-case. For those interested, we discuss implications of tax reform for banks in greater detail here.
While FinTech wasn’t even on the agenda when we first made the trip to Scottsdale for AOBA in the mid-2000s, it was all over this year’s schedule. One panelist humorously compared bankers’ reactions to FinTech with the “Seven Stages of Grief” noting that bankers seemed to have finally progressed beyond the early-stages of anger and denial toward the latter-stage of acceptance. Bankers are considering practical solutions to incorporate FinTech into their strategic plans. Sessions included panel discussions on the nuts and bolts of structuring FinTech partnerships and creating value through leveraging FinTech to enhance profitability. (For those interested in FinTech, learn more about our book on the topic.) Niches of FinTech that garnered particular attention included digital lending, payments (both consumer and business), blockchain, and artificial intelligence. AI in particular was top-of-mind, and one panel noted it as an area of FinTech offering strong potential for banks in the next few years.
We look forward to discussing these three themes with clients in 2018 and monitoring how they evolve within the banking industry over the next few years. As always, Mercer Capital is available to discuss these trends as they relate to your bank – feel free to call or email.
Originally published in Bank Watch, February 2018.