Could the need to consolidate drive M&A in US banking sector?

Mergers and acquisitions are still extremely thin on the ground within the US banking sector, but more activity does seem likely in the near future as pressure to consolidate increases.

 

Only 168 banking M&A deals were announced in 2011, despite the fact that there are some 7,500 banks in the US. This year has not experienced the best of starts either, with the number of deals announced in January and February down by 17 per cent on the same two-months last year. However, analysts claim there are several indicators that suggest things are about to change in the banking arena.

The first of these is the improvement in credit quality. Credit quality has been improving for eight consecutive quarters, which has given potential dealmakers more confidence in the value of target banks.

 

This improvement has also led to a rise in bank stock values in recent months, which provide another psychological boost to the industry. The KBW Bank Index listing 23 large and medium stocks has risen by 14 per cent so far in 2012, for example.

Investors are now beginning to trade based on what a bank’s asset could one day be worth, rather than their potential value if the bank were to become bankrupt, according to William Hickey of Sandler O’Neill & Partners, who spoke to Reuters on the topic.

 

As well as the credit quality and the stock values, banks are under increasing pressure to consolidate to increase value for shareholders, analysts have claimed. KBW’s CEO Thomas Michaud told Reuters: "Consolidation has to happen as a way of driving better shareholder returns in the banking industry.

"It could be the acquirers looking to take expenses out of the target. It could be the sellers thinking that their shareholders are better off joining a bigger company with a broader platform," he added.

 

Bankers have also claimed that the high cost of adhering to increasingly demanding regulatory requirements, while interest rates remain at rock bottom, is also putting the pressure on banks to merge. The Federal Reserve has said that low interest rates are likely to remain in place until the end of 2014 and this is straining banks’ ability to make money through their net interest margins. This pressure is even greater for smaller banks, with assets of less than $5 billion, making deals within this sphere the most likely.

 

There is also a general sense that M&A activity in the banking sector would send a positive message to industry and commerce in general. It would suggest that the demand for loans is increasing and that the US economy is expanding. Arthur Loomis, the president at Northeast Capital and Advisory told Reuters that he was confident of a domino effect once the M&A deals start to occur. He explained, "There are underlying pressures to do acquisitions. We could easily see half of today's banks disappear once buyers get the confidence to be acquisitive again."

So what is it that’s holding the banks back right now? The general reluctance to take the plunge seems to be down to a combination of ongoing uncertainty about the state of the economy in general, stock market distrust and regulatory issues, such as the Dodd Frank requirements. These are putting something of a dampener on banks' desire to grow, with those with more than $10 billion of assets affected by fee restrictions and those with over $50 billion affected by extra Federal Reserve scrutiny.

 

What does seem certain is that any deals that are done are unlikely to involve the largest banking groups, namely Bank of America Corp, JP Morgan Chase, Wells Fargo and Citigroup, as they are already close to exceeding their 10 per cent market control limit. It is, however, the next largest banks, which number around 25, which could form the epicenter of a revival in M&A activity in the near future.

 

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