Consolidation Drives Customer and Shareholder Value

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Although the COVID-19 pandemic has hit the pause button on deal activity, the compelling fundamental rationale of economies of scale, customer acquisition and shareholder value means M&A remains a clear strategy for the banking sector.

"Even in the current volatile environment, M&A is primarily a customer acquisition tool as banks take a long-term view."

- Gerard Cassidy

Intense consolidation has characterized the U.S. banking and financial services sector over the last three decades. Since the early 1980s, the number of U.S. commercial banks shrank from approximately 14,500 to some 4,700 at the end of 2018, but merger and acquisition activity is far from over. However, it has slowed as the COVID-19 outbreak interrupts due diligence, introduces short-term valuation volatility and creates forecasting uncertainties.

Despite the temporary disruption to M&A activity, the underlying drivers of technology investment, elimination of duplicative costs, and economies of scale continue to compel banks to come together. With excess liquidity on bank balance sheets, M&A may represent a better route to shareholder returns than stock buybacks. However, the desire to conserve capital may now be a factor in M&A considerations.

With the economy entering a downturn, precipitated by the COVID-19 containment strategies, the resulting decline in profitability and slowing in earnings per share growth will likely see shareholders put pressure on management to do deals. We can expect more M&A activity in the next two to three years. Indeed, we consider that, given the demand to do deals, M&A transactions may potentially lead to activity as soon as the turmoil shows signs of settling.

The forces of change

The emerging omni model, serving a customer seamlessly across multiple different channels from digital and mobile to the traditional branch, necessitates both technology and scale.

The typical branch size is shrinking as transaction volumes decline, and the core purpose of branches evolves towards selling products to customers, giving them advice and solving their problems. Since peaking in the year Apple introduced the iPhone, branch networks have been in a steady decline with up to 30% forecast to close in the next five years. They will always be needed, but there will be fewer of them.

Even in the current environment, M&A is primarily a customer acquisition tool as banks take a long-term view. There is a direct correlation between an increase in assets managed and improved the quality of technology. That explains why both customer retention and customer satisfaction are high after banking acquisitions. Organic growth is still essential and will continue to complement acquisitions, but it is tough to move a banking customer away from their existing company.

Uncovering opportunities

There is still a place for smaller community banks in underserved areas that don’t appeal to the larger institutions. They will be less profitable, and experience challenges on the technology front, but technology service providers can deliver the basics of digital and mobile banking for these smaller players. Smaller regional players will continue to grow with the trend of some 200-300 small bank acquisitions a year continuing to happen once the economy recovers its balance after the tumult caused by the COVID-19 Black Swan. The raising of the SIFI Threshold for banks, from $50 billion to $250 billion, is also likely to act as a stimulus for M&A activity.

Banking mergers typically result in improved profitability – achieving typical intra-market cost savings of 30-40% – but from the consumer perspective, the net effect is broadly neutral. Customers get access to better technology, but deposit and loan pricing don’t change as market-rate competition is the main factor.

In a landscape of increasingly larger consolidated banks, there are legitimate concerns that these expanded institutions risk becoming too big to fail and too big to manage.

However, regulatory oversight has improved since the financial crisis with rigorous stress testing and stricter capital and liquidity requirements. The system is resilient, as we have seen from its ability to withstand the latest shock.

Published April 20, 2020


RBC Financials Equity Team


COVID-19Coronavirus

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