Vito (00:06):
Hello and welcome to Strategic Alternatives, the RBC Capital Markets podcast. We're here today to uncover new ways to raise capital, drive growth, and create value in an ever-changing world. With insights and outlooks from the RBC Capital Markets team. I'm Vito Sto, global head of Mergers and Acquisitions, and as always, I'm joined by Larry Stein, deputy Chairman of Global Investment Banking. Hello, Larry. Welcome back. Hi, Vito. Really looking forward to today's discussion. Today, Larry and I are joined by some special guests from our financial institutions group. We have with us Vinny Badani Hall, who is the head of financial institutions here at RBC and Jason Bronstein who is the head of financial institutions m and a here at RBC Vinny. Jason, welcome to the podcast,
Vinny (00:51):
Vito Larry. Excited to be here and look forward to our podcast. Certainly exciting times in the financial institution sector. Good to be here.
Vito (01:00):
So guys, let's set the stage a little bit. A little over a year ago was everything that occurred with Silicon Valley Bank and that's certainly turned around and that situation evolved so quickly and it's been an eventful year, which we'll get into next. But as I think about and just look at the overall m and a landscape, 23 was a strong year at the end, but certainly not as strong as a number of us had thought. It was the lowest volume of m and a activity in 10 years. And interestingly in the US we probably had a little bit of a stronger market. It was only off in the single digit percentages as opposed to global volumes being off 16%. Your space financial institutions is generally about 10 or 11% of the overall m and a volume globally. And interestingly when I was looking at it in the US last year, it was slightly up, but it wasn't a big number. But we're certainly, as the conversations we're having with clients today are evolving, Vinny, I'm noticing a more positive tone from people and so I'd love to get your perspective on where are we today relative to the past year and especially what are you advising clients in terms of the go forward?
Vinny (02:13):
The overall views of our clients in the sector and the drivers of m and a remain the US market and many of the markets globally still hasn't seen the extent of consolidation that people thought that they would've seen by now. There's a significant number of players of different size. Scale is very relevant and as each company thinks about how to be competitive for the long term, they do care about scale and they look at m and a as one of those options to achieve that scale. One of the interesting things is the sector and the economy overall saw a very low interest rate environment for a very long period of time. We saw low growth economy, low inflation and low interest rates, and most of the balance sheets of financial institutions were set up for that environment. Covid obviously changed that the Fed was slower then probably people would've expected to react to the increasing inflation because many believed that was transitory by the time that Fed started to react to this interest rate environment.
(03:28):
That dynamic created an issue with the balance sheets of in institutions. So when we sat about a year ago, everyone felt very bullish, obviously about pursuing m and a, but the speed with which the impact of the rise in interest rate had on the balance sheets of the different players saw us From what we saw over the last one year, we saw upside down balance sheet because people were obviously used to borrowing at very low rates and then invested this in long-term investments also at a very low rates. So when suddenly short-term funding increased for all of these players that saw a tremendous impact on their balance sheet. And I think the second thing that we saw, which is very different over the last one year, is the speed with which we saw potential liquidity and deposits impacting some of the players. So that was the reason for what we saw with many of the names like Silicon Valley, first Republic signature, et cetera.
(04:36):
However, in one way there was a view that this would translate to a lot more names. Obviously we saw even the takeover of Credit Suisse by UBS and people were wondering who would be next. But as we sit sort of in March, 2024, the sector has been resilient through some of these challenges. Many of the players have strengthened their balance sheet, have worked through the liquidity issue and therefore they're sitting now today understanding the same issues that they had today, but with a little bit more clarity on where the future is and some of the drivers of m and a still remain but have been pushed back by a year. So they actually feel more motivated to pursue m and a in the years to come. There's still some near term challenges as we work through where rates and the economy is going, potential impact of credit on areas like CRE, et cetera, and also looming geopolitical issues and election cycles in some of the different major countries globally. But as we work through that through this year, people are getting ready to consider how they should think about consolidation and scale as we come on the backend of some of these dynamics.
Larry (05:57):
So Vinny and Jason last year, as you say, Vinny, there was kind of a rapid adjustment to the expectation that interest rates were going to be elevated and this year, a year later there's perhaps an adjustment to the expectation that interest rates are going to remain elevated, perhaps not at their peak, but certainly higher than during the zero interest rate decade that we experienced. So how are banks responding to that a year after the crisis?
Jason (06:30):
First of all, if we just look back over the last year, Finn just mentioned some of it, it was the most interesting year for the sector in a very long time. On the one hand, you had rising rates, great credit quality, which is sort of a dream scenario for banks. At the same time, you had the failure of some of the most storied franchises in the sector, private equity money coming into the sector, which is never a good sign. All those things are taking place at the same time, a great operating environment, great earnings, and you have these bank failures. I think as we sit here today, there certainly was a hope that interest rates would moderate. I think people are preparing a bit for a longer higher rate environment, which I think is going to be the case and funding costs are going to rise and margins will shrink At the end of the day, Larry, if you run a bank, you're in a business of extending credit, we can withstand lower growth, we can withstand shrinking margins as long as credit stays good. And right now all the focus on credit at the moment is on commercial real estate. I think those concerns will expand, but margins will shrink, business will slow, but if we can maintain credit, the sector will be just fine.
Vito (07:48):
Yesterday our US rates strategy and economics team just revised their fed call. They had been pretty consistent since the fourth quarter of last year of saying that they expected rate cuts to start in June and they expected about 125 basis points of cuts in 24. They said they still expect the June start, but as opposed to a set of monthly cuts, it's going to be reduced to quarterly cuts. And so now they're saying 75 basis points of cuts, which seems to be a bit of where everybody's coalescing and sort of where folks are looking at some of the strength in the economy and trying to figure out where the fed's going and certainly sounds like the Fed has signaled that they would really like the cut in the June July timeframe in terms of starting that off. So hopefully some of your clients are seeing that. I mean I guess as that one of the more significant drivers for your sector, Vinnie, you mentioned the commercial real estate exposure that everybody has or that some folks have. I mean, is the direction of rates going to be the determinant of how you think about those portfolios?
Vinny (09:00):
I think macro, the issue primarily we saw over the last 18 months VI and Larry was the speed with which the rates increased. As I said, had the Fed probably they moved earlier. I think there was a survey that was done that had they moved when they saw the initial signs of inflation, they probably would not have had to increase rates by about 75 to a hundred basis points compared to where they had to get to in the end. So I think most of the FINA institutions were probably surprised with the rapid speed with which these rates increased, even though technically you can believe that it was not surprising because some of the indicators on inflation and others probably were there. Now we've seen the institutions have an additional year to adjust to it. Second, the long end obviously when we were over six months ago and seeing a long end being 5% plus and some predicting a greater than 6% for that, that was probably when there was most concern in the sector.
(10:10):
As we sit today, the current environment that you presented of potentially having three cuts et cetera, is probably a positive scenario because if we were going to see six rate cuts, et cetera, even though rates were coming down, it just meant that the economy was in a much worse shape than probably one would've expected. So if we have a good soft landing, and I think as Jason said earlier, credit has actually been pretty good till now. If you're able to bring short-term rates down, the curve remains more flatter. Obviously we have an inverted curve right now and that credit doesn't implode all at one time, like how rates increase. So suddenly that allows financial institutions to work through those challenges. The offset of that is that we will see more subdued growth in the sector near term because of all these things we talked about, a slowing economy rates still reasonably elevated and obviously credit potential issues being there.
(11:18):
So where people will think about going forward is I have greater ability to look at options in terms of m and a and think about how to position the institution for the longer term. So we're actually more bullish on m and a than we probably were six months or one year ago where the volatility was very high. But that said, that's where we sit on March 24 and one thing we've learned in the last 18 months is things can change very quickly. Very, so if the Fed manages a very soft landing, we remain more bullish that as we get through some of these issues including the macro and geopolitical and election cycles that we should see a pickup in m and a. But on the other hand, if more volatility comes back in the sector, we might need to see different m and a like what we saw last year where we'll see certain more companies in distressed or whether we saw the recent situations with New York community that they were able to get a private equity investment into them. So it might not be the traditional offensive m and a, it might be more others who are needing to react to the increased volatility suddenly that they're probably not prepared for.
Larry (12:40):
Yeah. Jason, I want to follow up on Vinny's point and talk a little bit about industry structure, which is always relevant to m and a. The US has a slightly different industry structure than many advanced economies. We spend a lot of time talking about the biggest banks, but we have hundreds and hundreds and hundreds of smaller banks, and so it's almost a bifurcated industry in that way. Talk to us a little bit about how this macro environment that you and Vinny just summarized for us for banks, how it affects some of the smaller medium-sized banks as opposed to the larger banks as they think about m and a.
Jason (13:17):
We have, as you mentioned, an enormous number of banks in this country. We're relative per capita basis. We have more banks than many if not all of the countries. If you look at some of the work that the Federal Reserve and the FDIC did around the failures of SVB in Silicon Valley, they were very critical of the regulators in those cases and the supervision and the poor governance and poor risk management. Part of that is because of the number of banks we have, it's just impossible to properly regulate those banks. The smaller institutions are less complicated and can manage those institutions just fine. As you get larger, it becomes more difficult. The enhanced super advisory environment for banks as they reach, they've reached a hundred billion dollars threshold has become very onerous. There have been very few banks and we could talk more about it, that have crossed that threshold successfully.
(14:12):
So I think as you get bigger, it becomes much more difficult to keep up with the expected supervisory expectations. I do believe beyond my career, this sector will look dramatically different in the next couple of decades. I think there will be much larger banks or more trillion dollar banks. I think the regulators will get there on that. I'm going to realize that is the right thing for the system. There will be a lot of smaller banks which play a role in local communities, and it's the regional banks in the middle that I think will suffer the most pain and will consolidate into larger institutions.
Vito (14:48):
It's interesting, I look at the landscape guys and we are on the same page in terms of thinking about a resurgence in m and a in the financial institution sector. And it feels like, first of all, as our clients are thinking about their strategic alternatives, that m and a alternative all the sudden is much more viable than it was a year ago. Clearly, the conversations that we all have with your client base, that's been a consistent message and it seems that they're looking to m and a to grow, innovate and become more resilient in this environment. Vinny, you mentioned scale, and I think also in the past you've talked a lot about looking to m and a to acquire capabilities, whether it be sort of an advancement of technology or the like, and so it does feel like that's a bit of the driver as we look forward.
(15:42):
My sense, and I'd love your comment on it, is that we're going to have a strong 24 in financial institutions m and a, but it's really going to be 25, 26 and thereafter that we're going to see a steady pickup. And I've said a lot recently to clients, this isn't a matter of flipping a switch and you're going to see a ton of volume in m and a here, and I can apply that to a lot of sectors, but it's going to be a steady build given how much there is to do, whether it be a consolidation, whether it be portfolio rebalancing or the like. But would love your thought in terms of how you're seeing your client's plan for that if it's a longer term or is it near term in 24,
Vinny (16:28):
Vito, what we've seen recently and what we probably see near term is episodic or event driven m and a. So people are going through certain challenges for different reasons. Could be regulatory, could be balance sheet, could be credit, and they will need to pursue m and a as a potential solution for that. On a macro perspective, the drivers of m and a are certainly medium to longer term and scale can be looked at in many ways. People look at scale as adding additional capabilities, it's adding additional markets, it's adding greater density in markets you serve. Obviously in the past we talked about some technology scale that's needed in terms of expenses related technology, but it's also expenses related to marketing. It's expenses related to regulatory and the processes and procedures that need to be put in place as a institution gets larger. So most of the institutions almost at every size feels that they have a role to play at their size.
(17:35):
And Jason talked about the small players playing a critical role in the community, but that said, everyone sees the value of being larger, which allows them to be more profitable and provide greater returns for their key shareholders and stakeholders. So that's one dynamic that they're thinking about how to achieve As you think about the sector that generally most people try to grow at certain rate about the GDP, and then as you think about how do I create a return slightly greater than that m and a has to be a tool in addition to other tools for them to provide those returns. That's where we are hearing from clients that they're all beginning to get ready and thinking about how to play as we get through the current environment. And Fido, you said it well, m and a is not unless it's very specific event driven or episodic where you have to react instantly because you're in a crisis mode.
(18:43):
It's not something where you just turn on a switch and it happens. So what we are hearing from our clients is them beginning to understand their landscape potential partners, and one of the dynamics you always see in a finance institution is because of the impact of goodwill and capital to the balance sheets, it works very differently compared to corporate m and a on how they think about financial metrics and the return that m and a provides on that. So as these factors play out, I do think that you will see much more of a resurgence in m and a as more active and more proactive rather than currently, which is more reactive and event-driven m and a.
Vito (19:32):
Vinny, you talked a little bit about event-driven. It makes me think about some of the recent deals that have been announced, especially as examples of what we might see going forward. So from an m and a perspective, Jason maybe hit upon some of the transactions that you've seen in recent months or over the past year. Certainly we've seen some of the deals around a year ago between the Silicon Valley Bank transaction, first Republic transaction to JP Morgan and others. But what are you seeing right now in terms of some of the deals that maybe are examples of what we look at going forward?
Jason (20:10):
It's a good question. Let me just take a step back and just take a little bit of an issue with the notion that there has been a dramatic slowdown in consolidation. If you look on the bank side, we are typically used to two 300 bank deals announced a year. They're very small deals, most of them. There has been a dramatic slowdown in that, a number of deals. When you look at it from that perspective, it's probably close to a hundred deals last year, so a big fall off. But those are largely small deals. If you look at the larger deals that are done in the sector as far as the consolidation of the business, there has been a lot of consolidation over the past three years. There's probably been more a hundred billion dollars plus m and a deals than there has been in a very long time.
(20:57):
I realize some of them are FDIC failed bank situations, but that's consolidation. Silicon Valley signature, first Republic, bank of the West, BBVA, union Bank in California, discover, which is now pending. There's been a lot of consolidation over the past few years. The smaller deals will come back and we will rebound to two, 300 deals a year. But I don't think it's fair to say that the consolidation of the sector has really disappeared in recent times. I also think that the regulators, I know we'll talk about 'em a little more. I think they're more open to consolidate at least some of them or open to consolidation than they're given credit for. And I do think that the consolidation, we've seen a lot of the factors driving that consolidation has to do with the regulatory expectations of banks getting larger and that will not go away. And as banks grow, there will be hurdles they will not want to cross, and that will force consolidation. There are plenty of partners out there willing to take those institutions on as we sit here today. One, there's typical merger pain that people have to contemplate. Number two, there's a regulatory aspect of can you get a deal done, which I think you can, and I think we'll talk more about it. There's some regulatory hurdles that do need to be crossed, but I do think those factors will continue to drive m and a. As Vinny said, scale is important and those factors are what's driving it.
Larry (22:35):
Yeah, that's really interesting. Let's talk a little bit more though about the regulatory attitude to consolidation and certainly financial institutions and banks are not the only industry under scrutiny. We've seen deals challenged across the board, but it's certainly one of the industries that is under intense scrutiny and has the particular dimension of being related both to Fed oversight as well as normal political and antitrust kind of principles. So at times, Jason, it feels a little ambivalent in terms of the regulatory attitude. You just listed a number of the deals that are going forward or trying to go forward at the same time, you do see challenges to deals and you see statements of skepticism about further bank consolidation. And of course we all know this is going on not just in the macro environment. We discussed with the types of credit issues and commercial real estate we're all concerned about, but also with technological disruption for depository institutions. So give us a little bit more of insight. Insight from your perspective and from the perspective of some of our clients about how they're feeling about their dealings with the Fed as it pertains to potential deals.
Vinny (23:53):
Larry, this is a very good question. Regulatory uncertainty is not new. The reason is because there's a little bit of ambiguity people feel in the process, and generally if there's clarity and that becomes a big catalyst for m and a, if people feel like I know exactly how the process will play out, but however, there is a little bit of ambiguity and that certain players obviously are concerned about that or more at a pause because they feel they do not want to be exposed to that lack of clarity. However, there are others who believe that's part of the operating environment and we just need to take that into consideration as part of looking at m and a. That's really the one change that if you thought about from a year ago to now where you're seeing that number of players feeling that we need to be more open-minded to that lack of clarity to regulators from the regulatory environment and just maintain a more active dialogue.
(25:08):
And that just needs to be part of our considerations. That number is increasing as more people feel more comfortable and we sort of see more deals work itself way through the system. We feel that people, the comfort of players should increase on this topic. But that said that is Sealy one of the factors that you're hearing more and more from the different players, just a little bit less probably currently than we saw over the last one year or two years when that lack of clarity from regulators was even more of an issue in terms of m and a.
Jason (25:51):
Larry, just to add to that, I do think the Fed and the OCC are more open to m and A than people really think m and a has been a solution to many issues in the sector. There have been many banks that are not prepared to cross the a hundred billion dollar threshold, have regulatory issues, had consent orders that were used m and a as a solution m and a was clearly a solution to Silicon Valley and First Republic and others. I actually think the bigger risk today for the banking sector m and a is the DO OJ, which is amazing to me. I don't think of the banking sector as something that doesn't have enough competition in it, but that's in my mind really the more the risk and the OCC or the Fed.
Vito (26:33):
Larry and I watch what the DOJ and the FTC are doing very closely, especially with regards to implementing the new merger guidelines that were put out at the end of last year. And I know it's in a different space and I talked to a number of our clients about it, but the Kroger Albertsons deal in the supermarket space is a very good indicator. It's the first deal that's been challenged under the new merger guidelines. And what it highlighted was that there is a presumption of anti competitiveness when you go above certain levels of concentration. They also focused on any labor issues and competitive concerns, especially in terms of union labor and effects on it. And then the last piece is traditionally when you go into a situation like this, and I know a number of our bank clients have done the same thing, you go in with a remedy and you suggest that here's a package of branches or locations or like a business that I will divest and it should solve the issue.
(27:39):
And I think there's been a greater hesitation, especially on the part of the FTC and the DOJ as a result as well, to accept that remedies are going to be something that is going to make it work from a competition perspective. And they start off in a very skeptical position. And so Jason, you mentioned some of the transactions. It'll be interesting to watch because I know Capital One was at our conference last week and when they were talking about it, and clearly they're getting a lot of questions from investors, and a lot of it is around the regulatory approval process and they mentioned that both the Fed and the O CCC are going to be required for an approval process in that transaction, but then it's also the DOJ and the do OJ piece seemed to be the one that was more lingering on the table in terms of trying to figure out how those competitive dynamics between the two businesses in the card market are going to be characterized and as a result, what it means to the transaction.
(28:35):
So it's something we're going to be watching closely. So just to kind of wrap up our conversation in this segment, I think guys, certainly we're all on the same page in terms of expecting some continued growth in m and a activity. Jason, I'll acknowledge that there's been a good strong presence of m and a in the sector, and we're just expecting to have it continue to grow, especially as Vinnie mentioned, folks are looking to really grow scale. That is a very relevant factor, and you can't have this large number of banks as an example out there in the longer term. And we do expect consolidation and certainly expect to see that at a faster pace. And hopefully, Jason, you're right in terms of the Fed and OCC being open to mergers to assist in growing that scale and also making the sector overall more viable. So Larry, Vinny, Jason, great conversation. Look forward to the next episode in terms of catching up a bit of some of the themes we heard at our conference. So thank you for participating.
Larry (29:38):
Yeah, that was great, guys. Thank you so much. Thank you, John.
Vinny (29:41):
Thank you vi. Thank you, Larry.
Vito (29:48):
You have been listening to Strategic Alternatives, the RBC Capital Markets podcast. Join us for more analysis about what's moving the m and a markets in our next episode. If you'd like more information on the topics discussed today, please contact us directly or visit rbc cm.com/strategic alternatives. This podcast was recorded on March 13th, 2024. If you're enjoying Strategic Alternatives, don't miss an episode. Subscribe to us on Apple, Spotify, or wherever you listen to your podcasts, and please drop us a review and or a comment.
Speaker 5 (30:24):
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