M&A is Back on the Menu
The Covid-19 pandemic put bank mergers and acquisitions on the back burner in 2020, but the market is starting to heat up again.
There were 132 deals through August 31, compared to just 103 deals in all of 2020, according to S&P Global Market Intelligence. S&P forecasts that we could see up to 229 deals this year — with 70 in the fourth quarter alone. This would compare favorably with the 2018-2019 time frame, when there were 244 deals each year.
Why the resurgence in acquisitions in 2021?
Extreme economic volatility and deep apprehension about asset quality kept many buyers out of the market last year. A nationwide lockdown to battle the pandemic led to a record 31.4% decline in the country’s GDP in the second quarter of 2020, followed by a record 33.4% increase the following quarter. Bankers were uncertain about the quality of their own loan portfolios, let alone the portfolios of a potential merger partner. And while the feared loan loss tsunami never materialized, it was hardly an environment in which most banks were willing to take on the risk of an acquisition.
The situation this year is completely different. While the delta variant has led to a spike in Covid cases nationwide, the economy has stabilized and asset quality trends are largely benign. There are other factors driving the renewed interest in acquisitions, as well. The industry’s net interest margin dropped to 2.50% in the second quarter of 2021, a reflection of both the Federal Reserve’s monetary policy and an extremely competitive commercial loan market. This compares to a recent high of 3.48% in the fourth quarter of 2018. In fact, the second quarter industry-wide margin reflected a record low for the industry, according to the Federal Deposit Insurance Corp.
Banks are also concerned about a possible hike in the corporate tax rate and the capital gains tax as the Biden Administration looks for ways to pay for its ambitious spending plans. That probably explains the expected surge in M&A activity in the fourth quarter, as banks rush to complete their next deal before tax rates possibly change in 2022.
I’m confident that M&A is being discussed in many bank boardrooms across the country because it may be the most viable growth strategy available to them in today’s tough operating environment. Banks that have an aging CEO and no successor in place may also decide to throw in the towel if they’re struggling to grow organically.
Acquisitions are not without risks even during a healthy economy. Deal pricing is one of the many issues that boards contemplating an acquisition will have to carefully consider. Overpaying for an acquisition is one of the biggest reasons why many deals never achieve their desired profitability goals. The board should also make a sober decision about whether their institution and the target bank are a good cultural fit. Are their business philosophies and operating styles compatible enough to effectively mesh? Remember, you’re going to need the acquired bank’s employees to buy into your way of doing things. And can you work out the details on a variety of social issues, including executive leadership and board seats for the combined institution? Deals have fallen apart when two entities can’t come to terms over these details.
There were 4,951 U.S. banks at the end of the second quarter of 2021 — down from 15,158 in 1990, according to the FDIC. The great majority of that attrition occurred through mergers and acquisitions, and it looks as though we’re getting ready for another round of consolidation.
Things are heating up in the M&A kitchen.