MA Activity Remains High in Banking Industry

Jan 21, 2015

In a recent survey conducted in partnership by the Federal Reserve and the Conference of State Bank Supervisors (CSBS), over 1,000 community bankers weighed in on a range of hot button issues facing their organizations in 2014.

Among the topics in discussion was the continued upward trend in merger and acquisition (M&A) activity and further consolidation of the bank market as a whole. The below graph depicts the current and future landscape among community banks, and the continued propensity to buy and to be bought (blue indicates “yes” response, and teal “no”):

 

 

One in five banks made an offer to buy another institution in the past 12 months, and one in five expect to make an offer in the next 12 months. Taken loosely, one can assume that somewhere in the ballpark of 20% to 40% of institutions are actively looking to acquire or considering the possibility of being acquired by another institution.

This should come as no surprise. In recent years, the economic downturn coupled with a slew of fresh regulation has left in its wake a market primed for well-positioned institutions to acquire their lesser capitalized and struggling counterparts. This M&A activity, however, is by no means a recent trend. While the current decade has been full of factors contributing to market consolidation, on a larger scale the past ten years appear to be a simple continuation of a longer-term market shift.

Since the mid-1980’s, the advent of advanced technology in banking and the worldwide web have made financial institutions more agile, increased their reach, and drastically improved their overall efficiency. With that, however, the cost to operate a successful branch has been rising substantially amidst progressively slimming margins and an increasingly competitive landscape. All of these factors make acquisition a desirable option for institutions with deep pockets and sights set on expansion. The below graph from the Federal Reserve is a testament to this trend:

 

 

In a mere three decades, we have seen the number of commercial banking organizations plunge 60.47 percent, from 14,400 institutions in 1985 to a meager 5,693 as of Q2 2014.

Looking onward, it does not appear that this activity will subside; on the contrary, impending regulatory changes may well yield an even steeper curve of M&A activity. One example is the impending transition to an expected loss model as proposed by FASB.

While many institutions are likely aware of the CECL model’s implications on their ALLL calculation and data requirements, a less discussed repercussion is the effect it will have on capital planning. This one-time adjustment to transition ALLL levels from incurred to expected loss levels will be a capital adjustment, NOT a provision expense. Those that fail to plan for this adjustment may well run into capital adequacy issues and become yet another basis point in the wave of M&A activity.

While market consolidation is a likely byproduct of the banking industry’s natural evolution, CECL, Basel III and other regulatory changes serve as catalysts to the continued wave of mergers and acquisitions. Although community bankers are making a consolidated effort to have the Senate reduce the regulatory burden placed on banks, it appears that their pleas will not result in any drastic reduction of legislation. As such, capital and strategic planning will play a pivotal role in staying ahead of the curve.

If your institution is considering an acquisition, or if you are taking advantage of purchasing portfolios from other institutions, you may be interested in our whitepaper, “Accounting for Purchased Loans – Easier Said Than Done.”