A Look Ahead at M & A in the Banking Sector During 2016

Merger and Acquisition (M&A) activity has traditionally been a large part of banking. Most experienced bankers are familiar with the anxiety of being acquired or the challenges encountered when bringing a new institution into the fold. As in any industry, M&A activity ebbs and flows based on numerous factors, but remained strong during the early to mid-2000s.

This changed significantly during the financial crisis beginning in 2007, leading to the onset of bank closures that began in the latter portion of 2008. As many banks failed and uncertainty lingered in the economy, M&A activity slowed dramatically. However, over the last few years M&A activity has steadily increased and according to Mark Olson, a former FED Board Governor, is poised to have a banner year in 2016. There are several factors driving this increased activity. Two reasons for increased M&A activity are fewer FDIC assisted transactions due to earnings stability and heightened regulatory burden increasing the need for economies of scale.

As the overall economy has improved, so has bank profitability. This has translated into a healthier banking system, which naturally leads to fewer bank failures. During 2009 and 2010, the peak of the financial crisis, there were actually more FDIC assisted acquisitions (302), than M&A transactions (292) within the two year period. Thankfully, the ratio of FDIC assisted transaction to M&A activity reversed course in 2011 and has remained on a positive trend ever since.

In addition to the better overall economy, helping to spur M&A activity is the first Fed funds rate increase in nearly 10 years. Generally, rising interest rates have a positive impact on a bank’s overall net interest margins and creates an environment for increased earning power for financial institutions. Since the banking sector is stronger than it has been in many years, there are perceived opportunities for healthy institutions to grow, and M&A is always the fastest way to do so.

Just as important as economic factors, regulatory factors and expenses are a very serious concern for financial institutions of all sizes. However, it appears that these costs impact smaller institutions more severely than larger institutions. A Congressional Research Study in 2012 found that regulatory costs to banks less than $1B in assets were more than double, as a percentage of assets, when compared to peers greater than $1B in assets. The need for economies of scale to handle the dramatic increase in regulatory expenses is one of the reasons we continue to see smaller institutions looking to be acquired, or sell to a larger organization. Including, but not limited to, the factors of regulation and the economy, creates an environment ripe for further industry consolidation.

Looking back, M&A activity over the last 7 years has primarily impacted banks less than $500MM in assets, representing 81% of total acquisition targets. This is not surprising due to the overwhelming number of smaller institutions as a percentage of total financial institutions.

However, looking ahead to 2016 and agreements already in place, this same breakdown looks moderately different:

What we can take away from this snap shot of data is that there has been a shift towards larger institutions being acquired in 2016, especially those in the $500MM -$1B asset range.  This analysis showsthat it is possible regulatory burden is having a larger impact on institutions in this assets range as well. This is requiring them to seek out the greater economies of scale afforded to becoming part of a larger institution.

Predicting M&A activity is not an exact science, but considering the factors above, it is plausible to see why Mark Olson is predicting 400+ mergers in 2016. But, while it seems the industry is ready for more consolidations, it may not happen as fast as many industry experts are predicting. In Deloitte’s 2015 M&A Outlook for the Banking sector last year, they also predicted a banner year for bank mergers. Instead there was a fairly significant slowdown, with only 158 acquisitions, down from 286 in 2014. The banking industry is notoriously slow moving. Merging two institutions into one organization is a significant undertaking rife with risk, something the industry is naturally averse to.

In my opinion, with 115 agreements in place as of the end of 2015, there will be an increase in M&A activity in 2016. However, a more reasonable expectation in the neighborhood of 200 acquisitions and mergers is what I expect. It will be interesting to see as the year goes on  if the consolidation of larger institutions continues to accelerate or if this is just a bump in the road and we see more normalized numbers. Regardless, the nature of banking seems to be returning to more M&A activity, one more sign that the banking industry is back to business as usual.