The financial technology boom of the past few years will ultimately lead to opportunities for the banks willing to take advantage of them—either through partnership or acquisition. In November, 145 bank senior executives and board members shared their views on the fintech boom. The poll was conducted at Bank Director’s annual Bank Executive & Board Compensation Conference in Chicago. Additional respondents participated online. We’ve tabulated the results, which we share along with insights from leaders in the fintech space.
It’s no secret that what has been happening in the fintech space is attracting more attention from the world of banking. It’s hard to ignore the fact that venture capital invested $10 billion in fintech startups in 2014, compared to just $3 billion in 2013, according to an Accenture analysis of CB Insights data.
But watching M&A in the fintech space shows that these startups are much more likely to pair with others or get acquired by incumbents than they are to go public with an initial public offering, as noted by bank analyst Tai DiMaio in a KBW podcast recently.
“Together, through partnerships, acquisitions or direct investments, you can really have a situation where both parties benefit [the fintech company and the established player],’’ he says.
That may lend credence to my initial suspicions that there are more opportunities in fintech for banks than threats to established players and that these startups really need to pair up to be successful.
Take BlackRock’s announcement in August that it will acquire FutureAdvisor, a leading digital wealth management platform with technology-enabled investment advice capabilities (a so-called “robo advisor.”) With some $4.7 trillion in assets under management, BlackRock offers investment management, risk management and advisory services to institutional and retail clients worldwide—so this deal certainly caught my attention.
According to FT Partners, the investment bank that served as exclusive advisor to BlackRock, the combination of FutureAdvisor’s tech-enabled advice capabilities with Blackrock’s investment and risk management solutions “empowers partners to meet the growing demand among consumers to engage with technology to gain insights on their investment portfolios.” This should be seen as a competitive move to traditional institutions, as demand for such information “is particularly strong among the mass-affluent, who account for ~30 percent of investable assets in the U.S.”
Likewise, I am constantly impressed with Capital One Financial Corp., an institution that has very publicly shared its goal of being more of a technology company than a bank. To leapfrog the competition, Capital One is quite upfront in their desire to to deliver new tech-based features faster then any other bank. As our industry changes, the chief financial officer, Rob Alexander, opines that the winners will be the ones that become technology-focused businesses—and not remain old school banking companies. This attitude explains why Capital One was the top performing bank in Bank Director’s Bank Performance Scorecard this year.
Case-in-point, Capital One acquired money management app Level Money earlier this year to help consumers keep track of their spendable cash and savings. Prior to that, it acquired San Francisco-based design firm Adaptive Path “to further improve its user experience with digital.” Over the past three years, the company has also added e-commerce platform AmeriCommerce, digital marketing agency PushPoint, spending tracker Bundle and mobile startup BankOns. Heck, just last summer, one of Google’s “Wildest Designers” left the tech giant to join the bank.
When they aren’t being bought by banks, some tech companies are combining forces instead. Envestnet, a Chicago-based provider of online investment tools, acquired a provider of personal finance tools to banks, Yodlee, in a cash-and-stock transaction that valued Yodlee at about $590 million. By combining wealth management products with personal financial management tools, you see how non-banks are taking steps to stay competitive and gain scale.
Against this backdrop, Prosper Marketplace’s tie up with BillGuard really struck me as compelling. As a leading online marketplace for consumer credit that connects borrowers with investors, Prosper’s acquisition of BillGuard marked the first time an alternative lender is merging with a personal financial management service provider. While the combination of strong lending and financial management services by a non-bank institution is rare, I suspect we will see more deals like this one struck between non-traditional financial players.
There is a pattern I’m seeing when it comes to M&A in the financial space. Banks may get bought for potential earnings and cost savings, in addition to their contributions to the scale of a business. Fintech companies also are bought for scale, but they are mostly bringing in new and innovative ways to meet customers’ needs, as well as top-notch technology platforms. They often offer a more simple and intuitive approach to customer problems. And that is why it’s important to keep an eye on M&A in the fintech space. There may be more opportunity there than threat.
Anyone paying close attention is seeing that the number of bank deals in the United States is increasing.
There was a 25 percent increase in bank deals in the U.S. in 2014, compared to 2013, and there is a good possibility that the number of deals in 2015 will exceed that of 2014.
While good news for the deal makers, investors and regulators are ratcheting up the pressure on buyers and sellers to get things right. But, if history has taught us anything in mergers and acquisitions (M&A), it is that they often are fickle undertakings, where many of them simply don’t work out as planned.
Costly and sometimes fatal mistakes are made in the planning, due diligence, and execution stages, just to name a few steps along the way. Those and other critical factors make it vital to issue a common reminder: Stick to the basics.
Fundamental Questions Can Help Form the Foundation The top question management should ask themselves before the start of a M&A transaction is, “does this deal fit our current business model, both culturally and strategically?”
There must be a recognition that people sometimes get so wrapped up in trying to get the best deal possible that they lose sight of whether the deal makes sense on its merits.
A message we often deliver is that there will be times that participants might not get the best deal from a price perspective, but when deep considerations are made about the other matters that are involved—long-term strategic objectives, the people you will acquire, the level of technological sophistication, the seller’s culture of connecting with customers—the deal could be a very good one.
In short, it sometimes comes down to having to pay a bit of a premium on the price in order to get the best deal, given the circumstances and strategic plan.
We often counsel board members and top management—whether the buyer or the seller—to ask this question: Does the deal put me in a better place tomorrow than I am today? Beyond that baseline question, there always are considerations about fundamentals: Does this make sense as it relates to the strategy that is already laid out?
Four other key questions include:
What are the quality of earnings? Just a few years ago, many prospective buyers looking at the balance sheet of the target actually didn’t believe the financials. Now, in more than a few cases, we are seeing the main issue being some skepticism about earnings. Although we see fewer concerns about the balance sheet, it remains a prime area for deep review. When the issue of quality of earnings is raised, it is prudent to investigate whether there has been a flurry of reserve releases. Have costs been squeezed down so much that, from an operational perspective, there are some key processes that are untenable for a long-term period? Has the bank gone too far out the rate curve in seeking yield on the bond portfolio so that when rates finally start going up, the bank is going to get whipsawed and take a bunch of mark-to-market hits on those bonds?
What is the current asset / liability management profile of the bank? It would be useful to discover whether the target bank has been focused too much on short-term products. Another question: After rates rise, will the customers who are happy to be in a transaction product today (because they are not making much on CDs or money markets) walk out the door if another bank has a better product?
Is the target bank up to date on their regulatory compliance efforts? Beyond the numbers, there should be ample evidence that the target’s regulatory profile is rock solid. Is there clear evidence that the bank has had professional assistance in determining any liability relating to anti-money-laundering or Bank Secrecy Act issues? If it has not engaged professional assistance, ask the bank board and senior management how it gained comfort that it has done the proper level of diligence regarding these critical challenges?
What are the data practices of the target bank? Where and how is data stored? What security protocols have been instituted and followed? How often are those protocols reviewed and updated? Does the board and top management believe the data it receives after it orders a report?
In a rapidly evolving M&A landscape, our message is simple: When the time comes to do a deal, rely on the basics.
Thirty years ago there were a record high 18,000+ banks in the United States. We’re now down to around 6,700 with all indications pointing to further consolidation. Meanwhile, new bank charters have dwindled to near non-existence with one new bank opened between the end of 2010 and 2013.
20 years ago
10 years ago
Total number of institutions
Total number of banks $1 – $50B in assets
Total number of banks $50B+ in assets
Total number of banks less than $500MM in assets
Between the number of industry disrupters trying to win a slice of the traditional banking business and the plethora of investment opportunities in other industries with less regulation, it’s easy to imagine the number of banks falling by a full 50 percent in the next 20 years.
For better or worse, banking has become a scale business. The costs of regulatory compliance, necessary investments in new technology, physical and digital channels, and thinning industry margins mean banks will either need to be of a certain size or have a defensible niche built on knowledge rather than transactions.
For the better part of the past decade, the folks at Cornerstone have touted the $1 billion asset threshold as a marker of scale. Because of our friends in Washington and the dizzying pace with which technology has changed our industry, I think the new threshold to reach in the next five to seven years is more in the $5 billion asset neighborhood. If my prediction bears out, the vast majority of M&A activity and consolidation will take place in the midsize bank space ($1 – $50 billion), either with smaller midsize banks buying community banks or banks at the upper end acquiring $5 and $8 billion banks.
I have always been a proponent of having a solid organic growth strategy, but midsize banks will need to develop AND execute upon a solid M&A strategy to survive. Most banks lamely describe their M&A strategy as “opportunistic,” which is code word for: “waiting for the investment banker to call with a proposed deal.” This simply won’t cut it in the fast-consolidating, commoditized industry we call banking today. Here are some key areas your M&A strategy should address.
Define Your Value Proposition. Define in financial AND human terms what makes you an attractive acquirer. The list of possibilities are endless: opportunities for stock value gains, opportunities for employee growth at a larger bank, track record of performance, a willingness to negotiate system choices, or a holding company type business model that allows the acquired bank to maintain its brand and management team.
Identify M&A Partners. Define filters to narrow down what targets make the list including qualities like geography, asset size, branch network, balance sheet mix, capital levels and niche businesses. Tools like the Federal Deposit Insurance Corp. website or SNL Financial can easily help you produce your target list. Stack rank your target list starting with the most attractive to the least by assigning weighted values to your filters.
Cultivate the Courtship. If you are the acquirer, you need an active outreach program that includes management, directors and shareholders, with the mix changing depending on the target. Your outreach program needs to involve a consistent manner of communicating your value to your targets. Get creative. Courtship could involve providing shared services for a common core platform, inviting select management and directors to your strategic planning session, or offering to outsource from your niche expertise like trust and wealth management platforms.
Define the Merger Value. Once you find a receptive bank, you will need to paint a clear picture of the value a merger will bring to shareholders and management of the target bank that goes beyond the pro forma financial model. The target bank will want to know about management team composition, board seats, branch closures, surviving systems and products, efficiency targets, headcount reductions, and branding, to name a few.
Conduct Due Diligence and Begin Negotiations. If you’ve made it this far, the M&A strategy and framework you have laid out is obviously working. Now, the formal process begins.
At the end of the day, midsize banks have two choices: rely on a decades-old organic growth strategy combined with opportunistic M&A, or get in the game and execute upon a carefully defined M&A strategy. The risk of being left behind as other midsize banks scale up is not one I would want to take with my bank.
Several headwinds, including compliance costs, cyber threats and regulatory burdens, have taken the fun out of the business for many banking executives and boards. In preparation for our upcoming Acquire or Be Acquired Conference in January 2016, we asked Steve Hovde, chairman and CEO of the Hovde Group, to share his insights on the future of bank M&A deals. In this short video, Hovde looks at how community banks who are struggling to generate organic growth can survive in a consolidating industry.
Most banks would like to grow but some have found it easier than others. Let’s look at a few perceptions and statistics about growth and a few opportunities to exploit it as well.
Many bankers feel that given the legislative and regulatory environment coupled with low rates, low margins, low loan demand and high competition, growth is very difficult. For those who experience this, they should consider selling. Far too many banks are seeing their franchise value diminish by not doing so. The good news is they can sell for a nice price and even receive stock from an acquirer improving their future growth and returns potential. Plenty of banks are able to do this. Bank stocks have outperformed the S&P 500 for the first six months of 2015 (8.56 percent vs. 1.09 percent), and should continue to do so based on their relative intrinsic values.
While the nation’s top five largest banks have over 80 percent of the industry’s assets, community banks, on average, have grown six times faster in terms of revenue growth. Assets of banks between $100 million and $1 billion have grown 27 percent from 1985 to 2013. Assets of banks larger than $10 billion have grown only 4 percent.
The banks showing the most growth have created that growth from three areas:
Organic loan origination
Mergers and acquisitions including branch acquisitions
Fee-related businesses such as:
Trust and wealth management
Insurance and other related offerings
Growing by acquisition is much easier for smaller banks than larger ones, which suffer from “too big to fail” scrutiny and acquisition limitations. Of the 301 deals done in 2014, only five had deal values in excess of $500 million. Most of the activity is in small banks. While the total number of financial institutions has shrunk from 15,158 in 1990 to 6,419 today, the number of banks between $100 million to $10 billion in assets has grown from 4,194 in 1995 to 4,400 at March 31, 2015: a growth rate of 5.9 percent, representing over 68 percent of the number of financial institutions.
The M&A activity will remain healthy for the next several years as those who do not have the ability to grow and cope with the pressures will have to sell.
The keys to good M&A transactions are having ready access to debt and capital, an ability to strike quickly and efficiently, and a reputation for execution. A good capital plan can deal with the first issue, having capital available in all forms: senior/junior debt, preferred stock, privately placed retail and institutional capital, as well as public offerings. Pricing and placing the capital varies among investors and investment banks and can be more inefficient than most would think. The biggest inefficiency is placing subordinated debt with origination costs varying 1 to 3 points and rate differences of 2 to 3 points, even among banks whose funding capabilities should be equal. The ability to make a purchase offer quickly is an internal issue and is based on structure, experience and fast decision making processes. Quite frankly, most bankers are not as good as they think they are, and unfortunately this affects the issue of buyer reputation.
An open, honest assessment of the banker’s capabilities can do wonders for improvement of an acquisition success rate. There are many investment banks and consultants ready to help if asked and most would charge little or nothing for the added opportunity to be the advisors on the next deal.
The leading non-interest income area of growth targeted by banks is trust/wealth management. Yet far too many banks enter trust/wealth management without a proper assessment of what is realistic for time frames, opportunities, profitability and competitive advantage in products. There are good products, bad products, low margin and high margin in both, as well as high and low levels of competition. Most think they have the expertise to deal with all the new products and opportunities, but few do. Entering into niche opportunities such as alternative assets, 401(k) programs, or asset allocation models, while showing the most promise, are fraught with roadblocks and disappointment if not executed correctly.
By optimizing capital levels, opportunity sets and product lines as well as pursuing M&A opportunities, a good, clean, well run bank with a green light from regulators can grow at a very rapid rate over the next few years, increasing franchise value for the community bank and its investors.