Currency Rates Become Wildly Important

As we’re seeing with the COVID-19 crisis, very little in our economy is purely local.

Currency markets are one example. The markets are reflections of what is happening globally. They serve as the ultimate sentiment indicator, telling us what the future may bring for a country, region or the world at large.

But the sentiment can be costly — changes in currency rates can alter business costs in the blink of an eye. Still, many have no understanding of how currencies work, an opportunity ripe for your bank to offer some education.

While most would assume that the stock market is the biggest asset class on the trade block, it pales in comparison to currency trading volumes. Bloomberg reports that $6.6 trillion USD traded daily in 2019.

Since the 1920s, the U.S. dollar has enjoyed a long period of stability. This has allowed most business owners to go about their lives barely giving currency a fleeting thought, except perhaps when they’re traveling abroad or making a major international purchase.

But here’s another surprising undercurrent to this impression: Much of what we think of as domestic buying is an illusion.

Your business clients may buy a product from a local manufacturer, but where does that manufacturer buy its machinery? Where do they buy supplies to create their goods? Even local businesses tend to have international partners somewhere in their supply chains. Because of this, prices of the local goods are affected by currency rates.

Further, the world of currencies is surprisingly abstract. The U.S. dollar doesn’t have a single price. It has a unique price relative to the 200 or so other currencies in the world.

All of those prices fluctuate moment to moment because currency rates aren’t anchored by specific metrics. Instead, they reflect how buyers feel about the economic outlook of one country compared to another at any given time.

Buyers speculate about a country’s future inflation and interest rates, as well as intangibles like politics and socioeconomics. The pricing of currency is more art than science; more emotion than math. It’s enough to make heads spin.

The speculative nature of currency valuations makes them volatile. They are highly susceptible to world affairs; bad news can easily send them into an overnight tailspin. The global coronavirus crisis is the most recent example of this, sending currencies around the world reeling.

This is why your business clients can no longer be complacent. Outside the pandemic, previously stable countries have become unsettled by climate change. Once developing economies are maturing. It’s no longer the case that any particular currency is the safest bet. More and more, the name of the game is currency diversification.

But the good news is, your bank can help business clients protect themselves from currency fluctuations. The first step is to figure out how they’re at risk.

Advise business owners to figure out what percentage of their costs are in foreign currencies. If rates changed and suddenly those costs were 15% higher, could they absorb it? What about 20%? What is their back-up plan if they can no longer afford these suppliers?

Based on what they discover, your clients should consider diversifying their business costs through currency to help reduce the chances of over-exposure to any particular one.

Finally, advise your clients to increase their awareness of currencies. Suggest that they select a few that most affect their business and track them to see how their movements could affect their company’s well-being over time.

It’s true that uncertainty is always part of life, but preparation creates resilience.

Pending, Future Bank M&A Challenged by Coronavirus Crisis

The coronavirus pandemic has complicated bank M&A, throwing prospective buyers and sellers into limbo.

The crisis and economic fallout have made mergers and acquisitions an even-more tenuous proposition for banks that find themselves in the middle of a uniquely challenging operating environment. Industry experts believe that activity may come to a standstill for the time being but see opportunity for patient buyers once it thaws.

“I think it’s kind of high drama in every situation, if you put yourself on the board of either side of these transactions,” says Curtis Carpenter, principal and head of investment banking at Sheshunoff & Co. Investment Banking. “I’m really surprised that more deals have not fallen apart, quite frankly.”

Deals that have held together so far are most likely situations where both parties have been equally impacted by the economic shutdown and believe that the transaction’s merits will remain unchanged once the pandemic subsides, he says.

But the selloff in the equity markets has weighed on valuations for stock-based deals, making them untenable for some parties. Increasing credit risk, low interest rates, net interest margin compression and high unemployment are all headwinds for bank earnings, creating a potential ceiling on stock valuations. The average share price of an acquirer with an outstanding transaction has dropped about 20% in the last three months, says Crowe partner Rick Childs. If a transaction was all stock, the discount is fully included in the price; a split between cash and stock dilutes the selloff discount.

Half of the eight deals that have been terminated since the start of the year were impacted by the coronavirus crisis, Childs says. The largest of the terminated deals was the proposed $3.3 billion merger between the $36 billion Texas Capital Bancshares, based in Dallas, and Independent Bank Group, which is based in McKinney, Texas, and has $16 billion in assets. Several more have been postponed or renegotiated.

Buyers may try to argue that stock declines are temporary, though some are choosing to renegotiate. San Diego-based Southern California Bancorp, which has $852 million in assets, disclosed in April that it had renegotiated its October 2019 merger agreement with CalWest Bancorp. It lowered its all-cash offer by 19% for the Rancho Santa Margarita, California-based bank, to $25.9 million. The acquisition of the $226 million bank closed June 1.

But there is still risk for cash buyers and other parties committing to closing a deal. For years, credit had been so clean that buyers risked “giving lip service” to doing due diligence on a seller, Childs says. Now, acquirers must take pains to understand the potential risks they might be buying, especially as banks process deferrals and loan forgiveness applications for the Small Business Administration’s Paycheck Protection Program.

Deals may also take longer to close during the pandemic because regulators have limited capacity, though not in every case. Childs is involved in some delayed deals because regulators have shifted their attention away from applications to assisting banks with changing policies and emerging issues or questions. Banks that have announced delays are adding an average of two additional months, he says.

However, some banks have managed to receive timely, or early, approvals. CenterState Bank Corp., which has $19 billion in assets and is based in Winter Haven, Florida, disclosed that it had received all regulatory approvals ahead of schedule for its merger with South State Corp., which has $17 billion in assets and is based in Columbia, South Carolina.

While the environment may be challenging for pending deals, it could be productive for prospective ones. Childs says cash buyers may find management teams with an increased interest in selling because of crisis fatigue and the anticipation of a long road to economic recovery, which could lead to compelling valuations. Carpenter counters that sellers may not want to accept a cash deal because it would be a permanent discounted valuation. Accepting equity gives the seller’s shareholders a way to ride out the recovery and could make a lower initial valuation more palpable. Both Childs and Carpenter are working on deals that have yet to be announced.

Buyers that have stock may want to include struggling fintechs in their search for potential targets, Childs says. Fintechs may have superior technology or capabilities that could add a business line or increase a buyer’s capabilities, but face funding or capital challenges because of the economic crisis.

“Either taking a significant ownership stake or buying it outright might be a heck of a deal for you, and your stock is probably going to be better than their stock,” he says.

In the meantime, Childs advises banks to trim the fat from their financial statements. If a bank has been on the fence about assets, business lines or portfolios it owns, now is an opportunistic time to sell them and raise cash. It is also a good time for cash buyers to establish credit lines or loan arrangements they may use to finance a deal, but cautioned stock buyers against raising equity capital until prices recover.

“I think we’ll have a few more deals called off between now and their expected closing dates, but probably what we’ll see is very few announced deals unless we come back in a big way,” Childs says. “We may end up having a great fourth quarter because of pent-up demand, but there will probably be a dip in the middle part of the year.”