Banking and capital markets deals insights: Q1 2019

Banking and capital markets outlook

Two large deals rocked banking and capital markets during the first quarter of 2019—the $28.3 billion proposed merger between BB&T Corporation and SunTrust Banks, and the $3.6 billion combination of Chemical Financial Corporation and TCF Financial Corporation. The transactions signal a possible future direction for the industry, driven by these themes:

Innovation and digital capabilities: The largest US banks have leveraged their ability to fund and develop digital capabilities at scale and grown faster than their regional competitors. The big institutions can invest significantly more than their rivals in brand marketing, data analytics and digital products and services. Meanwhile, smaller firms that don’t or can’t, invest to achieve digital capabilities at scale are at a growing disadvantage. Banks involved in the two mega deals described above cited a strategic reason for the transactions—a desire to invest in innovation and digital capabilities.

The emergence of the Merger of Equals: High priced deals typically require clear synergy and aggressive growth targets to generate attractive returns. Our research has shown that more than half of banks fail to achieve their growth-adjusted, cost-synergy targets. However, recent deals referred to as “mergers of equals” (MOEs) have found a sweet spot in which both sides structure a deal with book value multiples and targets that may reward all stakeholders. Recent transactions are setting a new standard for attractive bank deals:

• At around 1.7x, the BBT/STI and CHCF/TCF mergers represent attractive prices for strong organizations. The deals appear reasonably priced compared with 2018, when the average P/TBV was 1.8x, with some transactions hitting as high as 3.2x. The pricing increases the odds the banks will generate the desired return on investment.
• The announcement of a bank transaction is usually coupled with significant cost saving and synergy expectations ranging from 10% to 45% of the acquired bank’s non-interest expense. Our experience with bank integration shows that synergy targets ranging from 20% to 30% tend to be conservatively achievable. Synergies exceeding 30% usually require rationalization of branch networks, products and operations that are far more ambitious and harder to attain. BB&T and SunTrust announced a target of 29% of SunTrust’s non-interest expense, while Chemical Financial Corporation and TCF aim for a goal of 18% of TCF’s non-interest expense.

Receptive market sentiment: Investors reacted positively to the MOE transactions in contrast to the negative share price impact that followed some other recently announced banking deals. In light of the market optimism, we expect to see a pick up in the pace of MOEs.

MOEs usually involve complementary firms. For example, a strong commercial bank may merge with a strong community bank franchise. Or the institutions may bring together distinctive product sets, or their adjacent business territories. Both firms in a transaction may boost top-line revenue if they can distribute their combined product portfolios across their combined geographies. Digital capabilities may serve as additional tools for achieving these synergies.

We expect the trend toward M&A in the community and regional banking sector to continue. Consolidation is a promising path for many banks in the sector, especially those that are beginning to invest in customer-focused digital transformation. The BB&T and Chemical Financial transactions suggest that fairly priced deals with reasonable synergy targets will usually always attract interest, especially when shareholders believe that the integration is achievable.

Payments deals may accelerate: In January 2019, Fiserv entered into a definitive merger agreement to acquire First Data in an all stock transaction valued at $22 billion. The combined firm will offer technology enabling a range of payments and financial services, including integrated payments, card issuer processing and network services and tools for account processing and digital banking. In March 2019, Fidelity National Information Services Inc, a global leader in financial services technology, and Worldpay, Inc., a global leader in eCommerce and payments, announced that they have entered into a definitive merger agreement for a cash and stock deal valued at approximately $35 billion. The transaction expands the capabilities of FIS by enhancing its acquiring and payment offerings. It also significantly increases Worldpay’s distribution footprint, accelerating its geographical expansion. The deal is one of the largest in the sector to date. We expect more consolidation as regulatory scrutiny and rising competition increase pressure on existing cost structures.