Interesting piece by Meredith Whitney in American Banker today on bank stocks, basically saying that in the current weak revenue environment, large banks (which are precluded from M&A) must improve returns by getting smaller, while smaller banks must improve returns by getting bigger. I agree more or less, but there’s an additional layer of complexity. Let’s break the problem into industry issues, and then look at M&A specifically.
The industry issue is not weak revenue or even low net income – in fact, both are at or near record levels. Rather, the core issues are: (1) ROA and ROE remain well below par, (2) top-line revenue growth has been lacking, and (3) huge fixed branch costs are no longer sustainable.
The first is largely about low interest rates and high capital usage; the second about lack of loan demand and one-time regulatory “hits” to fees; the third about technology and customer behavior catching up to free checking.
These industry issues require banks – both large and small – to:
(1) out-compete for superior loan growth or fee revenue,
(2) dramatically restructure their branch costs while investing in e-channels, and
(3) reduce their excess capital.
Now let’s translate these issues to large and small banks, and then add M&A. Large banks can do all three: win lending, restructure branch cost, and reduce capital. In fact, without M&A the large banks must live or die on how well they can out-compete – some will thrive, others will suffer. The mid-sized banks that thrive will create shareholder value by turning to M&A. However, for many smaller banks, the hunt for loans and branch cost reduction may prove too difficult, and as a result the exodus of the smallest banks will likely continue.
I’ll be publishing more on the different challenges of large and small banks this quarter, and I look forward to discussing this on our free webinar Thursday at 2pm ET on trends and issues for 2013. You can pre-register online here.