February 1, 2021
L.The past year has been difficult for companies across the country and in our region, and banks are no exception.
In 2020, the banks faced new challenges, such as B. Falling interest rates in response to the COVID-19 pandemic, steering the paycheck protection program, and working with community businesses to help them stay afloat in every possible way amid government shutdowns and restrictions. These challenges have led to innovation, but also opened up opportunities for partnerships, mergers or acquisitions between local banks. In 2021, we see three key dynamics that can impact bank M&A activity in Central PA.
Local banks rely primarily on the net interest margin (NIM), which is the difference between the interest rates on deposits and loans. With interest rates at record lows, NIM is compressed, making revenue growth difficult. Banks, like any other business, focus on operational leverage and create more value by growing revenue faster than spending.
Currently, the low margins caused by low interest rates make it difficult (but not impossible) to do this and generate a return for investors. At some point, a fundamental change in infrastructure will need to be made in order to continue to deliver investor returns. However, smaller companies can only go so far as to make cuts. Partnering with or selling to another company provides a larger pool of assets to distribute the fixed costs, creating a degree of scalability for better control of operational leverage.
In addition, by diversifying income streams, banks can create more value. Smaller banks typically don’t have multiple lines of business. They just take deposits and make loans. Diversifying with home loans, insurance, trusts, assets, or other services can provide a larger revenue base to spread these costs out and a greater opportunity to increase margins.
Fintech is here to stay. JPMorgan Chase’s Jamie Dimon famously said that in the banking industry we should be scared of fintech – it’s unregulated, it’s dynamic in the way these companies do business, and it quickly picks up on the most fundamental aspects of the credit world on. Companies like Facebook, Google, and Apple could cause big disruptions for small banks as they have millions of people in their ecosystems. If these companies break into the banking world, they will have the power and customer density to transform the local banking system profoundly.
At Univest we have been investing in our digital evolution for years. While this forward thinking has allowed us to stay relevant in the age of technology, many smaller banks have not been able to make these investments and do not have the financial resources to grow their digital banking capabilities. These institutions may be forced to become partners and turn to sophisticated companies to convert traditional brick and mortar stores to the digital world.
Navigating pandemic outages
While we continue to crack down on the pandemic, we are still unsure of its long-term effects. The government has stimulated the economy by buying government bonds, offering loans and forgiveness through the paycheck protection program, and sending out economic checks – all of which were necessary, but there will still be an impact. These lifelines have not been fast or substantial enough to keep everyone afloat and, as a consequence, some banks will suffer credit losses.
Smaller banks may not be able to absorb losses, especially if their hospitality, entertainment and restaurant loan portfolios are overexposed. This can lead to banking partnerships in which smaller banks enter into larger partnerships and at the same time incorporate the expected credit loss expectation into the sales price. Such non-premium deals allow peers to band together and achieve economies of scale to more effectively achieve their goals. At the national level, we saw this with the merger of BB&T and SunTrust into Truist. This is the type of business that could take place in Central PA as well.
Looking ahead, banks – and businesses in general – need to focus on how to effectively digitize their business and increase sales. There are several options for local banks to consider, but I believe that mergers and acquisitions will be an essential part of creating value and innovation as we deal with the aftermath of the pandemic.
Thomas J. Jordan IV, is Market President, Central PA, for Univest Bank and Trust Co.