Last year was a difficult one for businesses across the country and our region, and banks are no exception.
In 2020 banks took on new challenges, such as declining interest rates, in response to the COVID-19 pandemic, navigating the Paycheck Protection Program and working with community businesses to help them stay afloat in any way possible during government shutdowns and restrictions. These challenges have led to innovation, but also exposed opportunities for partnerships, mergers or acquisitions among local banks. In 2021, we see three key dynamics that may impact M&A activity for banks in Central PA.
Local banks rely primarily on net interest margin (NIM), which is the difference between rates on deposits and loans. With interest rates at record lows, NIM is compressed, making revenue growth difficult. Banks, like any other businesses, focus on operating leverage, creating more value by driving revenue at a greater pace than expenses increase.
Right now, the thin margins caused by low interest rates make it difficult (but not impossible) to do this and create a return for investors. At a certain point, a fundamental change to infrastructure must occur to continue creating investor returns, but smaller entities can only go so far in making cuts. Partnering with or selling to another entity brings a larger pool of assets to spread fixed costs across, creating some scale to better manage operating leverage.
Additionally, banks can create more value by diversifying income streams. Smaller banks don’t typically have multiple lines of business; they simply take deposits and issue loans. Diversifying with home loans, insurance, trust, wealth or other services can provide a bigger revenue base to spread those costs over, offering a greater opportunity to increase margins.
Fintech is here to stay. Jamie Dimon of JPMorgan Chase has famously said that we in the banking industry should be scared of fintech — it’s not regulated, it’s dynamic in the way these companies approach business and it’s quickly encroaching on the most basic aspects of the lending world. Companies like Facebook, Google and Apple could be huge disruptors for small banks because they have millions of people in their ecosystems. If these companies penetrate the banking world, they have the power and client density to fundamentally change local banking.
At Univest, we’ve 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 don’t have the necessary financial resources to ramp up their digital banking capabilities. Those institutions may be forced to partner, looking to sophisticated companies to convert traditional brick-and-mortar operations to the digital world.
Navigation of pandemic fallout
While we continue to navigate the pandemic, we’re still unsure of the long-term impacts. The government has stimulated the economy by buying Treasury bonds, offering loans and forgiveness through the Paycheck Protection Program and sending out stimulus checks — which was all necessary, but there will still be fallout. These lifelines weren’t quick or substantial enough to keep everyone afloat, and one consequence is that some banks will experience loan losses.
Smaller banks may be unable to absorb losses, especially if their loan portfolios are overexposed to the hospitality, entertainment and restaurant industries. This may encourage bank partnerships, where smaller banks tuck into larger ones while factoring the projected loan loss expectation into the sale price. Such non-premium deals allow peers to merge and create scale to more effectively achieve their goals. On a national level, we’ve seen this with the merger of BB&T and SunTrust to form Truist. It is the type of deal that could also happen in Central PA.
When looking toward the future, banks — and companies, in general — need to focus on how to effectively digitize business and grow revenue. For local banks, there are various avenues to consider, but I believe M&A will be a major factor in creating value and innovation against the backdrop of navigating fallout from the pandemic.
Thomas J. Jordan IV, is market president, Central PA, for Univest Bank and Trust Co.