Larger Financial Institutions Lead M&A

MBA (5/16/2008 ) Palaparty, Vijay
In banking industry consolidation, total purchasing opportunities shrink while high value opportunities concentrate at larger institutions, a trend forecasted to continue through 2010 by Financial Insights, Framingham, Mass. Total purchasing opportunities compressed 31.6 percent in the last decade.
Institutions with assets greater than $10 billion have a 77.7 percent share of growth in total assets—rising from 63.2 percent in 1998. Institutions with assets between $1 billion and $10 billion have a 10.9 percent share of growth in total assets, a number that declined from 17.5 percent reported in 1998. Institutions with assets less than $1 billion have an 11.4 percent share of growth in total assets, also dropping from 19.3 percent in 1998.

“There has been a massive shift of industry assets to the larger institutions and that has a lot to do with earning capacity,” said Bill Bradway, president of Bradway Research, Boston, in a Financial Insights webcast. “Consolidation trends reshape the mix of institutions and you have to consider what the dynamics are of the institutions by size and market power they have. It is clear that smaller institutions are becoming marginalized, having fewer opportunities.”

Total institution count fell from 13,421 in 1998 to 9,182 in 2003. Both banks and thrift institutions can expect further declines. Financial Insights predicts that total bank institutions will shrink from 7,230 in 2007 to 6,928 in 2010. The steepest drops will be among Tier 4 institutions which have less than $100 million in assets. Thrift institutions can expect a decline to 1,030 institutions in 2010 from 1,145 last year. Decreases will be felt most in Tier 3—institutions with assets between $100 million and $1 billion—and Tier 4 institutions.

“From a profitability perspective, the larger institutions are most profitable while the small institutions are hard pressed to maintain profits,” Bradway said. "Return on assets for institutions with under $100 million in assets was negative 17.4 percent in the last 10 years. Institutions with over $10 billion had a 22.4 percent gain during the same period.

In terms of non-interest expenses, larger institutions with assets greater than $10 billion achieved operational efficiency faster, expanding NIE share to 77.1 percent last year. Other institutions below the $10 billion mark remained relatively flat, Bradway reported.

“You can begin to see the almost inevitable sense that larger institutions are really very effective,” Bradway said. “IT spending represented 12 percent of NIE in 2003 and expanded to 12.8 percent of NIE in 2007, which accounts for a larger share of spend.”

“When you look at M&A, it's not just about getting bigger,” Bradway said. “What we’ve seen at the high end of the market and also downscale is that the value of cost savings exceeds premiums and that successful institutions have a deep, proven management team to handle integration along with a strong balance sheet and significant capital generation.”

Bradway said CIOs, in M&A, would have to balance regulatory and compliance requirements that do not generate revenue but increase costs and also be responsive to M&A for cost take outs from consolidating IT and operations.

“Inflationary and expansion pressures drive up costs,” Bradway said. “Consolidation also forces a fresh look at the entire IT framework and options and green IT issues also factor in.”

For financial technology vendors, Bradway said they have to face fewer new business opportunities but help existing clients use IT to displace non-IT spending. He added that vendors would also have to balance cost structure versus revenues and “stay smart” on the buy side.

In terms of new technology opportunities such as software-as-a-service, Bradway said he does not expect to see many cases where it would be brought in to complete a transaction, but that it would be incorporated into operations on a case-by-case basis. With some financial institutions have legacy systems, however, he said they could pose obstacles that would have to be overcome.

“Expect consolidation waves to continue,” Bradway said. “But as larger transactions take place, they may have escalating operational risks. Also, successful financial institution M&A needs to have symmetry between business models, cultures and buyer’s acquisition strategy. Furthermor, institutions gain competitive advantage with a planning framework for IT applications and infrastructure that incorporates M&A.”