More than in almost any other industry, banks depend on the value of their shares as currency for mergers and acquisitions. Recently, the combined market value of the nation's 100 largest banks has neared $450 billion.
James J. McDermott Jr., president of Keefe, Bruyette & Woods Inc., the New York investment banking firm that specializes in banking securities, recently assessed how banks, armed with this market capital, may expand.
The biggest banks have enjoyed huge gains in market capitalization, to almost $450 billion from only $100 billion at their low point just five years ago. In the first quarter alone, they added $40 billion. Where is this taking them?
McDERMOTT: The huge growth in the banks' market cap suggests to me that the big guys in the industry are eventually going to move outside the traditional banking area and look at other kinds of companies - investment banking, consumer finance, computer software or hardware, even somebody like American Express.
Why this direction?
McDERMOTT: As they evolve, I think the biggest banks are finally going to reach the saturation point on brick and mortar and the saturation point geographically as banks. They are going to have to develop alternative expansion plans and alternative delivery systems.
You're not saying there won't be many acquisitions of other banks?
McDERMOTT: Oh, no. There's still plenty of that to come, too. In fact, I think we will see a pickup in bank deals later in the year.
Why haven't we seen that many deals so far this year?
McDERMOTT: There's an eerie quiet right now. Basically, the deals that wanted to be done were done last year. The active buyers and sellers all met in 1995. After the record $70 billion-plus deal volume of last year, we are now naturally in a digestion phase for these companies.
Also, expectations were lifted for sellers by some of the prices paid last year.
There are deals that aren't getting done because of these expectations. In fact, there is a growing list of them. In some cases, companies have invited bids and not gotten the price they hoped for and pulled back. The longer that list gets, the closer we are to another round of deals.
What might cause expectations to change later in the year?
McDERMOTT: A couple of things. Some banks may hit that famous revenue wall we've talked about, and hit it pretty hard. Earnings growth prospects may not look so good, and that forces adjustment of expectations. Also, the cost of technology investment is high. That could affect strategic thinking.
Longer term, changes in the marketplace will have an impact, especially in markets where recent deals have been done. As some of these companies realize their competitive position has been reduced, they will come around more willingly to the idea of selling. But this is a process that takes time, of course, and may not show up on the radar today or tomorrow.
Finally, those buyers who have been active will at some point be getting far enough along in integrating acquisitions to start looking again. Assuming things have gone well, they will have the confidence to go looking on their own terms.
Bank mergers and acquisitions also tend to be a concentrated in the second half of the year, don't they?
McDERMOTT: Yes. I don't know why, but the deals do seem to start percolating in the summer. It was true both last summer and in the mid 1980s.
What about the big players who didn't do deals last year?
McDERMOTT: Some were on the sidelines to concentrate on taking care of business internally or because they didn't have the required (stock) valuations. Banc One Corp., a high-flier of the 1980s, is an example.
Others have been rethinking their strategy with regard to mergers and acquisitions. BankAmerica, with its new management, is doing this. KeyCorp, once a very active dealmaker for other banks, is another case. They seem to have turned their own sights on nonbank acquisitions.
What does all of this mean for bank stock investors? Deals and the prospect of deals have been big drivers of these stocks.
McDERMOTT: I think these developments are actually good news for investors. They are going to be able to pick among companies with a host of different strategies. After all the talk around Wall Street for years about the banks moving away from being a homogenous lookalike industry and toward being more heterogenous, different from each other, we're finally beginning to see this happening in a meaningful way.
Did you imagine five years ago the scenario of banks having this much market capital to work, when the banks and their stocks were at low tide?
In 1990, there were a lot of savvy players who thought the banking industry was going out of business. Their recovery has been spectacular, beyond my imagination.
