Tax reform has the potential to spur more bank consolidation in 2018.
Financial institutions have already outlined several ways — higher minimum wages, staff bonuses and charitable contributions — to pass along the windfall that should come from a lower corporate tax rate.
M&A is another way banks could reinvest in their businesses, industry observers said. The topic is certain to come up as banks begin reporting fourth-quarter results.
“I think it should hasten consolidation,” said Steven Dunlevie, a lawyer at Womble Bond Dickinson. “It frees up capital to spend. This year should be a robust year, maybe even stronger than 2017.”
Roughly 250 bank acquisitions were announced last year, representing a slight increase from 2016, based on data from Keefe, Bruyette & Woods and S&P Global Market Intelligence.
Activity is “higher than it has ever been,” said Bob Wray, a managing director at The Capital Corp., an investment bank. He estimated that interest is up as much as 25% from a year earlier.
Still, it could take some time before tax reform translates to increased deal activity.
Some initial optimism for acquisitions could be tempered by a short-term hit many banks will take to earnings and tangible book value, largely due to impairment charges for deferred-tax assets affected by the new law.
Bankers may also choose to be cautious until they fully vet what impact, if any, tax reform will have on certain transactions, Wray said.
Valuations for banks that rely on mortgages or lending to highly leveraged firms could be lowered due to the law’s impact on borrowers, including deduction changes that could make owning a home less appealing.
It is also unclear how tax reform will influence potential sellers.
The promise of higher earnings could convince some executives and boards to stay independent to see if areas such as interest rates show more improvement.
On the other hand, rising stocks could persuade some targets to sell while the industry is on a high, industry observers said. Many of the underlying problems that drive banks to consider selling — lack of succession, technological demands and regulatory pressure — remain.
“If I’m a seller, I wouldn’t want to go through another downturn,” said Lynn Fuller, chairman and CEO of Heartland Financial, a serial acquirer in Dubuque, Iowa. The company has bought a dozen banks since mid-2012 with two more deals pending.
The tax changes will be “additive” to getting deals done due to high stock prices and stronger premiums, Fuller said. California is an area where Heartland is scouting for deals as it aims to have at least $1 billion in assets in each state where it does business, he said.
Heartland, which takes pride in its conservative approach to evaluating targets, will likely factor in a tax rate higher than 21% in case political winds change, Fuller said.
There are a number of intangibles that will likely spur consolidation over the long term.
Investor optimism will likely continue as banks explain the overall benefit of lower tax rates, which in turn will provide acquirers with a stronger currency for deals, industry observers said. Lower taxes should also boost earnings, giving buyers more capital for acquisitions.
The law could encourage large banks to consider foreign acquisitions, said James Wickett, a partner at Hogan Lovells and an expert on tax policy. The law moves the U.S. to the territorial tax system, where corporations only pay taxes on income earned within a country’s borders.
“Overall, we should see a consistent level of transactions,” said Matthew Veneri, who co-leads the investment banking team at FIG Partners. “Pricing multiples will increase.”
Banks are more apt to pursue acquisitions “when they feel good about themselves,” said H. Rodgin Cohen, senior chairman at Sullivan & Cromwell. A bank’s stock price is usually a gauge of that sentiment.
“If you have substantially more earnings and just maintain your [price-to-earnings] multiple, you’ll have a higher stock price,” Cohen said. “You’ll feel good about yourself. Then you tend to do more deals.”