Redefine a bank's worth for the digital age
Digital banking is reshaping relationships between banks and customers, and at some point it is going to reshape bank acquisitions too.
After all, deals are about customer relationships.
"If technology is impacting the way customers and potential customers seek to interact with their bank, then you as the acquirer have to start taking that into consideration," said Brian Sterling, a principal and co-head of investment banking at Sandler O'Neill.
Today, when banks acquire, the slide deck that shows off the highlights of the deal often has a map of the branches of the two banks. The closer the dots are to each other, the more opportunity there is to strip out costs. The farther they are from each other, the more opportunity for mining a new market.
Though the emphasis on branches is likely to continue in M&A for the immediate future, this is poised to change.
"The question in my mind is when, and how do we get there, and how does that express itself," Sterling said.
Customers are increasingly relying on online and mobile channels to interact with their banks - a factor that does not get much play in deal pricing or even rate a bullet point on the list of deal highlights.
But industry insiders envision a future deal metric that takes into account increasingly precious customer data.
Many bankers say that the true value for banks going forward will be in the data. They are building loyalty digitally through additional services, rather than treating mobile banking as just another delivery channel for the same products available at the branch and online. Essentially, they want their customers to love their mobile app, not just see it as a utility.
So, as digital banking evolves, the way banks and their advisers view franchise value is likely to change. Banks will be valued less on their branch networks and more on their ability to generate revenue through online and mobile banking.
Banks are spending more to acquire data in order to identify new customers, said Jefferson Harralson, an analyst at Keefe, Bruyette & Woods, in a November research note.
"As customer acquisition via data grows, the value of branch networks and the concept of franchise value changes - as acquirers begin to care more about customer lists than branch footprints," Harralson wrote.
Of course, the ones that excel at getting new customers via data may not need to do acquisitions at all, but investment bankers say that scenario is not fundamentally different than with, say, a bank that has the highest market share in its county. It is not typically a buyer because it is already effective at getting customers and the people that it doesn't bank likely have a reason for not being customers.
Several deal advisers say this issue is something the industry is going to have to address eventually.
"We are early in the curve, but customers' behaviors are changing and banks are increasingly dependent on their ability to differentiate themselves to attract and retain customers through channels that are not branch-based," Sterling said. "As that continues, the industry is going to have to look for ways to value that form of franchise creation."
For now, digital banking is not a real consideration as bankers and their advisers size up targets. They cite several reasons for this.
First, branches still matter enough that many consider digital banking to be a secondary channel, not the primary one.
"Everyone realizes that, at some point, digital banking is the future and that they'll need to downsize unprofitable branches, but I still think there is a major need for them," said Stephen Klein, an attorney at Miller Nash Graham & Dunn.
Also, acquirers tend to be larger and typically have better technology than their targets. So the thinking is that they'll just fold the acquired institution into their shiny rocket of a platform. KeyCorp and First Interstate BancSystem are among those that have talked up their ability to better leverage acquisitions via new banking platforms.
Others say there is a worry about banking becoming a commodity via digital channels. Valuing a commodity is, frankly, not very sexy.
Chris Donat, an analyst at Sandler O'Neill, said that the lack of value attributed to digital banking is vexing. For instance, he covers Ally Financial, which has a digital bank that managed to add $11.7 billion in deposits over the last year.
"They are pretty effective in growing deposits with a branchless model, but I don't think the market gives them much credit for it," Donat said. "They have a complicated story, but it is impressive and is not something that can be built in a day."
Digital banks use their lower overhead to pay up for deposits, which bolsters the perception that they have fickle customers hunting for yield.
But Donat said this discounting of digital banking is bound to change. He points to Capital One, which has an extensive branch network but is investing heavily in bolstering its digital banking capabilities. Among other things, it has bought a digital design firm, along with an online price adjuster.
"I don't think they would be investing there if they didn't think that was where the future was headed," Donat said.
One of the struggles will be in figuring out what digital banking is worth. In the physical world, banks can lean on things like deposits per branch or market share in various metropolitan statistical areas. Such measures may seem irrelevant when one of the benefits of digital banking is not having to go to a branch. Notably, Citigroup reported in January last year that its investments in digital channels have helped it retain more than half of its deposit customers in markets it exited, like Philadelphia and Dallas.
Klein argues that commerce trends will help drive a shift in value. As spending becomes more digital, so will banking.
"It all really comes down to how commerce will be conducted," Klein said.