Good morning. Recently, Donald Trump put forth two rather alarming industrial policy proposals. First, to promote more investment in military equipment, he suggested banning dividends and stock buybacks, as well as capping executive compensation at $5 million for defense contractors until they build “new, modern production plants.” Then, addressing housing affordability, he claimed he would swiftly act to prevent large institutional investors from buying additional single-family homes.
Both of these ideas seem fundamentally flawed—and, interestingly, for similar reasons. You can’t stimulate investment or productivity in an industry by making it illegal for its investors to profit in certain ways. We also can’t increase housing supply, which is the only sustainable way to improve affordability, by blocking financial institutions from investing in housing. Essentially, both proposals could have the opposite effect of what’s intended. Let’s hope these suggestions are more of a desperate attempt at gaining popularity than an accurate reflection of the president’s understanding of the economy.
Another Bank Merger?
A few days ago, I discussed how consolidation might benefit the U.S. banking sector. In a field where economies of scale matter, and where fixed costs are significant, local banks might feel the pressure to “join or die.” U.S. banking regulators, chosen by President Trump, seem ready to expedite acquisitions. If done correctly, consolidation could finally alleviate the struggles faced by local bank investors.
But “done correctly” is the crucial caveat. The previous regional bank merger of BB&T and SunTrust didn’t pan out as planned, with stock prices stagnant since its announcement in early 2019.
This raises the question: What constitutes a successful integration? I’ve noted that some local bank leaders are hesitant to sell their banks, which is part of the problem. Yet, after chatting with some insiders, it appears this might only be half the story. Many bank executives get overly eager about acquisitions and often end up paying too much or choosing poorly. This reluctance to sell can lead to a dearth of viable targets, pushing hungry buyers into even worse deals.
Those heading acquiring banks might be tempted by the potential for higher pay, as running a larger bank generally offers better compensation. A graph from Barclays illustrates the correlation between the size of bank assets and CEO salaries.
This creates an added incentive to accumulate assets swiftly through acquisitions. However, the challenge arises: if the price paid for the target bank exceeds the acquirer’s value based on net assets or “book value,” you end up with a bigger bank, but the value per share diminishes. In technical jargon, that’s referred to as “visible book dilution.” The CEO might benefit, but investors often see losses.
Proponents argue that cutting excess costs will eventually lead to restored profits per share. Sometimes, that holds true. Yet, more often than not, it doesn’t work out as hoped. Holdco Asset Management, known for its activist approach, recently tried to persuade Comerica to sell to Fifth Third. Interestingly, in some situations, investors don’t push for mergers; they actually advise against them. Last year, for instance, Holdco urged the Colombian banking leadership to shun future acquisitions entirely and instead focus on using surplus capital for stock buybacks.
It’s not just about visible dilution that complicates these mergers. Holdco also raised issues related to deposit costs; if the cost of acquiring deposits is higher than what the buyer has, the deal may increase overall assets but reduce profitability.
After overcoming financial hurdles, the real work lies in merging cultures and tech systems, not to mention the layoffs involved. A year ago, Trust had 38,000 employees, which is significantly less than the combined 58,000 of BB&T and SunTrust at the end of 2018. Integration challenges, rather than financial structures, seem to be where Trust’s merger efforts have faltered. As bank analyst Ebrahim Poonawalla noted, these banks had notably different cultures, leading to talent departures and market share losses.
Ultimately, pondering the intricacies of bank mergers reveals just how complicated they are. Nonetheless, the economic rationale remains, and the regulatory environment appears favorable for at least a few more years. A graph from Bank of America suggests that bank mergers and acquisitions might pick up speed in 2025, with further acceleration projected for 2026.
As consolidation progresses, more mergers are on the horizon. Whether this will benefit both bankers and shareholders, however, remains uncertain.
A Book I Read Often
About the London fox.
