Capabilities plays and restructuring for digital transformations

 
Overall competitiveness and positioning in B&CM spiked in 2021, with both defensive and offensive M&A tactics on the rise. According to Deloitte 2021 M&A Survey respondents, a top-priority B&CM defensive tactic for the year was acquiring capabilities, while top offensive tactics included capitalizing on disruptive opportunities and accelerating digital transformation.

Since the pandemic began, banks have led financial services and other industries in instances of restructuring. Survey results show that 72% of banks undertook restructuring initiatives since the pandemic began, and almost all of B&CM intends to at least consider it in the near term—which could be a trigger for subsequent M&A. Respondents’ primary reason for B&CM restructuring has not been cost-cutting; rather, it has been for digital transformation purposes.

In addition to addressing changing consumer preferences in how to conduct business, B&CM organizations are considering how digital transformation can support the M&A process itself. Pre- and post-close transaction planning and execution over the next year is projected to be substantially more virtual in B&CM, including integration.

 
Continued development of suitable merger partners at the regional level

One of the biggest headwinds in the banking M&A market at the regional level tends to be the dearth of suitable “in-market” merger partners to drive sufficient synergies to justify the purchase price premium. Over the past eight quarters, 13 banks with more than $10 billion in assets have been sold and removed from the candidate pool. But on the plus side, the corresponding period has seen an uptick in the number of total banks with more than $10 billion in assets. Continuation of this trend will drive future deal volume.

 
Stalled loan growth, soaring deposits complicate net interest margin improvements and mergers

 
Loan growth in the industry over the past eight quarters has been just 5.8%. Probing a bit deeper, consumer lending is up 2.4% during this period, real estate lending has grown 4.9%, and C&I lending is up only 1.2%. The primary source of loan growth in the banking industry during this period has been lending to non-depository financial institutions. When you layer on the fact that during that same period domestic deposits have grown more than 35%, it’s not surprising that cash holdings at banks have also risen more than 12%, held-to-maturity securities are up more than 82%, and available-for-sales securities are also up more than 39%.

The downward shift in net interest margins from 2019 to 2021 makes it challenging for banks to achieve the types of returns their stakeholders expect and what is included in planning documents to regulators. Margins at this level put pressure on management teams and boards and heighten the likelihood of leveraging an M&A partnership to improve the financial future of the enterprise. Franchises with a differentiated lending pipeline and product offering clearly have a valuation advantage in a market hungry for loan origination, especially with a glut of deposit dollars flooding the market.

More M&A around capabilities plays

Investment and wealth managers are on the hunt for acquisitions—especially smaller ones—to add digital technologies and/or help diversify their product and services portfolios. Target candidates typically sit at two ends of the spectrum: At one end, the illiquid alternative space is garnering significant attention, with real estate and private credit gaining steam. At the other end of the spectrum, indexing technology that enables product customization for investors is becoming an attractive purchase.

Strengthening digital engagement

IM/WM is a relationship-oriented business. Firms that can deliver on clients’ expectations for frictionless digital interactions will likely be more successful at growing and maintaining those relationships. Results from the Deloitte Center for Financial Services’ 2022 Global Outlook Survey show that 38% of respondents from digitally advanced firms expect significantly better revenue prospects in 2022 compared to just 13% for other, less digitally advanced firms, supporting the idea that digital interaction is part of the relationship.

The survey also shows that adding new technology capabilities is the top driver for respondents’ M&A transactions, followed by increasing scale and distribution channel expansion. These firms are looking to fuel growth through enhanced products and customer experience delivered to an expanded client (and prospect) base—a consistent trend from the previous year.

Tech and talent deals

The majority of 2022 fintech-related M&A likely will be driven by organizations’ growing technology and talent needs. Incumbent banks and IM/WM firms are on a quest for fintech products, people, and capabilities. Many B&CM organizations are struggling to attract the type of talent that can help them grow and keep pace with fintechs. They see M&A as the mechanism to quickly achieve key platform capabilities, customer acquisition, and talent goals.

Meanwhile, we expect fintechs to continue seeking funding sources to help them scale operations. They also are acquiring other fintechs to rapidly expand their capabilities and transition from niche players to end-to-end service providers, further disrupting incumbent financial institutions. Integration diligence and planning are critical to ensure that a newly acquired fintech’s products and people can be successfully integrated into the acquirer’s established environment and culture without destroying their value. Cultivating a deep understanding of a target’s business model, maturity level, and revenue drivers are key to enabling continued growth post-acquisition.

Growing crowd in the BNPL lending space

Payments, retail, and banking are converging in the buy now, pay later (BNPL) lending space, which provides point-of-sale financing products that allow consumers to split the purchase price at checkout, typically into four equal payments over a period of weeks or months. Major fintech BNPL lenders have seen rapid growth during the pandemic driven by the e-commerce boom and merchants’ desire to connect digitally with younger consumers, especially millennials and Generation Z, who are wary of taking on credit card debt.

Payments industry leaders are spending billions of dollars in M&A to include BNPL offerings among their growing global portfolios. Traditional banks are responding in force so they aren’t pushed out of the BNPL market by both payments companies and retail and technology giants. Installment loans are, by intent, meant for a single purchase, and banks are well equipped to turn this interaction into a long-term relationship by cross-selling products to consumers or capital to merchants. Community banks that lack the scale to run credit card businesses of their own see BNPL as a viable way to build a consumer lending product and acquire new customers.

Acceleration of decentralized finance and cryptocurrency

In conjunction with the accelerating digitization of the financial services ecosystem, numerous financial services institutions are migrating away from centralized institutions to self-executing blockchain contracts and digital assets, including bitcoin, stablecoins, and other cryptocurrencies. Fintechs are at the forefront of this surging market: Cryptocurrency/blockchain is the fastest-growing fintech sector for both early- and late-stage funding, as investors anticipate that technologies broadly enable a decentralized financial system. Banks, meanwhile, are exploring adding digital wallet-type capabilities to hold cryptocurrencies and non-fungible tokens (NFTs) for their clients. We expect to see more alliances/tie-ups between fintechs as cryptocurrency and decentralized finance capabilities evolve.

Line between fintechs and banks is blurring

A number of fintech companies have been finding ways to scale and diversify in order to compete with large legacy banks. Fintechs are acquiring banking products to sell to their clients; some are even acquiring entire banks. The line is further blurring as fintechs become regulated. Still, the costs, necessary skill sets, and regulatory complexities of obtaining a banking charter—whether by acquiring or merging with a legacy institution—can be considerable, so fintech leaders should first assess their long-term goals and select the preferred path to get there.