Lexant Advisors anticipates that the pandemic, and the US government’s response to focus on injecting liquidity without a clear fiscal policy to support solvency, will lead to a wave of bank consolidations and creates an environment to drive M&A activity between banks and fintech companies.
Since the onset of the Covid pandemic, US government has injected more than $4 trillion into the economy via the CARES Act and the Fed’s bond purchase program. Through these programs, the stock market has recovered from the trough in March 2020 though unemployment remains high and economic growth remains anemic. Why?
The Fed’s near eternal zero interest rate policy has alleviated the debt service burden of big corporations. Its bond purchase program has improved the corporations’ free cash flow (FCF) thus enhancing stock valuation and resulting in the rapid recovery of the equity market.
However, these actions failed to benefit the small businesses (aka Main Street). Just $1.4 billion of Main Street loans had been issued as of September 10, 2020 with an additional $300mm or so being processed according to the Boston Fed. In contrast, blue chip companies have sold more than $1.2 trillion of corporate debt since March. Yet midsize and smaller companies employ about 48mm people and account for about a third of the GDP. A credit crunch for such companies could cause many to limp along or fail, undermining a post pandemic recovery. Year to date bankruptcy filings have already increased by more than 30%.
The PPP program, meanwhile, has provided the much-needed cash (liquidity) to individual households. Purpose of the payroll, of course, is to help citizens to maintain their livelihoods and pay for their daily necessities, such as rent, medicine, education and food. As layoffs continue, PPP becomes the only lifeline for the common citizens while household savings are being depleted.
Businesses need to be solvent in order to generate revenue and create new capital. New capital is now necessary to revive the economy. Monetary policy to inject liquidity unfortunately does not in itself create new jobs. The economy needs new jobs that will replace the old ones that have been eliminated and the government has not yet presented a fiscal policy that will facilitate this essential infrastructure development.
This dismal economic picture posts a serious challenge to the regional and community banks since they rely on small business and personal banking to thrive. Though most of the smaller banks have posted a profit as of third quarter end, 2020, clouds are gathering on the horizon. Revenue growth is decelerating due to weak loan demand and thinning of interest margin, loan loss reserve is up and capital is underutilized (though one could also argue that banks are well capitalized) and consequently, most of the bank stocks are trading below book.
At this critical juncture, Lexant Advisors foresee a wave of bank consolidations and potential integrations through M&A of banks and fintech companies.
Consolidation will help the banks to address these critical issues while merger with or acquisition by fintech companies will help the traditional brick and mortar operators to develop new markets at a much lower cost and improve compliance efficiency. The capital market, which is flooded with liquidity, can be the facilitator for these investment opportunities and help inject much needed solvency to the marketplace.
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