Banking M&A deals are heating up. Here’s what stock investors should know.

The banking environment is shifting. U.S. Treasury Secretary Janet Yellen recently suggested that bank mergers are more likely, given the banking crisis this past spring and pressures from higher interest rates. Moreover, both Yellen and the Acting Comptroller of the Currency Michael Hsu have indicated openness to bank mergers, boosting expectations for more deal activity.

The economic environment also is a clue that more consolidation may be coming. Mirroring the broader U.S. economy, the banking sector is in a volatile place. The differences between the top- and bottom tier performers are wide, leading to opportunities for M&A activity. Shares of large banks have rallied sharply in recent months, while those of smaller regional and community banks have shown modest gains. 

Consolidation in fact may be healthy for the banking industry, especially as smaller regional banks continue to see deposit outflows and slowing loan growth. Earnigns reports for the second-quarter of 2023 highlight this disparity between large and small banks. 

For stock investors, in addition to financial metrics including net-interest margin and loan-to-assets ratios, when considering which banks to back, these characteristics say a lot about how and whether a bank and its management are prepared for the current market climate:

1. Don’t wait for certainty: Volatility and uncertainty will continue. While it can be tempting to wait until there is more information, the cost of inactivity is typically greater than deciding with incomplete data, even if pivots are required later.

If banks focus on being more nimble and able to change strategy quickly, they can reduce the cost/challenge of making pivots when required. As an example, most banks have now started paying for deposits by offering higher-interest on CDs and savings accounts. By establishing guidelines, being explicit about assumptions, and being willing to change strategy frequently, banks can position themselves to succeed in changing contexts. Banks that demonstrate agility through quick decisions and making both small and large pivots are most likely to prosper in uncertainty. 

2. Communicate with transparency and clarity: Transparency and frequent communication is important for investors, customers and employees. In situations like a potential merger or poor financial performance, it is not surprising that many stakeholders feel anxious. The response from company leaders is often to assert confidence and certainty, even when there is none. This is dangerous and can lead to a loss of credibility.

Leaders who communicate with clarity around what is known and what is unknown are more likely to make good decisions and be willing to shift when the facts and environment change.

Being transparent builds trust. The added advantage of transparent communication is that it helps establish realistic expectations and is more effective at eliciting appropriate behaviors from individuals. In a situation where no change in behaviors or actions are required, it can be effective to not share information but, in a situation where change is required, more transparency and visibility of challenges is crucial to engaging all stakeholders.

3. Innovation and experimentation happens locally: Whether responding to external changes or integrating an acquisition, leaders never have all the information required to make the best decisions. Responding to fast-changing threats and opportunities requires employees closest to the situation to act quickly and in a coordinated manner. This aligned and empowered action in turn requires clear guidance around vision, values and strategy.

Organizations that have this clarity are able to move faster. Delegating authority and involving more people in decision-making and in executing change has the added benefit of fostering curiosity and innovation. Greater uncertainty requires the ability to process information quickly and make rapid decisions, which is only possible when more people are looking out for opportunities and taking action. For bank-stock investors, this empowered action can be visible in experimentation and innovation happening at the department or branch level. 

Whether getting ready for an acquisition, changing strategy, or looking to grow, banks will need to cultivate greater adaptability and agility to succeed. The banking-industry turmoil of the past few months has resulted in opportunities for investors and for bank leaders to stand out by focusing on well-run operations and robust, flexible strategies. This will require a greater willingness to operate with incomplete information, pivot quickly and often, and engage all employees in seeking out and taking advantage of emerging opportunities.

Gaurav Gupta is a managing director at consulting firm Kotter.

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