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By buying EverBank Financial, the insurance and retirement savings behemoth will gain billions of dollars in low-cost deposits and access to many new lending products that it can offer to millions of clients.
August 8 -
In a pair of proposals approved by the Federal Reserve Board Friday afternoon, the Federal Reserve signaled to the insurance industry that it knows the difference between them and banks. But the devil may still be lurking in the details.
June 3 -
Comments by former Citigroup chief executive Sandy Weill reignited the debate over whether to separate commercial banking from investment banking.
July 25
Will Roger Ferguson prove Sandy Weill was right?
Pretty much every merger of insurance and banking institutions since Weill in the '90s helped
As a result, some new-style deals — like the just-announced merger of Ferguson's
What Happened in the Late 1990s
Most of the old deals were premised on vain efforts to build a "financial supermarket." In all but rare circumstances, cross-selling will remain a mirage. New rules also bar some of the older, highly profitable cross-selling models, such as credit life insurance. As a result, it's hard to see new-style cross-selling as a cure to old-style customer silos.
But more fundamental problems confront the old deals. When those deals were finalized, it was the halcyon days when interest rates of 4-to-5% seemed a bit too low. The regulatory playbook was also more favorable compared to today. Up to 2010, the capital rules favored banking on its own and insurance was similarly secure in its own regulatory bulwark. Financial intermediation, fattened up a bit with newly authorized brokerage and derivatives-trading operations, was a fine business on its own, as was offering long-term insurance products like life and long-term-care policies. Neither of these premises holds true anymore — the rules are of course way different and interest rates are bouncing off the zero lower bound.
Looking into the 2020s
Given the post-Dodd-Frank regulatory framework and lower-for-longer interest rates, both banking and insurance are suffering and often for the same reasons. The key to understanding M&A transaction dynamics thus is to determine if banking/insurance deals solve for some of these current problems. Done right, they do.
To consider integrating banking and insurance, one must first dispense with the fear of coming under the Federal Reserve, which has long chilled these nontraditional combinations. I well remember working through all the economics of a similar deal for an acquisitive CEO at a major nonbank. Everything in the deal was a go until he learned that the Fed would bring supervisors into an annual board meeting. He didn't want someone venturing into those sacrosanct precincts to say something he didn't want to hear. No such deal was done until years later when the economics became so compelling that his less-sensitive successor made a similar acquisition at considerably higher cost.
The Fed isn't fun, as any BHC chief executive will quickly vouchsafe. However, understanding what it wants and managing to make it happy is not different than dealing with an activist investor asking awkward questions. Indeed, the Fed is better in the boardroom because its focus is long-term safety and soundness, not quick earnings. The Fed may overcompensate and may unduly constrain short-term earnings, but that's a discussion the CEO and board can have with the Fed, often to mutually satisfactory conclusions.
How the Numbers Now Work
Assuming one gets over fear of Fed and is ready to run the numbers, the post-crisis rulebook dramatically changes the M&A equation from both the bank and insurance company's perspective. Each transaction's outcomes differ based on critical determinants like business focus, size and the banking company's regulatory structure. But, most deals have common elements that make these nontraditional comparisons worth careful consideration.
First, there's the unique advantage of a banking charter. It gives a company access to low-cost funding from insured depositors, supplementing premium income and providing considerably more flexibility in terms of prudent maturity-transformation options. Interaffiliate transaction constraints are an important limit on the extent to which bank-derived funding is allowed to meet insurance balance-sheet needs.
Even taking this into account, though, low-cost funding should add revenue to the parent insurance company and permit it to rebalance asset composition. Banks are of course under acute yield pressure too, but their greater asset flexibility combined with the ability to place excess reserves at the Fed offers a lot of options insurance companies can't touch.
Second, there's the new set of capital rules that applies when banking and insurance come together in a company under the Fed's authority. If the insurer is designated as a "systemically important financial institution" by the Financial Stability Oversight Council, then these capital requirements are major constraints on traditional insurance-company economics — hence the effort by some insurers to escape systemic designation at all costs. However, for smaller companies, the Fed's
Third, it's an understatement to say that retail financial-product delivery has changed since the 1990s. New rules other than bank-specific standards — for example, the Department of Labor's fiduciary-duty rule — are also changing the way products are delivered, giving an edge in some cases to direct origination and advisory services already gaining ground due to new technology. Different deals have different dynamics based on the desired product suite, but significant opportunities exist to leverage an insurance company's capabilities with those of a regional bank, especially in the growing field of "mass affluent" wealth management.
Will Deals Be Easy?
Of course not. Any transaction that breaks new ground has a challenging job ahead of it with federal regulators, especially the Fed. However, regional BHCs are not exactly replete with attractive in-industry M&A opportunities. On the other side, insurance companies are trying to restructure more by selling off business lines than by buying new ones, but that's often because desired returns seem possible only by slimming down existing activities. New revenue sources are overlooked.
Given the current rulebook, interest rate environment and dynamic marketplace, thinking about M&A cannot be premised on old assumptions and past history. Not every merger between banking and insurance is a good idea and none will be easy to pull off, but some will make tremendous sense now and as the U.S. financial system continues to evolve.
Karen Shaw Petrou is managing partner of Federal Financial Analytics.
