Deals Gone Bad Scare Big Banks from M&A

Richard Davis of U.S. Bancorp (USB) has no interest in paying for the sins of others.

M&A by the largest banks has been nearly nonexistent in recent years, and the country's big players — including his Minneapolis bank — will stay out of the game for a long time, he says.

"In the old days it was about credit risk, and uncertainty about who you would acquire as it relates to long-term, systemic credit surprises," Davis said at the Bank of America Merrill Lynch Banking & Financial Services Conference in New York on Tuesday.

"But it is all about compliance now and as you've seen in this environment, you will be held accountable from day one for the company you buy," says Davis, who is U.S. Bancorp's chairman and chief executive. "And you can be held accountable for things up to 10 years in the past, even if they were approved back in the old rules that have changed."

Davis has been sour about bank M&A for a while now, but his thinking has evolved — and his reasons have multiplied.

Previously he had said the $361 billion-asset U.S. Bancorp was unlikely to buy other banks because the number of appealing candidates was low. Others say big bank M&A is on ice because the hurdles to regulatory approval are high.

Now, Davis describes an environment that has become more punishing for buyers. His remarks seemed to reference recent legal troubles at JPMorgan (JPM) and Bank of America (BAC) that stemmed from crisis-period deals for wayward firms such as Washington Mutual and Countrywide.

"Anyone who is going to do a deal needs to be very careful that they are not bringing a virus into a healthy room," Davis says.

Davis has long been concerned about the unintended consequences of dealmaking, says R. Scott Siefers, an analyst at Sandler O'Neill. "Richard looks at the world logically and objectively, and I think a multibillion-dollar settlement is just reinforcing the thoughts he already had about M&A."

Davis may also be taking stock of what is happening at M&T Bank (MTB) in Buffalo, N.Y., a similarly conservative lender that has been rattled with M&A-related troubles lately. Its deal to acquire Hudson City Bancorp (HCBK) in Paramus, N.J., hit a snag early in the year when regulators ordered it to fix its compliance with bank secrecy laws.

Then M&T announced Tuesday that the Securities and Exchange Commission and the Justice Department are investigating financial reports of Wilmington Trust from before its acquisition by M&T in 2011. The investigations could carry civil or criminal consequences, M&T warned.

Although Davis doesn't expect much big bank M&A, he is expecting a fattening of the midsize players. Using shorthand to describe banks with asset sizes in the billions of dollars, Davis says he doesn't expect "50s getting with 60s to become 110s."

"You might see a 10 and a 10 trying to get to 20, or a 10 and a 15 thinking about 25," Davis says. "You'll see a lot of fours and twos getting to six."

Davis said Tuesday that aiming for positive operating leverage — the extent to which revenue growth outpace expense growth — is the best way to make money in the low-rate environment.

U.S. Bancorp has a reputation for strong efficiency ratios, though it hasn't generated positive operating leverage the last two quarters. It expects to achieve positive operating leverage for the full year.

Davis returned to the concept in issuing another M&A warning.

"If you can't see revenue growth from the synergies, don't do it for expenses and don't do it for scale," Davis says. "Because you're going to end up being shortsighted."