The justification initially given for this combination related to the changing technological structure of the banking industry. Putting the two banks together will result in the construction of the seventh largest bank in the United States.
As Zach Carter, Senior Reporter for HuffPost, shifts the focus of the argument and argues, from primarily a political point of view that this combination will create “America's Next Too-Big-To-Fail Bank.”
Mr. Carter reasons that you have two, not very good banks, and combining them will not create a good one. In terms of the financial numbers, both BB&T and SunTrust have averaged only around an 8.5 percent return on shareholders' equity over the past five years.
Commercial banks, it is often argued, need to earn at least a 10.0 return on equity to cover a bank's hypothetical cost of capital. Hence, these banks are not high performing institutions.
Cutting costs is, of course, one way to do this, but how the costs are cut and how these cuts add to the business model of the combined banks is the big question.
Mr. Carter hones in on firing people and selling off real estate. He also mentions the large compliance staffs at each institution, which can be whittled in the new organization and, of course, he mentions, "740 branches that operate within two miles of each other" that can be reduced in number.
But for what reason? Mr. Carter reasons this way:
“In the years since the financial crisis, SunTrust has paid over $1.5 billion to settle charges of widespread mortgage abuse under six distinct categories of misconduct, from overcharging black families to lying to the government about toxic mortgages to straight-up fraud in the foreclosure process. In 2008, the Federal Deposit Insurance Corp. (FDIC) discovered ‘a pattern or practice of discrimination on the basis of race’ in BB&T’s consumer lending business, including ‘substantive violations’ of three anti-discrimination laws. Seven years later, the Consumer Financial Protection Bureau found that the bank was violating the Equal Credit Opportunity Act. BB&T paid $83 million in 2016 to settle claims that it knowingly sold the government junk mortgages, and both the Federal Reserve and the FDIC issued enforcement actions against the bank over its weak efforts against money-laundering operations.“
Mr. Carter then adds his final argument to his case, the move by President Trump to reduce regulation in order to encourage more banks to merge. Mr. Carter sees the BB&T/SunTrust deal just the first of many more mergers to follow.
Mr. Carter totally excludes the basic reason given initially by the management teams of BB&T and SunTrust for bringing the two banks together. There is not one mention of how the advances of information technology are massively transforming the banking industry in the whole article.
In fact, most of the discussion is in terms of the political division in the country, the division between Republicans and Democrats.
I believe this totally misses the economics of the situation and misleads investors from what they should really be focusing upon when considering investing in the banking industry and which banks within the industry are likely to create sustainable competitive advantages.
My initial response to the announced merger was my post “BB&T and SunTrust Merger: It's All About Technology, Stupid!!!”
In “The Growing Size of American Banks,” I emphasized the factors I see as important in this move to bigger and bigger banks.
“First, banking must be put within a global context these days. The banking structure is not just a "national" issue.”
Of course, moves on a global scale often hurt "local conditions", but that is a part of the world today and banks and governments and analysts need to make an effort to minimize the pain from such transformational changes, but the transformational changes are still going to take place.
In terms of the first of these arguments, current news is just confirming what is going on in the world and the pressure these movements are putting on the American banking system. I have tried to capture this revolution in my last post, “Transformational Technological Changes Coming In Banking.”
And, there is no doubt that China is one of the leading forces in the world pushing the advancements of information technology into the financial field.
“Second, banking is becoming an issue of information technology.”
In the BB&T/SunTrust article mentioned above, I write about how commercial banks are trying to become “new” Modern Corporations, following corporate changes in other parts of the economy.
I argue that “A major characteristic of the “new” Modern Corporation is that it is built upon intangibles, primarily intellectual capital. By creating platforms constructed out of this intellectual capital, it can build networks that can scale to enormous size, one major reason is that intangibles foundations can be expanded at zero or almost zero marginal cost.”
This expansion is what we are seeing in the tech giants in the information technology field. And, scale comes to dominate products and markets.
BB&T and SunTrust see this as one of the reasons the banks are not earning as much as they could. Their argument is that they need to transform their business model so as to build the scale necessary to earn a sufficient return on equity by introducing a more modern business model into their structure.
Scale is a major element in building a sustainable competitive advantage in the modern banking world. The cost structure of a company can be substantially changed.
There are two issues that, I believe, blind the modern investors to the realities of the evolving banking system and, hence, prevent them from making the best investment decisions they might make in this new corporate era.
First, a great deal of the investment research is done working with the old “linear” business model and fails to consider the move to platforms and networks similar to those of the “new” Modern Corporation. Thus, emphasis is put on product lines, which are just a relic of the “legacy” banking model.
Second, especially banking system and banking regulation can get caught up in political issues, especially between Wall Street interests and Main Street interests. The important thing to remember is that the world moves on and those that ignore the “future” are going to be the under-performers.
By missing these points, I believe that Mr. Carter has failed to capture the reality of the commercial banking scene, both in the United States and the world.
Investors cannot afford to be blinded by arguments like the ones made by Mr. Carter. Investors must accept the realities of the evolving world and pick the winners and losers as they reflect the changing nature of the world.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.