Why Big Banks Are Hunting for Acquisitions of Non-Bank Business

NEW YORK ( TheStreet) -- With their earnings hemmed in by increased government regulation and 6 1/2-years of record-low interest rates, big banks are on the prowl for acquisitions.

But it's not other banks they're looking at - that wouldn't fly with regulators. And it's not big deals they're looking at - that wouldn't fly with regulators either. Instead, it's deals of less than $1 billion for companies in the advisory business (wealth management, for example), payment processing/treasury services and the financial technology business.


Payment processing involves credit and debit card payments, securities transaction payments and trade finance and includes such companies as First Data Corp. and Global Payments.

The technology companies can enhance banks' cash management and stock/bond/currency trading systems among other things. Bank software providers include Avoka Technologies, Comarch, FidorTecs, Infosys, Misys and the Open.

"If you think about banks today, their balance sheets have been nationalized," says Dick Bove of Rafferty Capital Markets, dean of the country's bank analysts. "The government tells banks how big they can be and the structure of their assets and liabilities."

On one hand, banks have been forced to increase the amount of cash and treasuries on their balance sheets. On the other hand, they have to issue preferred stock to meet increased capital requirements. So they're earning about 25 basis points on cash, while paying out 5% on preferred shares after taxes, he explains. That's not a great deal for banking companies.

"Banks need to get far away from their balance sheets to reach lightly regulated businesses," Bove says. Hence their interest in the sectors cited above. But this isn't going to be a cake walk for the banks. "The problem is everyone wants the same thing at the same time," Bove says. And that, of course, will drive acquisition prices higher for the banks.

As for interest rates, given the pressure ultra-low rates are putting on banks' profits, fee-based businesses are where the money's at, says Dan Werner, a bank stock analyst for Morningstar.

When it comes to asset management, every major bank wants to join the party. "That will destroy profit margins," Bove says. The same is true with payment services, he notes. "There's intense price competition already. The biggest players - Bank of New York Mellon (BK), State Street (STT) and Northern Trust (NTRS) - are always trying to rip each other's heads off."

As more banks enter the fray, the situation will just worsen. JPMorgan Chase (JPM), Citigroup (C), Bank of America (BAC) and Wells Fargo (WFC) also want in on payment services, analysts say.

As for technology, the banking industry has historically spent more on it than any other industry, except the technology industry itself. "Banks tend to be leaders in technological breakthroughs," Bove notes. "They handle large amounts of money in small transactions over short time frames and need more than 99 percent accuracy or they're in big trouble."

The tech sector should account for most of the biggest purchases by banks, Werner says.

The author owns shares of JPMorgan Chase, Citigroup, Bank of America, Goldman Sachs and U.S. Bancorp.

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