Optimizing merger and acquisition strategies through asset liability management (ALM)

The current merger and acquisition (M&A) environment

Since the COVID-19 pandemic, the banking industry has experienced several ups and downs, including swings in loan and deposit growth, and interest rates. In the United States, M&A activity has also varied over the past couple of years, increasing dramatically in 2019 before plummeting in 2020, only to increase dramatically again in 2021. However, now that the economic market is volatile, many management teams are refraining from M&A activity until they see interest rates stabilize. Aug. 2023 saw the highest rate of M&A activity in over a year, showing signs that the market may stabilize sometime soon. Despite this, many industry professionals are expecting 2023 to be one of the slowest M&A years within the banking industry on record.

The midwestern United States continues to be a hotbed for M&A activity and is currently the most targeted region due to the large concentration of community banks. According to a 2023 Bank Director M&A survey, 85% of respondents said their bank either “plans to be active acquirers or were at least open to acquisitions. However, only 11% were very likely to acquire a bank this year, and of the 85% that were actively looking for or open to acquisitions, 34% said there were not enough suitable acquisition targets.

Our banking industry specialists have found that deposit base is the number one top target attribute for most M&A activity within the industry. Some other key focus areas are loan growth potential, branch locations, complementary balance sheets, complementary culture, efficiency gains and liquidity.

Asset liability management (ALM) modeling

Asset liability management (ALM), an important component of M&A transactions, is the process of managing financial risks that result from mismatches between assets and liabilities and the timing of cash flows. It focuses both on short-term (earnings) and long-term (market value of equity) risks and is a regulatory requirement for banks and credit unions to monitor interest rate risk. By calculating the economic value of equity (EVE), financial institutions can measure long-term interest rate risk by measuring the fair value of its assets and liabilities over their respective terms. On the other hand, net interest income (NII) reflects short-term interest rate risk, and NII scenarios typically project future earnings on assets and cost of funds on its liabilities. EVE and NII are both important factors that must be considered when determining whether a potential merger or acquisition would be a good fit for your financial institution.