Why Citi thinks Bank of Queensland Limited (ASX:BOQ) and Suncorp Group Ltd (ASX:SUN) should merge

The next merger and acquisition (M&A) hotspot on our market could be among second-tier mortgage lenders as Citigroup believes the industry is at an inflection point that is exposing the structural weaknesses of regional banks.

While it is the big banks like Commonwealth Bank of Australia (ASX: CBA) that are facing most of the public pressure from the Banking Royal Commission, it is the smaller players that will have to move quickly in order to stay relevant to the market in the face of the digital revolution, changing customer preferences, and declining retail banking returns.

The merger that makes the most sense to Citigroup is one between Bank of Queensland Limited (ASX: BOQ) and Suncorp Group Ltd (ASX: SUN).

“In other markets, similar banks have turned to consolidation to solve these deficiencies. Whilst in other cases, private equity sponsors have taken an interest,” said Citigroup.

“The time seems right for a similar wave of consolidation to occur in Australia.”

There are four key reasons why second-tier lenders have an urgency to act, according to the broker. These players have an over-reliance on branch-based banking, have poorer support from mortgage brokers, a lack of omni-channel presence, and the lack of resources to adequately invest in their business to keep up with digital and regulatory trends.

Citigroup’s analysis shows that merging the two regional banks would create the most value as their combined balance sheet and scale will address all of these shortcomings.

Bank of Queensland is the worst performer of the two with its share price crashing 16% since the start of the calendar year, when Suncorp is up 7% and the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index is 3% in the black.

This underperformance is unjustified in Citigroup’s opinion and the broker has upgraded BOQ to a “buy” from “neutral” with an $11.50 price target.

But there’s another interesting player in the market to watch. It’s Macquarie Group Ltd (ASX: MQG).

“The most interesting player in any consolidation wave is Macquarie with its superior market cap, a history of accelerating its position through acquisition, as well as its notable ambitions in retail banking,” said Citigroup.

“In the near future, MQG will face a deposit funding constraint on its organic lending growth strategy. We think an inorganic transaction (or two) will enable it to move to the next level.”

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Motley Fool contributor Brendon Lau owns shares of Macquarie Group Limited. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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