Analyst Forum Interview: What Investors Want in M&A

Brad Milsaps is managing director with Sandler O’Neill + Partners, L.P. in Atlanta covering small and mid-cap banks, mostly in the Midwest and Texas. He talks about M&A deals in his coverage area, what size banks are most likely to acquire, and what investors like to see in a deal. A shorter version of this interview appeared in the first quarter issue of Bank Director magazine.

What kind of M&A activity are you seeing?

The bulk of the activity has come from the west and Texas. They had better earnings multiples and the banks they were targeting had better asset quality [than other parts of the country]. It was easier to make the deals work. Most recently, ViewPoint Financial, Independent Bank and Prosperity Bancshares have all been very active acquirers. M&A for the largest banks is really not in the cards. The regulators are not going to allow those banks to get larger. What you are seeing is the emergence of these super-regional banks, the $2-billion [asset] to $25-billion [asset] banks are the ones with the best currency because efficiency is so much more important now. They have the currency to acquire and they can go in and get cost savings pretty easy.

What about the level of deal activity?

The deal activity is kind of on pace this year with last year. Our hope is it accelerates. I think it can as other markets get healthy. As Florida and the Pacific Northwest continue to get better, their banks will get better currencies. The banks that could sell will see asset quality continue to improve, and I think you will see more deals.

How has the market perceived the deals on the banks you cover?

Generally the reaction has been pretty positive. The Texas market deals have been very well received. The Texas banks get a premium to everywhere else in the country but they are still trading at less than before the financial crisis.

What do you look for in a deal?

First and foremost, you look at pricing. What are you getting for what you paid? I look at tangible book value dilution. What are the strategic merits? How much earnings accretion will the buyer get out of it? What is the driver of that earnings accretion? If you are making a lot of assumptions about the target’s growth, those deals I’m less enthused about it. You don’t know what’s going to happen in the future. If you lay the maps over each other and there is overlap, there are easy-to-see cost savings, and you take some capacity out of the system, those are my favorite deals.

Is M&A thawing?

The acquirers are telling me there are a lot more conversations. A lot of the social issues are tough to work through. What happens to the executive management team of the target? If they don’t own a lot of stock, what’s the incentive for them to sell? Those have historically been the big stumbling blocks. But to the extent the regulatory environment is the way it is, more costs are getting driven down to the smaller institutions, your costs are going up and to earn a reasonable return is going to be tougher and tougher to do. That’s going to drive M&A.

What size bank is going to have a tough time making a reasonable return?

Certainly anything below $1 billion will have a tough time. It’s going to be more costly for everyone. We did an equity conference in Florida a couple weeks ago and John Kanas [the CEO of BankUnited in Miami Lakes, Florida] spoke at our conference. He was the CEO of NorthFork Bank before they sold. They were a $63 billion bank, they had 27 people working in risk management, and that cost $5.5 million per year. Now he’s at BankUnited, a $14 billion bank, and he has more than 100 people working in risk management, and it costs him $30 million per year. It’s costing six times as much money.

Do you think banks don’t want to go above $10 billion in assets because of the increased regulatory burden at that level?

There is more stress testing and the Durbin amendment applies, which is less revenue. It’s a big decision. MB Financial hung out for several reporting periods in that $9-billion to $9.5-billion [asset] range, but they said if they were going over $10 billion, they were going to do it with gusto and go way over. They did that with the Taylor acquisition.

What do investors want in deals?

If you start to see less accretion from the deal, those are the ones people will start to scratch their heads on. Cost savings are things people can get their arms around. You can eliminate branches and achieve efficiencies. But if you say the bank is going to grow X, well, it may or it may not.