With an apology to the late, great playwright Samuel Beckett, the bank mergers and acquisitions market resembles the story line in Beckett’s Waiting for Godot where the two central characters—Estragon and Vladimir—spend the entire play waiting for a man named Godot, who never shows up. For the last few years, U.S. banks have been waiting anxiously for M&A activity to recover after the financial crisis of 2008, but the rebound has yet to arrive.
And based on the results of an October 2011 email survey of independent directors, CEOs and other senior bank executives conducted by Bank Director and Crowe Horwath LLP, 2012 might not turn out much better. Of the survey’s approximately 225 respondents, 48.3 percent said they did not expect to make any type of acquisition—including a healthy bank, failed bank purchased through the Federal Deposit Insurance Corp., or branches—for the next 12 months, which would extend into the fourth quarter of this year.
“Activity is occurring, but it’s at a more modest level than it has been in the recent past,” says Rick Childs, a director in Crowe’s Audit and Financial Advisory practice. “We are seeing some opportunistic buying, but buyers are being careful about what they take on.”
The survey also highlighted the wide gulf that exists between buyers and sellers when it comes to price. Many buyers are still being cautious given the uncertain outlook for the U.S. economy, among other factors. “There is still a bit of a price gap between buyers and sellers,” says Childs. “Sellers understand that prices are down, but they’re still hoping for a higher price.”
At 47.3 percent, outside directors made up the largest category of respondents. Chief executive officers were the next largest group at 17.4 percent, followed by bank executives other than CEOs at 14.7 percent, lead directors at 13.8 percent and CEOs who are also board chairs at 6.7 percent.
Deal volume has fallen off sharply since the financial crisis of 2008 as the industry has struggled under the weight of deteriorating asset quality, declining profitability and, more recently, higher capital requirements—all of which have put a big chill into the M&A market. In 2010, there were 178 whole bank deals with an aggregate value of $12.2 billion, and an average price-to-book-value ratio of 113.4 percent, according to SNL Financial. In 2011, there were just 162 deals for an aggregate value of $19.9 billion and an average price-to-book-value ratio of 101.4 percent. Instead of getting better in 2011, the M&A market actually got worse.
The survey results underscore just how little deal volume there has been in recent years. Sixty percent of the respondents said their institution had not done an acquisition within the last three years, while 13 percent said their most recent acquisition was a healthy bank, 12 percent had participated in a successful FDIC-assisted deal and 9 percent had bought branches.
Of the respondents, 36.6 percent expressed an interest in acquiring healthy banks, 26.8 percent in branches and 23.4 percent in an FDIC-assisted deal. Not surprisingly, there was little expressed interest—just 11.7 percent—in buying another bank’s loan portfolio, a probable sign that asset quality continues to be a concern throughout the industry. Childs says there are “some willing sellers out there,” including banks that have been unable to raise capital and are feeling the heat from their regulators, and banks that are worried about the rising cost of regulatory compliance following the passage of the Dodd-Frank Act and other recent regulatory initiatives.
There are willing buyers, as well—if they can find the right deal at the right price. For example, Ellicott City, Maryland-based Howard Bancorp Inc., a former de novo that opened its doors in 2004 and has managed to weather the industry’s recent storm quite nicely, will be watching the market closely in 2012. “Is there an opportunity to grow—not just organically but through acquisition?” says Mary Ann Scully, the bank’s chairman, president and CEO. “We’re pretty open to that.” Howard Bancorp, which had $321 million in assets in the third quarter of 2011, filed last November with the Securities and Exchange Commission to raise capital through an initial public offering, which it could use to finance a deal.
Also paying close attention to the M&A market is First Community Bancshares, a $2.2-billion asset institution in Bluefield, Virginia. “M&A offers a growth opportunity,” says Franklin P. Hall, an independent director. “We’ve been looking at it and talking about it.” First Community operates in West Virginia, southwest Virginia, Tennessee and North Carolina and is particularly interested in fill-in acquisitions that would expand its franchise. “Our board sees it as a great opportunity to fill in the footprint,” Halls explains.
When asked for their top three reasons for considering an acquisition of another bank, 61.3 percent of the respondents said they wanted to supplement or replace organic growth, followed by 59.8 percent who said they wanted to increase their market share. “For many geographical markets, the economy is very stagnant and organic growth is very hard to achieve,” says Childs. “M&A is the only way that some of these institutions are going to be able to grow.”
Interestingly, 38.2 percent of the respondents also said they were considering an acquisition because they wanted to rationalize the cost of regulation over a wider base—a clear sign that recent regulatory initiatives like the Dodd-Frank Act has elevated the cost of compliance to the point that it has become a significant monetary issue for some banks. Compliance has become “enormously difficult and expensive,” says Scully. “People have to find a way of [handling] these costs and still return something to shareholders.”
Among likely acquirers, the top barrier to doing a deal—cited by 66 percent of the respondents—was lingering concern about the asset quality of potential targets. Other impediments included the “unreasonably high” pricing expectation of most potential sellers (56.9 percent), and the perceived risk of doing an acquisition in an uncertain economic environment (43.7 percent).
Also, when asked what the greatest barriers to selling their banks were, 69.3 percent responded that current pricing was too low.
The mismatch between the expectations of buyers and sellers when it comes to pricing—which would seem to reflect two very different views of the world—is probably one of the biggest reasons why M&A activity remains depressed. On the one hand, many potential buyers are not yet so confident in the banking industry’s recovery from its widespread asset quality problems of just two years ago, or in the economy going forward, that they’re willing to compound the risk of an acquisition by paying too high a price. “Anyone who expects more than tangible book value probably isn’t going to find it,” Scully says.
And yet many potential sellers clearly have not yet recalibrated their pricing expectations from the pre-crisis era when strong banks with attractive franchises would fetch significant acquisition premiums over their book value. “People think that pricing is going to go back [to what it used to be], and they say ‘I have to have two times book [value],’” says Hall. “It’s going to be a long road back [to those kinds of premiums]. It’s not going to be one or two years. It’s going to be four or five.”
The reluctance of potential sellers to cash out in the current market was evident in their responses to other survey questions, as well. When asked whether their institution was intending to sell any of the following—branches, a line of business, a loan portfolio or the entire bank—over the next 12 months, 80 percent said they had no such plans. Also, when asked for the top three reasons why they might sell their institution—including the high cost of regulation, limited opportunities for organic growth and the inability to attract sufficient capital to meet regulatory requirements—68 percent said they were not considering a sale.
Nearly 55 percent of the respondents have directors on their boards with prior bank M&A experience, and another 26.7 percent have directors with M&A experience in their own businesses. But one of the survey’s more surprising findings is the ad hoc approach that many of the respondents’ institutions take to the M&A process despite this high degree of experience. Nearly 45 percent of the respondents said their banks did not have a “formalized system in place to review potential acquisitions or bids.” Equally surprising was that only 30.9 percent of the respondents discuss M&A as a regular part of the agenda at their board meetings, while 37.2 percent said they talk about M&A as opportunities arise, 18.3 percent discuss it “infrequently” at their board meetings and 13.6 percent deal with it at their board’s annual strategy meeting with management.
Childs says that in his experience, “M&A is a very reactive process for a lot of institutions”—although he believes there should be a disciplined process in place to review takeover opportunities if the bank is interested in making acquisitions. “The institutions that have a plan and process in place are better able to weed out situations that don’t fit,” he says. “That discipline can keep them from reaching for deals.”
One area that seems to pose a considerable challenge for boards when they do consider an acquisition is the issue of post-merger integration. When asked to identify the three most difficult aspects of their bank’s most recent acquisition, 53.3 percent cited integration—right behind due diligence at 57.6 percent and negotiating price at 55.4 percent. In a separate question, only 28 percent of the respondents said they feel “very prepared” to consider integration issues in an acquisition, and 24.9 percent feel “somewhat prepared.”
“Generally we see boards more involved in economic analysis of the deal,” says Jason Bomers, a principal in the Financial Services Group in Crowe’s Performance practice. “[Integration] gets passed over to the management team.” Of all the things that a board will typically look at while deliberating on a potential acquisition, understanding the mechanics of how two banks might fit together is especially difficult because there are so many variables, ranging from technology platforms and business practices to culture and personnel. And yet post-integration is crucial to an acquisition’s eventual success because the financial projections of most deals are predicated on the elimination of a certain percentage of cost from the combined institution’s overhead. Failure to make an accurate cost take-out assessment can end up being the difference between success and failure in an acquisition.
“Integration is always a challenge and always harder than you think it will be,” says Bomers. And while acquirers do try to give the target bank as thorough an inspection during the due diligence phase as time will allow, “Once you get three levels down you find, ‘Wow, they just do things differently,’” Bomers explains. “Integration is always hairy.”
Looking ahead to 2012, Childs expects there will continue to be an active market for FDIC-assisted deals since there is still in excess of 800 banks that are in some kind of trouble. Many of those could end up being taken into receivership by the FDIC and either sold or liquidated. However, Childs does not look to see a significant increase in healthy bank acquisitions in 2012, even though organic growth will also be harder to come by, which normally would be a strong argument in favor of more takeover activity.
Instead, expect to see potential buyers wait for a stronger economy to lessen the risk of doing an acquisition, and for likely sellers to wait for better pricing.
“I think we’ll see a pretty sluggish market next year,” Childs says.
Just like Estragon and Vladimir in Godot, everyone’s still waiting.