Acquire or Be Acquired Perspectives: A Bank Investor Talks M&A

This is the second in a five-part series that examines the bank M&A market from the perspective of five attendees at Bank Director’s Acquire or Be Acquired conference, which occurred in late January at the Arizona Biltmore resort in Phoenix.

Read the perspectives of other industry leaders:
John Asbury, president and CEO of Union Bankshares
Gary Bronstein, a partner at Kilpatrick Townsend & Stockton LLP
Eugene Ludwig, founder and CEO of Promontory Financial Group

It’s tempting to think that rising profits and higher stock valuations will spur merger and acquisition (M&A) activity in the bank industry. But that isn’t necessarily the case, says Kirk Wycoff, managing partner of Patriot Financial Partners L.P., a Philadelphia-based private equity fund that invests in banks with between $500 million and $5 billion in assets.

Wycoff characterizes the current M&A landscape as lukewarm. He gives it a grade of B. “About 4 percent of the industry consolidates every year,” he notes. “So 25 years ago, when there were 15,000 banks, there were 600 bank transactions a year. Now there are 6,000 banks, which translates into 240 transactions a year. The investment bankers always say, ‘Next year is going to be the best year ever,’ yet it’s always around 4 percent.”

There is no way to predict future transaction volumes with precision, of course, but Wycoff brings a lot of experience to bear on the issue. From 1991 to 2004, he was chairman and CEO of Progress Financial Corp., growing the Philadelphia-based bank from $280 million in assets to $1.2 billion before selling it to FleetBoston Financial Corp. After Bank of America Corp. bought FleetBoston in 2005, Wycoff founded Philadelphia-based Continental Bank. It became the fastest-growing de novo bank opened in the four years before the crisis and was sold in 2014 to Bryn Mawr Bank Corp., a $4.5 billion bank in neighboring Bryn Mawr, Pennsylvania. And since 2007, Wycoff has been a managing partner at Patriot Financial Partners.

Wycoff shared his perspective as a private equity investor on the M&A landscape with Bank Director at its latest Acquire or Be Acquired conference, held earlier this year at the Arizona Biltmore resort in Phoenix, Arizona. Wycoff’s perspective is one of five Bank Director has cultivated about the M&A landscape following the annual conference.

“I’ve been coming here for 24 years, both for the industry data that the presenters present and for the ideas on how to improve my companies,” says Wycoff. “I was a CEO the first 13 years I came here, so I used a lot of the ideas I picked up to improve the banks I was running. Since I’ve been an investor for the last 11 years we’ve been meeting our banks here, encouraging some of our banks and their boards to come here to learn about mergers and acquisitions, about concepts around accretion and dilution, about governance and the whole process of, if you need to do something strategically, how to do it right.”

Wycoff has a unique perspective on the relationship between profitability and M&A activity. The typical assumption is that higher profitability will spur transactions. It’s at the top of the cycle, after all, when buyers are flush with cash and sellers salivate at the prospect of high valuations. But Wycoff thinks there’s another way to look at this.

“People should think about the value of their bank as if M&A didn’t exist,” he says. “When banks return 15 percent on equity, which they’re on their way to doing, M&A becomes a much less necessary part of the plan because at that rate you’re going to double your capital every six years.”

Given the salutary impact of last year’s tax cuts, combined with the favorable operating environment, the industry could soon find itself in this situation. “As an investor, what struck me at this year’s conference is how good things are,” says Wycoff. “We’ve been in a very, very good credit environment, the industry has tremendous amount of capital, people are very optimistic and earnings are going up because of the tax bill.”

It’s in times like these that investors and board members need to avoid being lulled into a false sense of security, says Wycoff.

“CEOs will tell boards they deserve bonuses based on more earnings from tax reform when they maybe didn’t drive deposits or customer engagement or more margin.” Wycoff’s point is that now isn’t the time to become complacent. Instead, banks should be vigilant about operating expenses.

As an investor, Wycoff is also watching the evolution of bank stock ownership. The proliferation of exchange-traded funds and robo-advisors could detach bank valuations from fundamental performance, says Wycoff. This would create arbitrage opportunities for savvy investors, but it would break the feedback loop between the market and executives running banks. “That’s difficult because you like to think as a CEO or an investor that if a company does the right things, you get rewarded in your stock price.”

Fuller coffers also raise the importance of capital allocation. Should rising profits be used to increase dividends, accelerate stock buybacks, invest in the business or a combination of the three? That’s the question, notes Wycoff. “I hope that this additional profitability, which will inevitably drive stock prices higher for the banks that are doing well, isn’t frittered away on things that don’t create long-term value for shareholders.”