There is a growing likelihood that the bank M&A market in 2016 will see declines in both deal volume and pricing compared to the previous two years, even as the industry’s underlying fundamentals remain relatively unchanged. “The operating environment is tough,” said Rory McKinney, the co-head of investment banking at D.A. Davidson Companies, during a presentation at S&P Global Market Intelligence’s 8th annual M&A Symposium in Washington, D.C., late last month. “We think there should be more activity. There’s a lot of pressure to build earnings per share and M&A is one of the ways you can do that.”
There were 181 announced healthy banks deals through September 30, which is well off the pace set in 2015 and 2014 when there were 278 and 282 deals, respectively, according to S&P. To match even the 2015 total, there would have to be 97 announced deals between now and the end of the year, which is probably unlikely. Pricing was also off through the first nine months of the year, with an average price-to-tangible-book-value ratio of 133 compared to 143 last year and 142 in 2014. Pricing was also lower on a price-to-earnings basis for four trailing quarters, coming in at 22 times earnings through September 30, compared to 25 last year and 26 in 2014.
So what gives? In a subsequent interview, McKinney reiterated his surprise that there hadn’t been more deal volume at the three-quarter post this year. “My personal opinion is that there should be more M&A just given the challenges from a financial perspective,” he says. “But banks are sold, not bought.” One factor might be that many potential sellers aren’t sure if this is the best time to sell if they want to maximize their bank’s value, he explains. If the economic expansion still has a few more years left before hitting the recessionary brick wall that most experts assume is out there, then perhaps the best thing to do is to wait for pricing to improve.
Of course, many of those potential sellers might have an unreasonably optimistic expectation for what their bank is worth in today’s market. “We get the question all the time—when can I sell my bank for two times book [value]?” says McKinney. There was a time in the early 2000s when banks did fetch that kind of valuation, but generally they don’t today. “We’ve only seen six deals this year at two times book,” he says.
Another factor is that after several decades of consolidation, the banking industry is much smaller than it used to be. “When you look at the number of deals this year compared to last year, keep in mind there’s also fewer banks as well,” he says. “We’ve got a shrinking universe.”
The decline in pricing might have less to do with the industry’s underlying fundamentals than the types of deals that are getting done in 2016. After all, the fundamentals are pretty similar. “If you look at where bank stock trading multiples are today—and that’s a pretty big driver of M&A pricing—they are pretty similar to where they were a year ago,” McKinney says. “I would say that most banks have the same currency [valuation today] they had a year ago from an earnings multiple or price-to-book [basis].”
However, what is different is the size of banks that dominated the deal volume through the first nine months of 2016. According to S&P, well over 60 percent of all deals this year have been for banks under $250 million in assets, where the average price-to-tangible-book-value ratio has been approximately 117, and the price-to-earnings-multiple has been about 17 times earnings. By contrast, the highest valuations have been for banks with $1 billion in assets and above, where price-to-tangible-book value ratios have ranged from 160 to 180 depending on the size of the bank. Generally, large banks sell for more than small banks, demonstrating a clear buyer preference for scale.
McKinney says that for small banks, it’s a buyer’s market. “The buyer is in the position to drive pricing [down] on those deals because they know they’re only one of maybe two or three [prospective] buyers for those franchises,” he says. “Where we see pricing stabilizing or maybe even slightly higher is [for banks with] good long-term demographics [in] metro areas, and also with $1 billion dollars and above in assets.”