Last year I wrote an article for BankDirector.com entitled “Winning Over Shareholders with a Well-Constructed Merger.” In it, I laid out several suggestions for boards on how to structure a merger transaction that investors support. Also at this time last year, several investment bankers who presented at the Acquire or Be Acquired Conference advocated reasonably priced stock-for-stock mergers as the best M&A alternative for community and regional banks. In an instance of investment bankers correctly predicting a trend (many would say a rare instance), 2013 was in fact characterized by a series of well-structured mergers which produced a dramatic improvement in shareholder reaction to bank M&A.
Banks under $10 billion in assets have had an unprecedented opportunity to pursue merger transactions while larger regional banks have remained on the sidelines.
The preferred transaction structure of 2013 and early 2014 has been the friendly all stock (or nearly all stock) merger with the following characteristics:
- two banks of similar size
- exchange ratio and financial projections that produce shared long term upside
- price to tangible book value premiums below historic bank M&A averages
- meaningful non-financial deal terms for seller
- continuity of interest for both sides rather than a full change of control
I think there are a number of factors that will change the bank M&A environment as we move through 2014. In general, I expect a more competitive environment to emerge as the number of willing buyers gradually increases and the ability of sellers to pick the “friendliest” potential merger partner decreases. There will be more focus on price by selling shareholders and greater scrutiny of merger transactions, especially those labeled as mergers of equals (MOEs).
This is not to disparage the shared upside merger model or the many excellent transactions that have been announced in the past year. Rather, it is to caution boards that they will need to adjust their M&A planning as the environment changes.
Boards should consider the following environmental changes:
- Large regional banks (assets greater than $20 billion) will gradually become more active in traditional bank M&A assuming a successful round of regulatory stress testing and capital reviews.
- Banks that have already announced and integrated a recent merger and benefited from increased market valuation and balance sheet capacity are better positioned to be aggressive pursuing their next target and will be less likely to make major concessions on non-financial issues.
- Investors have become more tolerant of buyers paying market premiums.
- Banks that have not been able to execute a well-received M&A transaction will be under increased pressure to find a deal that works.
- Fewer potential buyers are feeling restrained by concerns over regulatory approval.
- The overall health of the industry continues to improve and more banks are able to consider acquisitions.
Also, a potential risk to M&A transactions is the possibility of an interloper disrupting an announced transaction. Boards need to consider a gradual increase in the number of potential buyers and in the capacity of these buyers to pay a meaningful premium. This risk remains limited but it is increasing.
For many healthy banks in good markets there has been only one viable buyer or merger partner. This situation will change and a merger may be more difficult to justify to shareholders if they perceive that a higher price is available from another bank.
Thus, selling banks may find more willing buyers and higher prices than was the case in the past several years. However, they will have less ability to merge with their preferred long term partner if that partner cannot be competitive on price.
Buying banks will encounter more competition and those with weaker relative multiples or less balance sheet capacity will not be able to structure deals that work.
The level and nature of M&A activity that we will see in 2014 and beyond is of course governed by many difficult to predict factors. For instance, a volatile bank stock market is always detrimental to deal activity. Also, if any of the 2013 vintage deals run into integration problems, investor receptivity to new deals will decline.
The window of available deals for smaller banks may be closing, but likely will remain open for at least the first half of 2014. However, boards should not be lulled into assuming that they can execute their preferred merger at any time and in any market. Do it while you can.