1-10-14-McGladrey.pngMerger and acquisition activity was flat for financial institutions in 2013, with whole bank deal volume down 2 percent from the previous year to 241 deals in 2013, according to SNL Financial. However, the average price to tangible book value increased by 7 percent to 123.89.

Prices aren’t headed up for everyone, though. In 2013, the average price to tangible book value for banks rose 7 percent, while it only rose 3 percent for thrifts. Why? Thrifts tend to be smaller and have less diverse portfolios. Plus, thrifts are now regulated under the Office of the Controller of the Currency (OCC), which adds a degree of regulatory pressure that many buyers would prefer to avoid.

Strategy Is Not Just in the Numbers

Many banks are looking to grow to survive. But prudent organic growth of more than 10 to 15 percent a year is difficult. That leaves acquisition as an alternative growth strategy.

Much of the consolidation occurring in the industry is in response to questions boards are asking due to the financial crisis and the resulting regulatory and market changes, including:

  • Are we the appropriate size to survive in today’s regulatory environment?
  • Are we in the appropriate markets to support operations and growth?
  • Do we have enough capital based upon increasing regulatory expectations?
  • Do we have the right management team to achieve growth?
  • Can we afford the specialized expertise to meet rising regulatory standards?
  • Do we have economies of scale and infrastructure to be competitive?
  • Do we have the right products, services and technology to meet the evolving needs of our customer base?
  • Do we have the energy and motivation necessary to move our organization to the next level?

The answers to these questions are the real drivers for transactions. Success in the M&A market isn’t driven by average multiples. It’s driven by strategy. That strategy should start long before a target is identified and must continue well beyond any transaction.

Buyer Perspectives

Buyers are not looking to buy just any bank. Most buyers are looking for acquisition targets that are:

  • Clean. Increased regulatory attention means that buyers are more sensitive than ever to clean loan portfolios, low non-performing assets and compliance concerns. CAMELS 1 or CAMELS 2-rated banks are attractive targets.
  • Well located. Attractive facilities in the right markets are vital. Urban and suburban banks are selling for higher multiples than rural banks. That doesn’t mean there are no opportunities in rural areas, though. With larger national banks abandoning many low-population areas, some rural banks are seizing the opportunity to use acquisitions to become the dominant brand in their specific markets.
  • Appropriate size. Larger banks are choosing larger acquisition targets. Smaller transactions take too much time and capital. This trend removes some of the historic active buyers in the smaller community bank space.
  • Market demographics and product mix. Banks looking to branch out into new customer segments or to expand their product offerings may consider these issues the same or even more heavily than the target’s geographical footprint.
  • Solid management. Banking has seen a talent drain in recent decades as many candidates who once might have chosen a banking career have instead opted for investment banking or other options. The result is a shortage of management talent in the banking industry today. Banks with solid management teams who are likely to stay on after the transaction are particularly attractive.

Seller Perspectives

Sellers have their own set of motivations. Sales are driven by a variety of concerns, including:

  • Age. Older owners, board members and executive management may want out of the industry.
  • Regulatory concerns. Many smaller banks are finding it hard to deal with the increased regulatory burden using their limited resources. Constraints on their activities due to new regulations are also squeezing profits. Finally, the risks associated with regulatory failures are an increasing concern. Directors, too, are concerned about their increased liability exposure.
  • Return on investment. For banks with the right risk and market characteristics, the current deal environment offers an excellent opportunity to realize a solid return for their investors.

New buyers are also entering the market, including payday and other specialty lenders, off-shore buyers and Native American tribes, but thus far with limited success. Based on increasing values and regulatory issues, we anticipate more growth in M&A activity in 2014 than we saw in 2013. In any case, it’s a good time to consider your options.

Jeff Baker

Bob Browne