It’s A Whole New Ball Game

When BB&T Corp. announced a $2.5-billion acquisition of Susquehanna Bancshares Inc. in November of last year, it was a return to business as usual. As much as any bank in the country, Winston-Salem, North Carolina-based BB&T is a product of the banking industry’s dramatic consolidation over the past 25 years. Takeovers are a line of business for BB&T, just like loans and deposits, but its acquisition growth strategy had pretty much been grounded in recent years.

The acquisition of Lititz, Pennsylvania-based Susquehanna is BB&T’s largest takeover since 2009, when it acquired the failed Colonial BancGroup from the Federal Deposit Insurance Corp. (FDIC) in a government assisted deal. With $187 billion in assets, BB&T has a 12-state retail banking franchise that is centered mostly in the Southeast. Susquehanna-the second largest bank headquartered in the Keystone State, with $18.6 billion in assets-will expand BB&T’s presence in Maryland and extend its retail footprint to Pennsylvania and New Jersey.

“We’ve always had a long-term strategic focus on growing our organization so that we could become more diversified, more profitable [and provide] better returns for our shareholders,” says Kelly King, who has been BB&T’s chairman and chief executive officer since 2009. “We’ve always had a strong focus on organic growth, but we’ve [also] tried to supplement that with mergers that met our strategic requirements.”

The bank’s strategic objective is to supplement its organic growth with acquisitions that would equal between 5 and 10 percent of its asset size every year. “We’ve tried to do that for a long time,” says King. “We don’t get it done every year, but that’s what we try to do.”

BB&T isn’t the only U.S. bank that’s counting on the M&A market to help it grow over the next few years. The Great Recession might have ended in June 2009, but the economy’s expansion since then hasn’t been sufficient to stimulate a strong demand for commercial loans, which is how most banks make most of their money. The result has been a squeeze on profit margins as banks have fought like dogs for what good commercial loans are available. In the face of diminished opportunities for organic growth, it’s not surprising that so many banks are looking to M&A to make up the difference.

“I think buyers are looking at what their organic growth is and realize that doing it on their own is going to be a challenge, so they are looking for opportunities in the M&A market,” says Bill Hickey, a principal and co-head of investment banking at Sandler O’Neill + Partners. “And I think some sellers recognize that banking is more of a scale industry than it has been in the past. Who should they be thinking about as a partner, and whose currency do they ultimately want to own if they’re thinking of some kind of strategic transaction?”

After the banking M&A market tumbled to a 20-year low in 2009 of just 109 transactions, according to SNL Financial, it has gradually recovered from the effects of the crisis. There were 288 bank and thrift deals last year, which was a considerable improvement on volume of 224 deals in 2013. Not only did deal volume increase in 2014, pricing edged upwards as well. Deals were priced at an average of 139.9 percent of tangible book value, compared to 124.4 percent in 2013. The primary catalysts would seem to be a significant improvement in asset quality since the recession ended, which has given banks more confidence to pursue acquisitions, as well as a general rebound in bank stock valuations, which has allowed buyers to pay more.

“Pricing has continued to move up, and I think the reason is that [stock] valuations throughout the bank sector have improved, so buyers have a currency that is valued higher than it was a year ago, or three years ago, on a multiple basis and that allows them to pay slightly higher prices to their targets,” says Hickey.

But the bank M&A market today is very different from the one that existed prior to the global financial crisis, which left a deep and lasting imprint on the U.S. banking industry. Tough, new requirements imposed on the industry by the Dodd-Frank Act and the Basel III agreement on capital, as well as the iron hand of stricter supervision by the Office of the Comptroller of the Currency (OCC), the Federal Reserve and FDIC, have made it more difficult to get deals approved. Banks that have significant compliance issues probably won’t be permitted to do an acquisition until the problems have been resolved to their regulator’s satisfaction.

There is also a different set of buyers than those that pushed M&A volume to record levels in previous years. Regulatory concerns about the systemic risk posed by very large banks have kept them out of the M&A market in recent years. Instead, the agencies have wanted big banks to focus on raising capital, strengthening their risk management capabilities and improving their regulatory compliance.

The most likely acquirers going forward are a smaller subset of publicly traded banks, probably between $1 billion and $50 billion, with some larger banks mixed in, which have capital ratios well in excess of the required minimum, clean compliance rap sheets and a good working relationship with their primary regulators. The buying and selling of banks has been the industry’s great game for the last couple of decades, but it’s a game that not all banks can play. And for those that can play, the rules have changed.

To understand why today’s M&A market is different from past markets, it is important to understand how 30 years of consolidation-combined with the financial crisis-has profoundly changed the U.S. banking system. As the number of banks has dropped from 12,000 in 1990 to approximately 6,700 today, a greater percentage of assets have been concentrated among a relatively small number of very large banks. Some of those very large institutions-including the likes of Washington Mutual and Wachovia Corp-either failed or were acquired by healthy banks after they got into trouble.

Both Congress and the regulators became more concerned about the systemic risk that large banks could pose to the economy during a downturn, and Dodd-Frank imposed a number of restrictions and new requirements on all U.S. banks, but particularly those with $50 billion in assets or more. Among other things, banks above that size threshold have been required to strengthen their risk management capabilities and perform periodic stress tests. Adoption of the Basel III agreement also raised the minimum capital requirements for all banks, which required some of them to raise capital.

Just as significantly, the three federal bank regulators tightened their supervision of the entire industry. Community banks have not escaped this heightened level of oversight, and for the first few years after the crisis there were widespread reports from investment bankers and lawyers that the regulators were taking an inordinate amount of time to approve acquisitions. The pace of regulatory approval did seem to quicken in 2013 for deals between institutions below $50 billion, but banks above that threshold have generally been directed by their primary regulators to focus their attention on regulatory compliance-including not only the new Dodd-Frank and Basel III requirements, but long-standing regulations like the Bank Secrecy Act-rather than doing any acquisitions.

It is doubtful that the three largest U.S. banks-JPMorgan Chase & Co., Bank of America Corp. and Wells Fargo & Co.-will ever buy another depository institution since all have deposit market shares in excess of 10 percent and are prohibited under federal law from increasing that further through an acquisition. However, it does seem likely that a larger group of banks that are above the $50 billion threshold but still well below the very largest institutions will be allowed to do acquisitions. Former Comptroller of the Currency John Dugan, a partner at Covington & Burling LLP, does not believe that a regulatory stay is permanent, at least for those banks under $250 billion in assets. “I definitely do not think that is the case,” he says. “That’s not to say [that deals] are easy to do when you are above $50 billion. I think there is more scrutiny, but I definitely think you can get deals done.”

For those banks that can play the game, M&A offers a way to supplement their organic growth efforts. And there is a particular emphasis on finding a strong strategic partner in what Ben Plotkin, vice chairman at Stifel Financial Corp., describes as “transformational deals.” “What I mean by that are deals where the buyer isn’t simply looking for a bolt-on financial transaction, but for a transaction where the target company is at least 35 or 40 percent of their size and [has the potential to] really move the needle in terms of leveraging their operating expense, their risk management, their funding or their asset generation,” Plotkin says.

One example of a recent transformative deal was Portland, Oregon-based Umpqua Holdings Co.’s April 2014, $2-billion acquisition of Sterling Financial Corp., which was headquartered in Spokane, Washington. With approximately $12 billion in assets, Umpqua was uncomfortably above the $10 billion threshold at which point the regulatory compliance costs rise significantly for banks. Not only did the deal enable Umpqua to nearly double in size, to $22 billion-giving it more scale to absorb those higher costs-it also strengthened the bank’s presence in its Pacific Northwest market. Although Umpqua is still in the process of integrating the two banks, the deal was 32 percent accretive to its second quarter 2014 earnings per share.

Although Umpqua has a long track record of doing acquisitions, CEO Ray Davis insists that he still has a preference for organic growth. “If we can’t grow organically, there’s something wrong with our value proposition,” he says. “All our guns are focused on organic growth.” However, acquisitions do provide the bank with an opportunity to deploy its strong organic growth skills in new markets. Before Umpqua will consider an acquisition, it must have the potential to accomplish an important strategic objective, it must be accretive to the bank’s earnings per share and it must help it grow. “If a deal is presented to us, my first question is, ‘Why would we do this? Why are we buying these guys?’”

In the case of BB&T, Susquehanna was an attractive target because it would extend the bank’s brand into new markets and give it more geographical diversification. “We try to be in the top five in market share in the places we operate,” King says. “[Susquehanna] gave us a little bit of extra presence in West Virginia, which is an important market for us. And it gave us a really compelling opportunity in central Pennsylvania and southern New Jersey.” The Mid-Atlantic region might not have as high a growth potential as BB&T’s traditional Southeastern markets, but its economy fared better during the recession. “Diversification is a really powerful driver of ours because that is the way you provide long-term, stable and less volatile shareholder returns,” he says.

King believes that it’s harder to do a bank M&A deal today than it was before the crisis because the regulators are looking at deals much more closely now. “The mechanics are meaningfully more difficult in that you really have to be sure that the deal is going to be acceptable from a regulator perspective,” he says. “In the old days you did the deal and when you got around to it talked to the regulators about it. In today’s world you definitely better be talking to your regulators in advance about your strategies and the particular deal.”

BB&T puts a lot of time and effort into maintaining a strong relationship with its primary federal regulator, the FDIC-which like all federal bank regulators has the authority to kill any deal that it doesn’t like.

King meets regularly with BB&T’s regulators to keep them apprised of its plans. “We on at least a quarterly basis sit down with them and share with them what our plans are long term and short term and talk to them about issues and challenges,” he explains. “We have a full and complete dialogue that is non-transaction based. They know what our strategies are. They know what type of M&A plans we have. They know the kinds of candidates that we’re considering. So when [an acquisition] actually comes along it’s simply a matter of filling in the blanks.”

When considering whether to approve an M&A transaction, the regulators will look closely at the acquirer’s compliance track record, and a glaring deficiency in a critical area like anti-money laundering could be enough to torpedo the deal. But that’s not all they look at-and transformative deals will receive an especially thorough review. If the proposed transaction would greatly increase the acquiring institution’s size, the regulators will want to know that its risk management operation can be scaled up appropriately, and they will need to be satisfied that its senior management team is capable of running a larger enterprise. “You have to think about what the picture of your bank will look like post-transaction and be able to convince the regulators that you have the wherewithal to make that work,” says Dugan.

It is critically important that any banks considering the pursuit of an M&A strategy-particularly if they have never done an acquisition before-analyze their own regulatory vulnerabilities first. “You have to take a good hard look at your own situation and the situation of the target institution and decide whether you have the kinds of issues that you know are likely to cause problems,” Dugan adds. “And if you do have certain kinds of problems, it’s better to try to fix them before you even approach the regulators.”

The regulators also want to review all proposed acquisitions well before they are announced to the public. “The day is long gone where you can call the regulator on Sunday night and say in eight hours we’re announcing a deal,” says H. Rodgin Cohen, senior chairman at the law firm Sullivan & Cromwell LLP in New York. “You will have to make a presentation [to the bank’s regulators] which focuses on the key issues they are likely to be sensitive to: compliance, capital, liquidity, stress testing [results], the level of due diligence and consumer issues.” The regulators won’t green light a proposed deal prior to the submission of a formal merger application, but they might identify problem areas that could make it hard to get the transaction approved.

The consequences of announcing a deal and then finding out later that it won’t pass regulatory muster are, at the very least, embarrassing. For example, M&T Bank Corp.’s $3.7-billion acquisition of Hudson City Bancorp, which was announced in August 2012, is still waiting approval by the Federal Reserve, which put the deal on hold after it discovered deficiencies in M&T’s anti-money laundering program.

“No one wants a deal to be announced and then not consummated,” says Cohen. “Banks don’t want it, and the regulators don’t want it because it’s negative for everyone.”


Jack Milligan


Jack Milligan is editor-at-large of Bank Director magazine, a position to which he brings over 40 years of experience in financial journalism organizations. Mr. Milligan directs Bank Director’s editorial coverage and leads its director training efforts. He has a master’s degree in Journalism from The Ohio State University.

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