Lean, Mean, Acquisition Machines: Revving Up for 2007

David Zalman, the chairman and CEO of Prosperity Bancshares in Houston, is on a roll. Over the past decade,Zalmanu00e2u20ac”with the help of his boardu00e2u20ac”has grown Prosperityu00e2u20acu2122s earnings per-share at a compounded 18% annual rate. Even today, as many other bankers struggle with flat yield curves and the like, profits are rising at a low-double-digit pace.

Location explains much of the performanceu00e2u20ac”Texas gained more population than any other state in 2006, and added 213,200 jobsu00e2u20ac”but make no mistake: the most important weapon in Zalmanu00e2u20acu2122s strategic arsenal is the acquisition. Over just the past five years, heu00e2u20acu2122s has done 14 deals, growing Prosperity into a $6.3 billion company with some 125 offices in the Lone Star Stateu00e2u20acu2122s u00e2u20acu0153golden triangleu00e2u20acu00e2u20ac”the area bounded by lines between Dallas, Houston, and San Antonio, where some 75% of the stateu00e2u20acu2122s residents live.

u00e2u20acu0153Prosperity has consolidation down to a science,u00e2u20ac says Will Luedke, a partner in the financial services practice at Houston law firm Bracewell & Giuliani, which counts the bank as a client. u00e2u20acu0153Theyu00e2u20acu2122re very efficient. In their due diligence, they know exactly where to cut the fat. And they have an eye for talent and making very smart decisions.u00e2u20ac

That acumen has, in turn,made Zalmanu00e2u20acu2122s office a sort of Texas M&A clearinghouseu00e2u20ac”a place where big out-of-state acquirers looking for instant scale (thus far in vain) might very well bump into smaller would-be sellers eager to escape the crush of operating and competitive pressures. u00e2u20acu0153We really have more banks interested in talking with us than we can give our full attention to,u00e2u20ac Zalman explains. u00e2u20acu0153But weu00e2u20acu2122ve got 700 banks in Texasu00e2u20ac”50 of them with more than $500 million in assets. Thatu00e2u20acu2122s too many. Thereu00e2u20acu2122s going to be a lot of consolidation in the next few years.u00e2u20ac

A similar sense of urgency surrounds the M&A market in California, where the economy has been strongu00e2u20ac”especially commercial real estateu00e2u20ac”but some banks have overextended themselves and are said to be partner-shopping. David Payne, chairman and CEO of $4.8 billion WestAmerica Bancorp in San Rafael, California, has several community bank targets on his radar screen and says the number of u00e2u20acu0153conversationsu00e2u20ac occurring between potential buyers and sellers is unusually high.

u00e2u20acu0153Weu00e2u20acu2122re seeing what I call u00e2u20acu02dcearnings exhaustion,u00e2u20acu2122u00e2u20ac Payne explains. u00e2u20acu0153The margin compression, the difficulties gathering depositsu00e2u20ac”the overall level of competitionu00e2u20ac”is wearing a lot of banks down and making more of them think about selling.u00e2u20ac

Even in slow-growth Ohio, the dam seems ready to burst. There, a tough state economy, based on autos and heavy manufacturing, has sparked a rash of mortgage foreclosures and made it exceedingly difficult for bankersu00e2u20ac”and there are a lot of themu00e2u20ac”to make a buck. u00e2u20acu0153At a time when thereu00e2u20acu2122s precious little growth to be had, this is a market crying out for consolidation,u00e2u20ac says Thomas Hoaglin, chairman and CEO of Huntington Bancshares in Columbus. u00e2u20acu0153We simply have too many banks chasing too little growth.u00e2u20ac

In 2006, the industry saw 278 bank and thrift deals, valued at $108.4 billion, according to SNL Financial in Charlottesville, Virginia. The volume was relatively flat compared to 2005, (and 2004 and 2003, for that matter), but the cumulative value spiked strongly, due mostly to four blockbusters priced at over $10 billion each. The whoppers included Wachovia Corp.u00e2u20acu2122s $25.5 billion deal for Golden West Financial Corp. in Oakland, California and credit-card giant Capital One Financial Corp.u00e2u20acu2122s $14.6 billion purchase of Melville,New York-based North Fork Bancorp.

How will 2007 be remembered? Listen to these bankers, and the answer appears obvious: While the details vary from region to region, the table is set for a surge in M&A activity reminiscent of the mid- and late-1990s,when 400-plus deals per-year was the norm.

For potential sellers, the tough operating environment makes partnering an attractive alternative to independence, says H. Rodgin Cohen, a partner with New York law firm Sullivan & Cromwell. u00e2u20acu0153If youu00e2u20acu2122re struggling to find even 5% growth in earnings, it leaves boards feeling more vulnerable and more willing to consider a sale.u00e2u20ac

Likewise, some buyers are looking for a jolt for the bottom line that a well-planned acquisition can provide. Steve Nelson, a principal at Hovde Financial, a Chicago investment bank, offers the example of a well-run bank trying to achieve 10% earnings growth. It might get 6% from existing operations, and another 1% through share repurchases or other financial maneuvers. u00e2u20acu0153Executing a smart acquisition well and achieving some cost savings is a really good way to make up the shortfall and keep investors happy,u00e2u20ac Nelson says.

Thatu00e2u20acu2122s part of the reasoning behind Huntingtonu00e2u20acu2122s $3.59 billion merger announced in December with in-state rival Sky Financial Group of Bowling Green. In Ohio, Hoaglin says, 5% growth is considered something of an achievement, making cost cuts an attractive alternative path to profits. The Huntington/Sky transaction is a low-premium deal thatu00e2u20acu2122s projected to produce some $115 million in cost savings. It also provides greater scale in key markets like Columbus, Toledo, and Canton. u00e2u20acu0153The two companies decided that the fundamentals in Ohio and interest-rate environment were going to remain difficult for some time, and that the best way to approach it was to partner up and cut some costs,u00e2u20ac says Scott Siefers, an analyst with New York-based investment bank Sandler Ou00e2u20acu2122Neill & Partners.

But donu00e2u20acu2122t get out the horns and party hats just yet, because thereu00e2u20acu2122s at least one significant hurdle that needs to be overcome before the M&A market can truly get rolling. Stated simply, sellersu00e2u20acu2122 pricing expectations are too high for many buyersu00e2u20acu2122 tastes. To a certain extent, thatu00e2u20acu2122s always the case. The difference today is that the operating environmentu00e2u20ac”defined as it is by the flat yield curve, margin compression, deposit competition, declining asset quality, and moreu00e2u20ac”presents too much uncertainty for many would-be acquirers to feel comfortable paying top dollar.And as things stand now, thatu00e2u20acu2122s what many sellers have been getting.

According to SNL, five of the nine biggest whole bank or thrift deals in 2006 garnered more than 20 times trailing earnings, while eight of the nine went for more than 2.5 times book value. An analysis of bank M&A transactions over the past three years by Hovde Financial found that pricing for urban banking franchisesu00e2u20ac”at an average of about 2.55 times book valueu00e2u20ac”ranks near the all-time highs of the late-1990s, the halcyon days of bank acquisition activity. (Rural bank valuations are significantly lower, at about 1.8 times book value.)

The high prices show no immediate signs of ebbing, which is great news for sellers. Indeed, one intriguing development was the February announcement that Temple-Inland Inc., whose main business is packaging, was spinning off its $16 billion Guaranty Bank subsidiary in Dallas.Many expect the unit, the biggest banking operation based in Texas, to be quickly sold. u00e2u20acu0153If youu00e2u20acu2122ve got an attractive bank and think you want to sell sometime in the next three years, the pricing makes now a good time to consider your options,u00e2u20acNelson says.

The problem in buyersu00e2u20acu2122 eyes is that weu00e2u20acu2122re not living in the go-go u00e2u20acu212290s any more. A steady stream of new competitors intent on building their businesses no matter what the short-term costsu00e2u20ac”in 2006, Florida, Georgia, and California each saw more than 20 de novo bank launches in 2006, while five other states witnessed at least eight openingsu00e2u20ac”has made pricing for loans and deposits more cutthroat than ever. In the fourth quarter, the industryu00e2u20acu2122s average net interest margin plummeted 18 basis points, to 3.2% from 3.38% a quarter earlier, according to the FDIC, with nearly two-thirds of all financial institutions reporting declines. Combine that with rising loan-loss reserves, and itu00e2u20acu2122s small wonder that banks everywhere are struggling to generate the kind of revenue and earnings growth that shareholders have come to expect in recent years.

For smaller and mid-sized banks that are among the most-likely sellers, things are especially rough. Many of these banks get the lionu00e2u20acu2122s share of their revenues from the spread, and have been trying to u00e2u20acu0153outrunu00e2u20ac the margin compression with greater loan volume, Payne says. Since there are only so many loans to go around, some bankers have been compromising on loan terms and underwriting standardsu00e2u20ac”and have sought to attract funding thatu00e2u20acu2122s either high-cost, such as CDs, or funding that is not very u00e2u20acu0153sticky,u00e2u20ac (Internet and brokered deposits).

u00e2u20acu0153Thereu00e2u20acu2122s so much pressure right now to grow revenues,u00e2u20ac Payne explains. u00e2u20acu0153You understand what some of these banks are doing, and even why theyu00e2u20acu2122re doing it.What you donu00e2u20acu2122t know are the implications three or four years down the road.u00e2u20ac

The dynamics have directors thinking harder, and quizzing managements more thoroughly than ever, about the details and impact of potential deals. In many cases, the uncertainty has left boards of potential acquirers hesitant to pull the trigger for fear of making a mistake.u00e2u20acu0153You want to buy when you understand the assets youu00e2u20acu2122re buying, and right now itu00e2u20acu2122s hard to get a handle on them,u00e2u20ac says William Ryan, chairman and CEO of TD Banknorth in Portland,Maine.

Ryan has been a voracious acquirer in recent years, but says heu00e2u20acu2122ll probably step back until thereu00e2u20acu2122s more clarity about conditionsu00e2u20ac”and more rationality in the pricing.

u00e2u20acu0153There are so many unknowns: Will nonperforming loans go higher? Will the yield curve continue to be inverted? Is the competition for deposits going to drive rates higher? u00e2u20acu00a6 Itu00e2u20acu2122s not good management to be buying at a premium into that much uncertainty.u00e2u20ac

In theory, the market should rectify the situation on its own and bring prices into balance by knocking down the multiples on banks that are struggling to live up to earnings goals. Thatu00e2u20acu2122s been the expectation for a while now, and perhaps it will eventually happen. But in todayu00e2u20acu2122s world, market mechanisms donu00e2u20acu2122t seem to be much help. In some hyped locales, such as Texas and Florida, banks that experience earnings stumbles or operational difficulties sometimes see valuations increase, because theyu00e2u20acu2122re viewed as more likely takeout candidates. u00e2u20acu0153The dynamics youu00e2u20acu2122re seeing today are pretty much every buyeru00e2u20acu2122s nightmare,u00e2u20ac Luedke says.

At first glance, this doesnu00e2u20acu2122t make much sense. With a few exceptions, the big-bank acquirers that traditionally sit at the top of the industryu00e2u20acu2122s food chainu00e2u20ac”and often set the paceu00e2u20ac”have scaled back their purchases. Theyu00e2u20acu2122re heeding a message from investors, often communicated via priceearnings multiples, to hold off from doing big deals.When is the last time you saw Wells Fargo & Co., Washington Mutual, Inc., or JPMorgan Chase & Co. buy a large bank?

U.S. Bancorp, the nationu00e2u20acu2122s No. 6 bank, landed in the investor doghouse earlier this decade after a run of large deals. Even after several years without a large transaction, it was recently trading at just 13.5 times earnings, a relatively low multiple that director and new CEO Richard Davis has taken to heart. He pledges to continue predecessor Jerry Grundhoferu00e2u20acu2122s three-year-old policy of returning four-fifths of profits to shareholders in the form of buybacks and dividends. u00e2u20acu0153Until the day we stop saying weu00e2u20acu2122re not going to return that 80%, you can count on us not doing a big deal,u00e2u20ac he says.

But big-bank restraint alone isnu00e2u20acu2122t enough to ratchet prices down, because a bevy of nontraditional buyersu00e2u20ac” insurers, investment banks, and foreign banking conglomerates among themu00e2u20ac”view the U.S. banking marketu00e2u20acu2122s return prospects as attractive. They also seem more than willing to support pricing that, through their investment prisms, doesnu00e2u20acu2122t seem all that unreasonable. The result is a boon for a select number of banks with franchises that are viewed as strategically compellingu00e2u20ac”and frustration for much of the rest of the industry.

WestAmericau00e2u20acu2122s Payne says negotiations with a potential target were moving along nicely early this year when investment bank Merrill Lynch announced a $1.8 billion acquisition of First Republic Bank, a $10.7 billion company in San Francisco. The 44% premium over First Republicu00e2u20acu2122s share price all-but destroyed Payneu00e2u20acu2122s rapport with his prey. u00e2u20acu0153The pricing expectations just rocketed up after that sale,u00e2u20ac he explains.u00e2u20acu0153I had to say,u00e2u20acu02dcI love you, but I canu00e2u20acu2122t justify that much money to my shareholderu00e2u20acu2122s.u00e2u20acu2122u00e2u20ac

Foreign banks are among the primary drivers of the pricing environment. Last year, Spainu00e2u20acu2122s Banco Bilbao Vizcaya Argentaria paid $2.2 billion for $7 billion Texas Regional Bancshares in McAllen, Texasu00e2u20ac”a deal worth 3.24 times book value and 24.3 times earnings, according to SNL. In February, it forked over another $9.7 billion for Birmingham, Alabama-based Compass Bancshares, a $34 billion company with 415 offices from Arizona to Florida. That deal was priced at 3.35 times book and 20.6 times earnings.

After the Compass deal closes, BBVA will be a top-20 U.S. bank,with 665 branches and $36 billion in depositsu00e2u20ac”impressive, but still behind foreign rivals Royal Bank of Scotland Group (owner of Providence-based Citizens Financial Corp.), HSBC Holdings, and Franceu00e2u20acu2122s BNP Paribas Group, owner of Bank of the West, all of which have bought their way into the market.

Andy Senchak, vice chairman and president of New York investment bank Keefe Bruyette & Woods, says foreign banks are willing to pay up for deals because U.S. banks look inexpensive compared to their counterparts in many European markets. It doesnu00e2u20acu2122t hurt that the U.S. regulatory system makes investing here less risky. Buying American u00e2u20acu0153is cheap from both a risk/reward and cost-of-capital point of viewu00e2u20ac”especially when they have to pay five times book for a bank in the Balkan states or Eastern Europe,u00e2u20ac Senchak explains. u00e2u20acu0153So their home constituents might ask, u00e2u20acu02dcWhy are you buying in the States?u00e2u20acu2122 But they have a ready answer: u00e2u20acu02dcItu00e2u20acu2122s better-priced, and right now the dollar is attractively valued for a foreign buyer.u00e2u20acu2122u00e2u20ac

If the world were filled with nontraditional buyers willing and able to pay outsized premiums, then all would be good.But the numbers and buying power of those players are limited. So if thereu00e2u20acu2122s to be an M&A boomu00e2u20ac”or even a boomletu00e2u20ac”itu00e2u20acu2122s the U.S. banks that will need to fuel it.

The good news is that American banks, especially the large ones, are still willing to pay strong premiums for smaller acquisitions that fill important strategic holes. u00e2u20acu0153The big buyers are more selective today,u00e2u20ac says Hovdeu00e2u20acu2122s Nelson.u00e2u20acu0153Theyu00e2u20acu2122ll say,u00e2u20acu02dcI want to grow in Dallas or Seattle, and these are the three or four targets weu00e2u20acu2122re interested in.u00e2u20acu2122 If one of those properties comes up, theyu00e2u20acu2122re willing to pay full price and then some.u00e2u20ac Adds Senchak: u00e2u20acu0153Todayu00e2u20acu2122s consolidation is occurring in a finer-grain state. The pieces that are being put in place are smaller; the moves are being thought out by boards and managements much more thoroughly.u00e2u20ac

In recent years, some well-known banks, including Cincinnatiu00e2u20acu2122s Fifth Third Bancorp and Cleveland-based National City Corp., have paid big premiums for banks in places like Florida or Arizona to improve their growth prospects. But itu00e2u20acu2122s not only the big guys who are pursuing such transactions. Some community banks, enabled by technology to run far-flung operations, also have been moving outside their home geographies.One example: Fort Dodge, Iowa-based Stark Bank Group Ltd., a $1 billion company that in 2006 acquired Pelican Financial Inc., a $200 million bank based in Naples, Florida.

Nelson, who advised Pelican on the transaction, says such deals are attractive all around: the seller gets a big payout for shareholders and retains local management,because thereu00e2u20acu2122s no physical overlap.The buyer,meanwhile, get access to better demographics.u00e2u20acu0153Theyu00e2u20acu2122ll say, u00e2u20acu02dcIu00e2u20acu2122ve got this cash-cow operation in the Midwest thatu00e2u20acu2122s throwing off good money, and we need to deploy that capital into higher-growth areas,u00e2u20acNelson explains.u00e2u20acu0153Both sides win.u00e2u20ac

The problem, Payne says, is that when an acquirer pays up for a transaction, it reinforcesu00e2u20ac”or boostsu00e2u20ac”the pricing expectations of sellers whose franchises might not be as attractive. He points to two recent smaller deals in northern California as examples:Wells Fargou00e2u20acu2122s $645 million purchase of Sacramento-based Placer Sierra Bancshares, (about four times tangible book value) and Portland, Oregon-based Umpqua Holdings Corp.u00e2u20acu2122s $156 million acquisition of North Bay Bancorp in Napa, California (2.8 times tangible book).u00e2u20acu0153If any one buyer jumps out and pays an aggressive price for a bank in your market, that establishes the standard by which all other sellers operation,u00e2u20ac Payne says.u00e2u20acu0153And then youu00e2u20acu2122re screwed.u00e2u20ac

All of this makes the dynamics of the present market particularly tricky for boards.On the selleru00e2u20acu2122s side, many boards continue to pursue sales due to such traditional concerns as succession planning, board splits, and capital concerns that are only tangentially connected to the operating environment. In January,TD Banknorth closed on a $480 million deal for Interchange Financial Services Corp., a 30-branch, $1.6 billion operation based in Saddle Brook, New Jersey. The primary reason, says Ryan, was that Interchange CEO Anthony Abbate, 67,was ready to retire and didnu00e2u20acu2122t have a replacement lined up. u00e2u20acu0153It spooks a lot of boards, trying to bring in a stranger to run the bank,u00e2u20acRyan says.

Other bank boards are being scared off by regulatory and compliance hassles. Jeffery Smith, partner in the financial services practice at law firm Bricker & Eckler in Columbus, says itu00e2u20acu2122s not unusual to see a publicly traded $300 million bank paying close to $300,000 a year on compliance efforts. u00e2u20acu0153All the regulatory pressures and costs are limiting the abilities of managements and boards to focus on strategy and earnings,u00e2u20ac Smith says. u00e2u20acu0153So you have many concluding that it makes sense to explore a sale.u00e2u20ac

Thereu00e2u20acu2122s also a growing subset of banks that were launched earlier this decade for the express purpose of being sold later. u00e2u20acu0153Weu00e2u20acu2122re seeing a number of three- to 10-year-old banks that were organized from day one with a goal of maximizing short-term value through a sale,u00e2u20ac says Walter Moeling IV, a senior partner in the banking practice of Atlanta law firm Powell Goldstein. u00e2u20acu0153With todayu00e2u20acu2122s high valuations, theyu00e2u20acu2122re saying, u00e2u20acu02dcIf someone wants to pay me three times book value, letu00e2u20acu2122s do it.u00e2u20acu2122u00e2u20ac Such decisions are usually the result of smart directors doing their homework.Most boards today conduct periodic reviews of their businesses to ascertain the institutionu00e2u20acu2122s earnings and growth prospects over the next few years, and then balance that against what could be fetched in a deal.

If the operating prospects look bright, Cohen says, u00e2u20acu0153then there isnu00e2u20acu2122t enormous pressure to sell, and you can wait for your price.u00e2u20ac Thatu00e2u20acu2122s the case with Prosperity, which has the second-largest independent franchise in Texasu00e2u20ac”and one thatu00e2u20acu2122s still producing strong numbers. Zalman claims to be feeling no pressure from shareholders, his board, or anyone else to sell.u00e2u20acu0153The bank isnu00e2u20acu2122t listed for sale,u00e2u20ac he explains. u00e2u20acu0153But the big guys talk with us regularly, and weu00e2u20acu2122re shareholder-driven. So weu00e2u20acu2122re always open to considering something that presents the right opportunity.u00e2u20ac

Thus far, Zalman adds, that u00e2u20acu0153opportunityu00e2u20ac hasnu00e2u20acu2122t emerged. Among the most important factors his board would weigh is whether a buyeru00e2u20acu2122s stock could produce the sameu00e2u20ac”or betteru00e2u20ac”shareholder returns that Prosperity has been generating. That would be difficult, given that its share price has risen about 140% over the past year, or about four times what the Philadelphia Bank Sector Index has produced. Prosperity is presently trading at about 19 times earnings, and Zalman hints that heu00e2u20acu2122s been offered about 15% over that number. u00e2u20acu0153If somebody wants to buy us, it wonu00e2u20acu2122t be at a 15% premium,u00e2u20ac he says. u00e2u20acu0153Now, if someone wants to offer somewhere in the 30% range, thatu00e2u20acu2122s something we might consider.u00e2u20ac

For banks in more challenging markets, the same calculation can yield different conclusions. In February, TD Banknorthu00e2u20acu2122s board exercised an option to sell the 49% of the company not already owned by TD Bank Financial Group to the Canadian giant for $3.2 billion.Ryan declined to discuss the reasoning in an interview, because the transaction has yet to close. But in an investor conference call following the announcement, he cited the yield curve, margin compression, and intense competition for loans and deposits as the motivation. u00e2u20acu0153It is a very difficult banking environment and should continue u00e2u20acu00a6 for the near future.u00e2u20ac

To alleviate concerns that TDu00e2u20acu2122s stock might suffer from similar challenges, TD Banknorthu00e2u20acu2122s shareholders are getting cash, which eliminates the potential for stock fluctuations to create uncertainty about the long-term price, Ryan says. Seeking cash is another big trend among sellers. According to the Hovde analysis, nearly 90% of all bank M&A deals in 2006 involved at least some cash, compared with 60% in 2000.

For the boards of buyers, meanwhile, thereu00e2u20acu2122s more pressure to get both the target and pricing correctu00e2u20ac”and that requires some hard work. At WestAmerica, directors track, monitor, and discuss the California M&A market at every board meeting, and Payneu00e2u20ac”the boardu00e2u20acu2122s lead negotiatoru00e2u20ac”provides regular updates on any active discussions in which heu00e2u20acu2122s involved. u00e2u20acu0153The directors will get an overview of the targetu00e2u20ac”the branch system, its loans and deposits, overall balance sheet, earnings streams,u00e2u20ac Payne explains. u00e2u20acu0153And as we get closer to a transaction, theyu00e2u20acu2122ll see more depth on the financial performance and due diligence workups.u00e2u20ac

Payneu00e2u20acu2122s nine-member board includes a lawyer, a former investment bank executive, and two sitting corporate presidents. While management is responsible for conducting due diligence and executing integrations, the board u00e2u20acu0153drives the process,u00e2u20ac Payne says. Members educate themselves thoroughly and always ask a lot of questions about branch overlap, economies of scale, and how product menus and cultures match up.After deals, they examine whether managementu00e2u20acu2122s projections became reality. u00e2u20acu0153Theyu00e2u20acu2122ll say, u00e2u20acu02dcYou guys said this was going to be three cents-per-quarter accretive. Thatu00e2u20acu2122s the financial plan we signed off on. Show us the three cents,u00e2u20acu2122u00e2u20ac Payne says. u00e2u20acu0153As management, that forces us to take a second look at our numbers, to make sure what weu00e2u20acu2122ve committed to is achievable.u00e2u20ac

In recent discussions,WestAmerica directors have been spending more time looking for red flagsu00e2u20ac”unusually strong short-term loan growth, for instance, or deposits that are priced too highu00e2u20ac”and digging behind the wouldbe acquireeu00e2u20acu2122s recent numbers to determine the u00e2u20acu0153real earnings stream,u00e2u20ac lest WestAmerica wind up buying a bank thatu00e2u20acu2122s been gussied up for sale.u00e2u20acu0153As a buyer, you canu00e2u20acu2122t afford to make a mistake and price off of earnings that canu00e2u20acu2122t be sustained,u00e2u20ac Payne explains.

Huntingtonu00e2u20acu2122s board, which aims to do more deals once the Sky franchise is integrated, employs its own set of criteria in assessing potential deals: u00e2u20acu0153Will it substantially increase our market share? Can we retain the local management? What sort of organizational model does it use?u00e2u20ac Hoaglin asks.u00e2u20acu0153Cultural fit is very important.Weu00e2u20acu2122re a decentralized operating company, so if a target bank is centralized, thatu00e2u20acu2122s less attractive to us.u00e2u20ac

Given Huntingtonu00e2u20acu2122s focus on Ohio, cost savings are considered crucial when weighing the price. u00e2u20acu0153We need the expense synergies to exceed the premium thatu00e2u20acu2122s being offered to the seller,u00e2u20ac Hoaglin explains. u00e2u20acu0153If they donu00e2u20acu2122t, then weu00e2u20acu2122re putting our shareholders at risk.u00e2u20ac The board reviews these criteria regularly, discussing tweaks as market conditions demand, with an eye for pouncing on opportunities when theyu00e2u20acu2122re presented. u00e2u20acu0153You want your screening criteria in place in advance, so you can quickly determine if a prospective candidate is of interest,u00e2u20acHoaglin says.

All this increased diligence by boards, combined with the fluidity of the operating conditions and continued high prices, could leave 2007 remembered as a year of unfulfilled promises. Then again, whou00e2u20acu2122s to say for sure? Sellersu00e2u20acu2122 asking prices could adjust downward, or buyers might conclude that paying up for more deals makes sense. Mergers of equals, such as the recent combination of Bank of New York and Mellon Financial Corp., also could become more prevalent.

Less than two years ago, there were nearly a dozen large independents in Texasu00e2u20ac”including Amegy Bancorp in Houston, McAllen-based Texas Regional Bancshares, and Texas United Bancshares in LaGrangeu00e2u20ac”all claiming the future was too bright to consider selling. Those three have since sold outu00e2u20ac”Texas United to Prosperity for $357 million in 2006u00e2u20ac”and today just a handful remain, including Prosperity, Sterling Bancshares in Houston, Texas Capital Bancshares in Dallas, and San Antoniou00e2u20acu2122s Cullen/Frost Bankers.

Prosperityu00e2u20acu2122s board is weighing all sorts of combinations, including a merger with one of its Texas kin. u00e2u20acu0153You could see us or Frost or Sterling eventually selling out to the big guys or acquiring more small banks. Or we could partner with each other. There are a lot of possibilities,u00e2u20ac Zalman says.He believes that, with the prices large outside banks are willing to pay, the chances are u00e2u20acu0153at least 70%u00e2u20ac that at least one more of the big Texas independents could be acquired by the end of this year.

History has shown that the M&A market is inherently unpredictable, prone to rapid changes. u00e2u20acu0153The reality is, all it takes is one CEO to wake up one morning and say,u00e2u20acu02dcWe really should get this deal done,u00e2u20acu2122u00e2u20ac Sullivan & Cromwellu00e2u20acu2122s Cohen says. It might not be quite that simple. But then in this kind of market, nothing else is, either.