Bank acquisitions rise in first quarter, but not by much


Top dealmakers include Sandler O’Neill & Partners, Raymond James & Associates and Keefe, Bruyette & Woods 

Top dealmakers by volume

Top dealmakers by number of deals

There weren’t a lot of fish to be had, but Sandler O’Neill & Partners took the bigger fish. With 34 total bank and thrift acquisitions worth just $2.3 billion in the first quarter, the firm’s investment bankers were the top dealmakers by volume in the first quarter, after handling the $1 billion Comerica Inc. acquisition of Sterling Bancshares, Inc., according to SNL Financial.

race-track.jpgSenior Managing Director Jimmy Dunne III of Sandler O’Neill was ranked number one with two deals worth a total $1.5 billion: He handled Comerica as well as People’s United Financial’s $489 million acquisition of Danvers Bancorp., both announced in January.

He was quickly followed by John Ziegler and Liz Jacobs, both of Sandler O’Neill & Partners, who both worked on the Comerica deal as well.

Tom Mecredy of Raymond James & Associates, Inc., and Jeff Brand and Steve Kent with Keefe, Bruyette & Woods, Inc., were the top bank deal makers by number of deals, with three deals each.

Deal volume improved in the first quarter compared to last year, with 34 deals done compared to 26 during the same quarter last year. But pricing remains lower than historic levels, with the average deal price to book value at 103.2 percent in the first quarter, down from 123.7 percent a year ago.

Last year, there were more than 170 bank mergers and acquisitions announced worth about $12 billion, compared to 296 in 2006 worth $109 billion, according to SNL.

What Is Your Bank’s Number?


The banking industry is poised for a rebound in merger and acquisition activity, which raises the fundamental question of what a bank is worth and how the board and its advisers should derive that number. The art of valuation can be mystifying and the terminology confusing. Every director at one time or another has seen industry data on values, but converting that data into a meaningful picture of a bank’s value requires an understanding of what drives value and how the process works. Understanding the valuation process can help bank directors and top managers better understand the valuation report.
 
Levels of Value 

When determining the value of your bank, you need to consider the purpose of the valuation and the type of value you need for that purpose.

controlling interest value is what an outside party would pay for ownership of the bank. It is often defined as ownership of more than 50 percent. In banking, however, control is typically the result of an acquisition or, in more recent years, a significant recapitalization.

marketable minority interest is the value of a bank’s publicly traded stock on an exchange or other over-the-counter market. A marketable minority interest can be traded without restrictions. Since it is a minority interest, the ownership level is below 50 percent or is such that the owner can’t effect changes that a controlling owner would be able to.

non-marketable minority interest does not have a readily traded market, and transferring the shares takes time and, potentially, can result in a price reduction. To determine a valuation for a non-marketable minority interest, some sort of discount for lack of marketability is applied to the marketable minority interest.

To arrive at this discount, two sources of data are often relied on. The first set of data stems from restricted stock studies. Restricted stocks are shares of public companies that are restricted from public trading under SEC Rule 144. Although they cannot be sold on the open market, they can be bought by qualified institutional investors. Restricted stock studies compare the price of restricted shares of a public company with the freely traded public market price on the same date. Price differences are attributed to liquidity. Many consider the discounts a reliable guide to discounts for the lack of marketability.

A second set of commonly used reference data for determining lack-of-marketability discounts is derived from pre-IPO stock studies. A pre-IPO transaction is one involving a private company stock prior to an initial public offering. Pre-IPO studies compare the price of the private stock transaction with the public offering price. The percentage below the public offering price at which the private transaction occurred is a proxy for the discount.

Valuation Methodologies 

There are several approaches to determining a valuation.

The income approach to valuation indicates the fair value of a bank based on the value of the cash flows that it can be expected to generate in the future. A discounted cash flow (DCF) analysis is one widely accepted method of the income approach.

The DCF technique measures intrinsic value by reference to a bank’s expected annual free cash flows. Typically, this involves the use of revenue and expense projections and other sources and uses of cash. Factors that form the basis for expected future financial performance include the bank’s historical growth rate, business plans, anticipated needs for capital, and historical and expected levels of operating profitability.

An alternative method is the market approach, where a bank is valued by comparing it to publicly traded banks as well as market transactions involving banks with similar lines of business. Factors to consider when determining the comparability of publicly traded banks include asset size, products, markets, growth patterns, relative size, earning trends, loan quality and risk characteristics.

Big Challenges, Bigger Opportunities in Bank M&A


Following our 2011 Acquire or Be Acquired conference in Arizona, Nichole Jordan, Grant Thornton LLP National Banking and Securities Industry Leader, Molly Curl, Grant Thornton Bank Regulatory National Advisory Partner, and George Mark, Grant Thornton Audit Partner and New York Financial Institutions Industry Leader, discuss the important issues facing banks today and how those are likely to help drive M&A activity over the next few years.

The issues addressed include:

  • Principal drivers of M&A activity
  • Critical post-acquisition issues
  • Effects of the Dodd-Frank Act
  • Pursuing growth in the year ahead

Download a PDF of the article.

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Profit outlook for 2013: Still hobbled


Size and location will matter

What’s the outlook for community banks for the next few years? Well, not so great. That’s the view of about 30 investment bankers, equity analysts and consultants surveyed by Atlanta attorneys Jim McAlpin and Walt Moeling of Bryan Cave recently.

McAlpin said he was struck by how similar the respondents viewed the future for banking.
 
Community banks in particular have the worst prospects for profitability, in part because a lot of them relied too heavily on commercial real estate lending. Plus, bigger banks have more diversified income sources.

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“We do have some community banks that are doing very well,’’ said McAlpin. “The challenge has been the significant increase in community banks in large urban areas, where it is more difficult to compete. We believe there is going to be opportunity in suburban and rural areas (instead).”

In fact, the consistent view of the industry analysts was that banks with less than $500 million in assets will have a tough time competing anywhere outside a rural area.

“Size and scale will increasingly matter in the world of community banks,’’ the attorneys wrote in their survey summary.

The expectations for profits are more dismal the smaller the bank. The survey respondents on average expect 2013 returns on assets to be:

  • For banks under $500 million in assets: .50 to .85 percent.
  • For banks between $500 million and $1 billion in assets: .7 percent to 1 percent.
  • For banks between $1 billion and $10 billion: 1 percent to 1.25 percent.
  • For banks above $10 billion in assets: 1.25 percent to 1.3 percent.

Industry analysts also expect mergers and acquisition pricing to stay lower for years to come.

“1.5 (times) book will be the new 2.5 (times) book value of a few years ago,” Peyton Green of Sterne Agee wrote in response to the survey.

Nobody expects huge rebounds in earnings and growth, so there’s not much premium buyers will be willing to pay, analysts said.

What was the prediction for pricing in 2013?

  • Banks with less than $500 million in assets: lucky to get book value.
  • Banks with between $500 million and $1 billion in assets: 1.25 times book.
  • Banks with between $ 1 billion and $10 billion in assets: 1.25 times book to 1.5 times book.

Because of the lack of organic growth opportunities in a slow economy, bankers will focus on profitability and cutting expenses, some industry observers said. Core deposits will be significant drivers of value, the attorneys said.

“There will continue to be consolidation but viable communities will always recognize the need for a ‘local’ bank,’” the report said.

For more information, you can read the final report provided by Bryan Cave.

Where My Deals At?


Last summer, Keefe Bruyette & Wood’s released an interesting bank takeover list. It had the usual suspects — potential buyers and potential sellers — and a “surprising” third: potential buyers who could become sellers. I thought back to this report while watching a handful of videos from our annual Acquire or Be Acquired conference over the weekend. With so much discussion at AOBA centering on FDIC-assisted transactions (which we will explore in greater detail in Chicago this May), this survey came back to me as it focused on so-called open-bank consolidation, comprising potential deals that wouldn’t involve a shutdown by the FDIC first.

Quite a few presented their views on non-distressed bank mergers at our 17th annual M&A conference —  forecasting a huge wave of bank M&A driven by aging management, the need to cut expenses and boost earnings, heightened regulatory costs and more. Of course, FDIC-assisted bank transactions continue to attract strategic acquirers, and the bidding process remains competitive. So “escaping” this particular discussion at our event proved nearly impossible. Indeed, for any healthy bank, considering this type of deal as a growth strategy bears real consideration.  

Case-in-point, this short video of Ben Plotkin, Vice Chairman of Stifel Nicolaus & Co.and long-time Bank Director supporter. We asked Ben to provide his thoughts on the impact of FDIC-assisted deals on M&A activity when we were together at AOBA; take a look:

A random fact that might interest only me…

As we celebrate President’s Day today, February 22, did you know today’s federal holiday celebrates George Washington’s birthday? In fact, this is the first federal holiday to honor an American citizen — celebrated on Washington’s actual birthday in 1796 (the last full year of his presidency).

The Return of Bank M&A


Bank Director is expecting record attendance at our 2011 Acquire or Be Acquired conference which starts on Sunday, Jan. 30, in Scottsdale, Arizona, and the driving factor is probably more than the forecasted sunny skies and temperature in the low to mid-seventies. Bank merger and acquisition activity finally picked up in 2010 after two down years, and the outlook for 2011 is even better. 

It was extremely difficult to sell a bank in 2008 or 2009 because the recession brought about a significant deterioration in loan quality throughout the industry. It’s hard to put together a deal when neither buyer nor seller has confidence in their loan portfolios. The buyer worries that it could end up overpaying if the acquired institution’s loan book performs worse than expected after the deal has been consummated – and in a declining economy, asset quality tends to be a moving target. Meanwhile, the seller worries that the buyer’s currency in an all-stock deal could end up being worth less than it thought if that organization’s asset quality deteriorates unexpectedly after the transaction has closed.

As you would expect, M&A deal volume in recent years has reflected this pricing dilemma. There were 296 bank and thrift deals in 2006 with an aggregate value of almost $109 billion, according to the research mavens at SNL Financial in Charlottesville, Virginia. Total deal volume dropped slightly to 288 and the aggregate value more sharply–to $72 billion– in 2007. Then an economic tsunami washed over the U.S. banking industry and the M&A market practically disappeared. There were 144 deals in 2008 for a total of $35.6 billion and 120 deals for a paltry $1.3 billion in 2009.

The past year shows that the trend has begun to reverse itself, with a total of 176 deals for an aggregate value of approximately $12 billion, according to SNL.

Banks get sold for a variety of reasons in a normal economy. The institution’s financial performance could be lackluster and the board might lack confidence in management’s ability to improve its profitability, so it decides to reward long-suffering shareholders by selling out. Perhaps the CEO is retiring and the board doesn’t have a qualified successor in place. Or the institution might be a relatively recent start-up that had always intended to provide its investors with an exit strategy after it had been in business for a few years.

These are all valid reasons to put a bank up for sale, but that option becomes less viable in a recession when the board might not be able to find a buyer at a price that it’s willing to accept. But now that the U.S. economy seems to be on a more solid footing and the industry’s asset quality has finally stabilized, buyers and seller alike are more confident about doing deals. And the normal demand from potential sellers who were bottled up in 2007 and 2008 – when the recession acted like a cork – should help drive deal volume in 2011.

1q2011.jpg[To read more about the M&A market, check out the cover story, Eat or Be Eaten in Bank Director’s 1st quarter 2011 digital issue.]

I occasionally run into the misconception that bank CEOs and directors come to AOBA to do deals, but that’s not the case. Most bank M&A transactions are a local phenomenon involving institutions in the same or contiguous markets and are negotiated behind the scenes, often by the CEOs first and later by the boards of directors.

Most attendees come to this conference to learn. How do you determine a fair value for your institution? What are buyers looking for when they scout for acquisitions? Is this a good time to sell? How do you ward off a hostile takeover attempt if your board doesn’t want to sell?

Each year we try to put together an agenda that provides CEOs and directors with the kind of knowledge that will help them make better decisions. The event is taking place at the Hyatt Regency Scottsdale Resort at Gainey Ranch and will conclude on Tuesday Feb. 1. I’ll be spending most of that time talking to CEOs and directors, listening to presentations and trying to soak up some of that same knowledge (and a little sun, truth be told), which I will share in a post-conference blog.

So stay tuned!

 

Will 2011 be the year for bank stocks?


The bad news seems endless. Unemployment remains high. Bad real estate loans continue to hurt banks. Increased government regulation and caps on fees will hurt bank income in the future. And yet, so many bank analysts are so bullish on bank stocks in 2011.

Why?

Profitability is returning or will return this year to many mid-sized or small banks, several analysts say.

Stronger banks will be able to buy weaker rivals and grow market share. Even the investors of struggling banks stand to gain after years of misery. Their banks will get bought out at premiums compared to the disappointing prices of the last two years. 

Here is a review of what bank analysts are saying about the outlook for bank stocks in 2011 and their favorite picks:

mmosby.jpgMarty Mosby, a bank analyst at Guggenheim Partners in Memphis,
 says he thinks all of the 15 large-cap banks he covers will be profitable by the middle of this year and he projects a 30 percent stock market gain on average for his group, which includes Winston-Salem, North Carolina-based BB&T Corp., Atlanta-based SunTrust Banks, and San Francisco-based Wells Fargo & Co. 

“We believe 2011 will be the year of the recovery,’’ he says. “We will finally see banks return to the norm.”

Some banks will be better off than others in the new normal, of course.  Banks such as Wells Fargo & Co., Pittsburgh-based PNC Financial Services Group and New York-based BNY Mellon have revenue potential and strong capital, he says, which means they could buy other banks or increase dividends, always a plus for the many dividend-starved investors out there. PNC Financial Services Group reported today record profits of $3.4 billion for 2010.

Jim Sinegal, associate director of equity research at Chicago-based
Morningstar, Incexpects his top picks such as New York-based JPMorgan Chase & Co. and Wells Fargo to return 25 to 30 percent gains for investors. He hedges that a bit by saying it may happen in the next year—or two.

“We don’t see any surprises ahead that could derail something,’’ he says. “We’ll see a slow and steady improvement. Credit is slowly and steadily improving. A lot of banks already are benefiting from that. The worst loans on their balance sheets have already been charged off.” 

He even likes Charlotte, North Carolina-based Bank of America, even though other analysts are just too worried about an ongoing investigation into the bank’s foreclosure processes to recommend the stock. 

“We think the best values can be found in recovering banks,’’ he explains. “We think the stock is cheap.”

Bank of America was trading at $14.37 per share Thursday midday on the New York Stock Exchange.

jharralson.jpgJefferson Harralson, managing director in Atlanta for Keefe, Bruyette & Woods, says smaller banks might have a more difficult time seeing stock market gains this year than big banks. They could be hit hard by new regulations that limit fee income. New restrictions on debit card fees charged to merchants could limit that source of income by as much as 75 to 80 percent, he says. 

Plus, many small and even regional banks have not paid back the government for the Troubled Asset Relief Program money, which could weigh on stock prices this year as well. Investors worried the bank will be forced to raise more capital to pay back TARP won’t be eager to buy those banks.

kitzsimmons.jpgKevin Fitzsimmons, managing director at Sandler O’Neill & Partners in New York, says 36 percent of the group’s bank stocks have a buy rating, compared to 26 percent in January of last year. 

He also thinks there will be more risk in small bank stocks this year, because the heavy weight of regulation will move to smaller banks, as in rolling downhill, as regulators begin forcing those banks to recognize their problem loans.

“This is not going to be smooth going (for all banks),’’ he says. “(The market) will be selective.”

The good news is all that new regulatory pressure on small banks could lead more banks to sell out—for a premium this time.

Sinegal said recent acquisitions have netted prices at two times tangible book value for the acquiring bank, as opposed to no premium or 1.5 times book value during the last year.

“There is more optimism that the worst is behind us,’’ Fitzsimmons says. “There has been optimism that some banks will be able to go out and acquire more banks and the acquired banks can be bought at some sort of premium.”

The Recipe for Success at Reliant Bank


recipe.jpgWith the end of 2010 quickly approaching, there’s no doubt that many bankers won’t be sad to see the end of yet another tumultuous year for the financial industry. However, the outlook for this badly bruised industry is beginning to show signs of improvement per a historical trends analysis shared by Ben Plotkin, EVP and vice chairman at the investment banking firm Stifel Nicolaus Weisel, during our recent Bank Executive and Board Compensation event.

Looking Toward the Future

Looking ahead to 2011, I had the opportunity to speak with fellow Nashvillian and CEO of Reliant Bank, DeVan Ard, who coincidentally will be speaking at our upcoming Acquire or Be Acquired conference scheduled for January 29th through February 1st in Scottsdale, Arizona. After briefly catching up, DeVan reiterated to me a theme that I have heard throughout the past few months, that this is most definitely a challenging time for bankers.

But the question on my mind was how did Reliant Bank, a $400-million community bank, manage to achieve over 46% growth in assets from 2008 to 2010 despite one of the worst economic downturns this country as faced since the 1930s? The answer to that question also happens to be the focus of DeVan’s panel next month, as he and Andrew Samuel, the CEO of Tower Bancorp Inc. in Enola, PA, will share their philosophies and methods for profitably growing their institutions during these competitive and challenging times.

Recipe of Success

As a non-TARP bank, DeVan attributes the continuing success of Reliant Bank to a talented team of employees, a strong board of directors invested financially and personally into the bank, and the continued dedication of building solid customer relationships.

Although DeVan ponders if he would even join the board of a bank today with all the regulations and liability piled on already stretched bank directors, he is confident that smart business decisions and good strategic planning goes a long way. Over the next few years, as loan demand continues to decline, Reliant Bank plans to improve interest margins, reduce expenses across the institution and look for non-interest partnerships to stretch profitability rather than focus on growth.

Results vs. Regulation

The trickle down effect of regulations aimed at larger institutions will most certainly hurt many small community banks proving once again that a few bad apples spoil the bunch. But with an engaged and invested group of directors who aid in the business development of the bank and are determined to make a positive impact in their community, hopefully Reliant Bank’s results will speak louder than regulations.

The Return of Darwinian Banking


Listening to Ben Plotkin, EVP and vice chairman at the investment banking firm Stifel Nicolaus Weisel, as he provided a broad industry overview at our Bank Executive & Board Compensation event last week in Chicago, the image that came to mind was a heavy-weight boxer who has been staggered by repeated blows to the head but somehow is still standing.

Looking at the fundamentals, there’s no question that the U.S. banking industry has been bloodied by the worst economic downturn since the Great Depression of the 1930. According to Plotkin, the industry’s profitability plummeted from a high-water mark of $128.2 billion in 2006, to $97.6 billion in 2007 – to just $15.3 billion in 2008. Plotkin illustrated this on a bar chart, and that dramatic 2009 earnings decline resembled a Sears Tower elevator dropping from the top floor to darn near the basement.

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“Unreal” Earnings

Of course, we all know that industry’s record profitability from 2002 through 2006 was fueled by the bubble economy and a hyperactive mortgage market. Or as Plotkin put it, “A lot of people say those earnings weren’t real.” And indeed they weren’t considering how much of that money was given back in the form of loan and bond losses, but I think it’s also amazing that the banking industry didn’t sustain even more damage than it did.

The number of banks on the Federal Deposit Insurance Corp.’s troubled institution list rose to 829 in the second quarter of this year, but banks are dropping at a much lower rate than in the early 1990s, when the collapse of the commercial real estate market resulted in many more bank failures than we’re likely to see this time around.

Improving Trends

But there is light at the end of the tunnel for most banks, and it’s not necessarily a freight train hurtling towards them. Based on Plotkin’s numbers, it would seem that the industry’s asset quality problems have finally peaked. After rising sharply from 2006 through 2009, non-performing loans have finally leveled out and even declined slightly to about 3.2% in November. Healthy banks with strong balance sheets (including better than average asset quality) have also been able to raise capital from institutional investors.

The industry’s net interest margin (which is essentially the difference between the interest rate on a loan and all the costs associated with getting that loan) has also shown recent improvement. Through the first two quarters of 2010 the margin was approximately 3.85% — compared to 3.39% in 2006 and 3.35% in 2007, when the industry was (ironically enough) rolling in dough. Those numbers say two things to me.

One, loan pricing is gradually improving as bankers are able to charge higher rates on their loans. And two, the industry compensated for its cut-rate pricing in 2006-2007 with volume – which turned out to be a recipe for disaster.

Why would the big pension and mutual funds be willing to invest capital in a troubled industry? Perhaps because they anticipate a predatory environment in which the strong and the swift will devour the weak and the weary. “Many of the catalysts for renewal of the traditional M&A market are beginning to take shape,” Plotkin told the audience. Asset quality is slowly beginning to improve, signaling potential acquirers that the worst is over. Strong banks have access to capital, so they can afford to acquire. And banks with diminished earnings power and little or no access to institutional sources of capital may find that selling out to a more highly valued competitor is their only viable strategy to reward their long suffering owners.

It’s a Darwinian principal that has helped drive bank consolidation for the past 25 years, and no doubt for a few years more.