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.”

Optimists, Welcome.


Since returning from the west coast a few weeks ago, I’ve read a number of reports, white papers and yes, promotional pieces that suggest a wide-spread optimism for the financial industry in 2011. With U.S. banks expanding their loans to consumers for the first time in years, and a number of institutions releasing earnings this week (expectations are high for stellar Q4 numbers), one can see why. In fact, JPMorgan Chase may have laid the foundation when it reported a 47% jump in fourth-quarter earnings to $4.8 billion, or $1.12 per share on Friday.

So all of this enthusiasm and excitement has me grabbing as much data and financial information as possible to form my own opinions. While sifting through a number of bank analyst reports, I randomly came across a sentence on Bain‘s website that I wholly endorse: 

…turbulence does present opportunities for savvy players in all regions to out-perform the overall “average” through such means as cost reduction, strategies to gather new deposits and customers, challenging troubled competitors and, where strength exists, targeted M&A activities.

To the management consulting firm’s last point, I’ve been hearing from a number of our investment banking partners speculation that the pent up demand to buy and sell banks might pop this year. If the record numbers of officers and directors signing up to attend our annual “Acquire or Be Acquired” conference serves as an indicator, how right they will be.  
For those attending this year’s event, expect to hear the case made for buying and/or owning bank stocks thanks to “greater clarity on the regulatory front, historically attractive normalized EPS and book value multiples, and the prospect of a revival in whole bank mergers” (*I can’t claim credit for this outlook; the good folks at Stifel Nicolaus offered such an opinion in a recent analyst report entitled “Random Thoughts on Banking: Why Own Banks?”). 

In a few weeks, more than 600 of the industry’s leaders will discuss how recent financial reform (and revised capital standards) has impacted capital structure, valuation and strategic activity. And we’ll prepare for what seems inevitable: a coming wave of M&A. So are things looking up? I guess you can say all signs point to becoming cautiously optimistic. 

Opportunity is Knocking in Bank M&A


If there was one compelling theme at Bank Director’s “FDIC-Assisted Bank Deals: Opportunity Knocks” one-day seminar, which took place on Oct. 22 at the Four Seasons Hotel in Las Vegas, it’s that acquiring a failed bank from the Federal Deposit Insurance Corp. is one of the best growth options available to banks and thrifts today.
 
Although the actual structure may vary from one transaction to another, the typical FDIC-assisted deal involves a loss sharing arrangement where the agency agrees to reimburse up to 80% of losses incurred by the acquirer on “covered assets” up to a certain amount. The bank acquirer would be responsible for 20% of the losses up to the agreed upon ceiling – and 100% of the losses thereafter.

Non-Traditional Growth Opportunity

While FDIC-assisted deals offer tremendous opportunities for growth in a banking market where traditional M&A volume is at historically low levels, and where organic growth has been limited by a lackluster economy, they are a demanding and extremely complex undertaking. Interested banks are not told how many competitors are bidding for the failed institution, due diligence is limited and all deals are final – which places tremendous pressure on participants not only to submit competitive bids, but also to avoid missing something that could have serious financial ramifications later on. These are high stakes deals that place considerable pressure on the bidding institutions and their financial and legal advisors.

Not just any bank or thrift can bid on a failed bank, either. Qualified bidders must have at least a CAMEL I or II rating for capital adequacy and management. (So-called CAMEL ratings are used by federal banking regulators to assess the condition of a financial institution, with I being the highest.) And according to experts at the seminar, it also helps if the bidder has a proven track record at acquiring and integrating banks.

Future of Bank Earnings

John Duffy, CEO of investment bank Keefe Bruyette & Woods Inc. in New York, kicked off the seminar with an extensive overview of the banking industry. According to Duffy, the industry’s profitability (defined as earnings prior to taxes and loss reserve provisions) bottomed out in the second quarter of 2009, but any growth since then has been modest at best. One important bright spot is that the three-year rise in non-performing assets finally peaked in the second quarter of this year, which holds out hope that a somewhat stronger rebound in bank earnings may be in the offing.

Jeff Brand, a KBW principal who has worked on several FDIC deals in the past year, pointed out that as of Oct. 22 there were 829 banks on the FDIC’s trouble bank list. And with the agency expected to spend an estimated $60 billion over the next four years to clean up after failed banks, the market for FDIC-assisted deals should remain strong for the foreseeable future.
The regions of the country with the most failures (and therefore the greatest opportunities), according to Brand, are the Southeast, upper Midwest and West.

Tips on Making a Bid

Jim McAlpin Jr., a partner at the law firm Bryan Cave in Atlanta, advised the directors in attendance to contact the senior FDIC officials in their region even before making a bid on a failed bank. Although the FDIC is required by law to seek the lowest cost resolution when a failed bank has been placed under its control through receivership, it’s still beneficial for the agency to have had personal contact with the management team at an institution prior to the submission of a bid.

Surprisingly, McAlpin also advised that prospective bidders should attempt to talk with trouble banks in their region before they fail and are placed in receivership. The FDIC’s own watch list, as well as other easily obtained analyses that are based on public data, can help identify troubled banks that are in danger of failing. Because FDIC restrictions make it next to impossible to perform a thorough due diligence prior to submitting a bid, any insight that the bidder can glean by talking to the management team of the troubled bank beforehand can prove to be invaluable.

The bidding process is quite complex, and Rick Bennett, managing partner and leader of the bank integration practice at the New York-based consulting firm PricewaterhouseCoopers, said that bidders will need to build a sophisticated data model that will enable them to consider a variety of economic and deal structure scenarios when developing their bid. And because all FDIC-assisted deals are final, it’s crucial that potential acquirers base their bids on solid analytics.

As the old saying goes, caveat emptor!