Cautious Optimism for Bank M&A


industry-1-29-18.pngThere is a general sense of optimism about the state of deal-making in the banking industry at Bank Director’s Acquire or Be Acquired conference in Phoenix, Arizona. Bankers and industry observers pointed repeatedly throughout the first day to the fact that bank stock valuations have soared in the 14 months since the 2016 presidential election, opening up new possibilities for interested buyers and sellers.

Bank stocks faced an uncertain if not bleak future two years ago, a point that Thomas Michaud, president and CEO of Keefe, Bruyette & Woods, used to set the scene for the state of banking in 2018. Oil prices had dropped to below $30 a barrel, economic growth in China seemed to be tempering and the United Kingdom was lurching towards a nationwide referendum on quitting the European Union. This trifecta of bad news led bank stocks to drop, producing a dour outlook for prospective sellers.

Yet, you only had to flash forward to the end of 2016 to find a dramatically altered landscape. Stocks soared following the presidential election. And no industry benefited more than banks, where share prices rose by nearly a third over the next four months. Since the beginning of 2016, large-cap bank stocks have climbed 55 percent while regional bank stocks have gained 44 percent—both having bettered the S&P 500’s 36 percent advance over the same stretch.

This has resulted in meaningfully higher valuations, a core driver of deal activity. Prior to the presidential election, banks were valued below their 15-year median of 15.2 times forward earnings per share estimates. After peaking at 18.8 times forward earnings in the immediate wake of the election, they have settled at 15.4. But even though bank valuations are up, which makes deals more attractive to buyers and sellers with higher multiples, they are nowhere near euphoric levels, given the mere 20 basis point premium over the long-run average.

Virtually everyone you talk to at this year’s gathering of more than 1,000 bankers from across the country believes there is still room for these valuations to climb even higher. This was a point made in a session on the drivers of a bank’s value by Curtis Carpenter, principal and head of investment banking at Sheshunoff & Co. Investment Banking. In just the last five weeks of 2017, six deals priced for more than two times tangible book value were announced, creating strong momentum for 2018.

Underlying all of this is an improved outlook for bank profitability, the primary determinate of valuation. In the immediate wake of the financial crisis, it was common to hear people say that banks would be lucky to return 1 percent on their assets. Now, a combination of factors is leading people like Michaud to forecast that the average bank will generate a 1.2 percent return on assets.

Multiple factors are playing into this, beginning with the pristine state of the industry’s asset quality. You have to go back to the 1970s to find the last time the current credit outlook for banks was this good, says Michaud. This has some industry observers watching closely. One of them is Tim Johnson, who leads KPMG LLP’s deal advisory financial services sector. Johnson commented in a panel discussion on deal-making that he believes the consumer credit cycle could take a turn for the worse this year. But there are others, like Tom Brown, founder and chief executive officer of the hedge fund Second Curve Capital, who doesn’t see any reason to be worried about consumer credit trends in light of the low unemployment rate and high consumer confidence.

The expected changing of the guard atop the regulatory agencies is a second factor fueling optimism that profitability will improve this year. Former banker Joseph Otting is the new comptroller of the currency, while Jerome Powell has been confirmed as the new chair of the Federal Reserve Board. Jelena McWilliams awaits confirmation by the U.S. Senate as the new chairman of the Federal Deposit Insurance Corp., and President Donald Trump is expected to nominate a new director to lead the Consumer Financial Protection Bureau. While there are few signs of tangible benefits in terms of a lower compliance burden from the new administration, this should eventually change once new leaders are in place at the top of all of the agencies.

Last but not least, the biggest boost to profitability in the industry will come from the recently enacted corporate tax cuts, which lower the corporate income tax rate from 35 percent down to 21 percent. The drop is so significant that it caused KBW to raise its earnings estimates for banks by 14 percent in 2018 and 12 percent in 2019. And when you factor in the likelihood that many banks will use the savings to buy back stock, KBW projects that earnings per share in the industry will climb this year by 25.6 percent over 2017.

The atmosphere on the first day of the conference was thus upbeat, with presenters and attendees projecting a sense of cautious optimism over the improved outlook for the industry. At the same time, there is recognition that the longer-term macro consolidation cycle that shifted into high gear following the elimination of laws against interstate banking in the mid-1990s could soon reach critical mass. If that were to happen, banks that don’t capitalize on today’s improved outlook by seeking a partner could be left standing alone at the merger alter.

Acquirers Cautious and Disciplined in 2017


merger-1-8-18.pngThe bank M&A market was no doubt a disappointment to buyers and sellers alike in 2017, because it failed to rocket skyward on the strengths of a steady economy and the Republican Party’s control of both the White House and Congress, factors that helped boost bank stock valuations for most of the year. However, higher valuations didn’t translate into a surge in deals compared to the recent past. There were 261 healthy bank acquisitions in 2017 compared to 240 deals in 2016 and 278 in 2015. If buyers had more money to spend thanks to their higher stock valuations, then sellers were expecting a higher price for the same reason, and the two factors helped cancel each other out.

Notably absent from the list of deals were the mega-transactions that in decades past both drove and defined the bank M&A market. The largest deal in 2017 was Montebello, New York-based Sterling Bancorp’s $2.3 billion acquisition of Astoria Financial Corp. in Lake Success, New York. The second largest deal last year was Memphis, Tennessee-based First Horizon National Corp.’s $2.2 billion purchase of Capital Bank Financial Corp. in Charlotte, North Carolina. Of the 25 largest deals in 2017, according to S&P Global Market Intelligence, all but the top five were valued at less than $1 billion. One reason for this has been the absence of large banks over $50 billion in assets from the market, which have largely been blocked from doing deals by their regulators since the financial crisis and passage of the Dodd-Frank Act of 2010, which subjected them to a much higher level of government oversight. Deal activity has since been driven by smaller regional banks with more limited buying capacity.

Top 10 Bank M&A Deals in 2017

Buyer State Seller State Deal Value (Millions)
Sterling Bancorp NY Astoria Financial Corp. NY $2,230
First Horizon National Corp. TN Capital Bank Financial Corp. NC $2,189
Pinnacle Financial Partners TN BNC Bancorp NC $1,732
IBERIABANK Corp. LA Sabadel United Bank N.A. FL $1,028
First Financial Bancorp. OH MainSource Financial Group IN $1,006
Valley National Bancorp NJ USAmeriBancorp FL $852
Home BancShares AR Stonegate Bank FL $781
PacWest Bancorp CA CU Bancorp CA $706
Union Bankshares Corp. VA Xenith Bankshares VA $700
South State Corp. SC Park Sterling Corp. NC $694

Source: S&P Global Market Intelligence

But even without the absence of large acquirers, bank M&A has also become a more cautious and disciplined market in recent years, including 2017. “Because there is a limited group of buyers, they can be choosey,” says Gary Bronstein, a partner at the law firm of Kilpatrick Townsend & Stockton. “They tend to be disciplined, and what we’ve experienced from representing sellers is that many times when you contact that group of buyers, they’ll give you any number of reasons why they’re not interested. Could be because they’re working on something else. Could be that they have five other deals that they’re looking at, and this doesn’t fit their criteria.”

Twelve of the 25 largest deals were market extensions where the acquirers crossed state lines in search of growth. “Serial acquirers are continuing to bolt on sensible market extension transactions, with a few in-market deals,” says Steve Kent, a managing director in the financial services group at Piper Jaffray. For example, Nashville-based Pinnacle Financial Partners’ acquisition of BNC Bancorp gives it a significant presence in North Carolina. “The deal provided Pinnacle with a new geography and reasonable market share entry into North Carolina and a platform to support future growth across a larger geographic footprint,” says Bill Hickey, a principal and co-head of investment banking at Sandler O’Neill + Partners. “Pinnacle is a very good lender on the commercial side. Bank of North Carolina is very good on the commercial real estate side, so they fit together quite well. This bank has one of the best platform for growth in the country and the team to execute on that growth strategy.”

First Horizon’s acquisition of Capital makes it the fourth largest bank in the Southeast and was the company’s first acquisition of a commercial bank since the financial crisis, when its performance suffered after the collapse of the residential mortgage market. “This is a clear announcement that they are back and looking to play in the broader Southeast again,” says Robert Klingler, a partner at the law firm Bryan Cave.

The largest acquisition last year—Sterling’s takeover of Astoria—was actually more of an in-market deal, although Sterling’s presence was largely in metropolitan New York and counties to the north, while Astoria operated primarily on Long Island. “You have a pretty nice business combination between an asset generator, which is Sterling, and a pretty good funding base, which is Astoria, with very attractive markets in Long Island and the New York metro market,” says Hickey. The deal also has the marked distinction of being just one of five transactions in the top 25 that were immediately accretive to shareholders.

One interesting footnote to the M&A market in 2017 was the decision by three active acquirers to become sellers. Capital Bank, BNC Bancorp and Park Sterling Corp. in Charlotte, which was acquired by Columbia, South Carolina-based South State Corp. in a $640 million deal, cashed out after building attractive franchises through a series of deals. That all three banks are located in North Carolina might create a dilemma for small banks in the Tar Heel State that were hoping to sell themselves to one of those institutions and now must look elsewhere for a buyer.

The M&A Limitations of Privately-Held Banks


More than half of bank executives and directors responding the Bank Director’s 2018 Bank M&A Survey see an environment that’s more favorable to deal activity, but those at privately-held institutions—which comprise 52 percent of survey respondents—are slightly more likely to see a less favorable environment for deals, and significantly more likely to expect limitations in their ability to attract an acquisition partner and complete the transaction.

In the survey, 30 percent of respondents from private banks say their bank has acquired or merged with another institution within the past three years, compared to 53 percent of respondents from publicly traded institutions. Respondents from private banks—which, it should be noted, also tend to be smaller institutions—are also less likely to believe that their bank will acquire another institution in 2018, with 47 percent of private bank respondents saying their institutions are somewhat or very likely to acquire another bank within the next year, compared to 61 percent of public bank respondents.

Rising bank valuations are largely to blame for dampened enthusiasm on the part of private banks that would like to consider acquisitions as a growth strategy, but feel excluded from the M&A market. Higher valuations mean two things. Potential sellers have higher price expectations, according to 84 percent of survey respondents. And public buyers—whose currency now holds more value in a favorable market—could have an edge in making a deal. Half of private bank respondents say that rising bank valuations have made it more difficult for the institution to compete for or attract acquisition targets, compared to 36 percent of respondents from public banks looking to acquire.

manda-bank-valuations-chart.png

For the most part, private buyers “have to do an all-cash deal,” says Rick Childs, a partner at Crowe Horwath LLP, which sponsored the 2018 Bank M&A Survey. Banks under $1 billion in assets have some flexibility in leveraging their holding company to lessen the impact on the bank’s capital ratios in such a transaction, as a small bank holding company can use debt to fund up to 75 percent of the purchase price. “I can borrow fairly easily in today’s environment at the holding company, then fuse it down into the bank and make the capital ratios acceptable, and be able to use those cash funds,” says Childs. “But it does mean that there’s an upper limit on how much [the bank] can pay because of the goodwill impact, and that I think is having a detrimental impact on [privately-held] institutions.”

Thirty-five percent of private bank respondents say they would favor an all-cash transaction if their bank were to make an acquisition, compared to 5 percent of public respondents. More than half of private bank respondents would want to structure a transaction as a combination of cash and stock—despite these banks’ stocks being thinly traded at best and relatively illiquid. Equity in the transaction “potentially adds to the pool of available shareholders who might want to buy stock back and produce a more liquid market,” says Childs. While some sellers may prefer to take stock in a deal to defer taxes until the stock can be sold, shareholders still want to know that they will be able to take that stock and cash out if desired. Private buyers that want to issue stock in the transaction should have a plan for that stock to become more liquid within a relatively short period of time, says Childs. Remember, boards have a fiduciary duty to represent their owners’ best interests. If another bank is willing to offer a deal that provides more liquidity, that’s going to be of more interest to most sellers.

manda-transaction-chart.png

For a private bank, offering a cash deal has its benefits, despite limiting the size of the target the bank can acquire. Just 39 percent of private bank directors and executives responding to the survey say they would agree to an all-stock or majority-stock transaction if the board and management team sold the bank, compared to 63 percent of public bank respondents. “For some sellers, that’s actually easier to understand, because it gives you ultimate liquidity and takes some of the decision-making anxiety out of the seller’s hands” in terms of how long the seller should hold onto the stock and how it fits within that person’s portfolio, says Childs. The tax repercussions are immediate, but the seller is also paying today’s tax rates, versus an unknown future rate that could be higher.

That’s not to say that private banks won’t make deals in 2018. Some will, of course, buy other banks. But other types of transactions could pique the interest of private institutions and be particularly advantageous. Branch deals allow banks to cherry-pick the markets they want to enter and pick up deposits at a better price, says Childs. Thirty-nine percent of respondents from privately-held banks say their institution is likely to buy a branch in 2018, compared to 30 percent of public bank respondents.

acquisition-chart.PNG

Private banks are also more inclined to acquire nondepository lines of business, as indicated by 30 percent of survey respondents from private banks, compared to 20 percent from publicly traded institutions. Acquiring wealth management firms and specialty lending shops are of particular interest to private banks, according to Childs. Both allow the institution to expand its services to customers and generate fee income without going too far afield of the bank’s primary strategic focus.

Both branch and nondepository business line acquisitions carry fewer due diligence and integration burdens as well.

Potential regulatory reform on the horizon could make the deal environment even more competitive, says Childs. Bank boards and management teams that worried about the impact of the regulatory burden on the sustainability of their bank may feel that the viability of their institution as an independent entity is suddenly more certain. “That likely lowers the pool of institutions that feel like they have to sell,” says Childs. And most bank executives and directors indicate that they want to remain independent—in this year’s survey, just 18 percent of respondents say they’re open to selling, with another 4 percent indicating their institution is considering a sale or in an agreement with another bank, and 1 percent actively seeking an acquirer.

The 2018 Bank M&A Survey gathered responses from 189 directors and executives of U.S. banks to examine the M&A landscape, M&A strategies and the economic, regulatory and legislative climate. The survey was conducted in September and October of 2017, and was sponsored by Crowe Horwath LLP. Click here to view the full results of the survey.

Sellers: Be Vigilant About Stock in a Deal


bank-stock-11-10-17.pngThrough the first nine months of 2017, the pace of bank merger and acquisitions has been up slightly from prior years in terms of the number of deals, and the strong performance of bank stocks since the U.S. Presidential election—the KBW Nasdaq Bank Index is up almost 40 percent—has led to an increase in deal prices for bank sellers in 2017. Price to tangible book value for all deals through Sept. 30, 2017, is up approximately 24 percent compared to the same nine-month period in 2016. Although sellers are happy about rising deal prices and bank stocks trading at high levels, they should consider how to protect the value of a deal in an all- or mostly-stock transaction negotiated in the period after the announcement and beyond the deal closing. Here are three considerations for boards and management teams.

1. Use a stock collar.
A stock collar allows the selling institution to walk away from the transaction without penalty, given a change in the buyer’s stock price. A double trigger often is required, meaning an agreed-upon decline in the buyer’s stock price along with a percentage deviation from a set market index. A 15 to 20 percent trigger often is used. The seller may require that a cap be used if a collar is requested. A cap would act in a similar manner as a collar and provide the buyer with the chance to walk away or renegotiate the number of shares should the buyer’s stock increase 15 or 20 percent from the announcement date. While collars and caps often are symmetrical, they do not need to be, and a higher cap percentage can be negotiated. The need for a collar tends to be driven by the buyer’s recent stock trends and financial performance.

2. Consider trading volumes and liquidity in your deliberations.
In an all-stock or a combination stock and cash deal, the seller makes a significant investment for their shareholders in the stock of the buyer. For many shareholders, this represents a significant opportunity for liquidity and wealth diversification. But these goals can be thwarted if the buyer’s stock is not liquid or doesn’t trade in enough daily volume to absorb the shares without detrimental impact. The table below indicates some of the volume and pricing differences between exchanges. The total number of shares to be issued in a transaction should be considered in comparison to the number of shares that trade on a weekly basis.

Exchange Avg Weekly Volume/Shares Outstanding (%) Number of Banks Median Price/LTM Core EPS (x) Median Price/Tangible Book (%) Median Dividend Yield (%)
Grey Mkt 0.00 8 13.60 92.38 2.07
OTC Pink 0.07 433 15.02 109.55 1.79
OTCQB 0.14 36 15.34 130.59 2.00
OTCQX 0.20 76 16.06 126.04 2.00
NASDAQ 1.18 344 19.35 184.02 1.69
NYSE MKT 0.98 6 18.88 197.00 2.10
NYSE 3.10 51 16.40 197.75 1.99

Source: S&P Global Market Intelligence as of Sept. 30, 2017
LTM: Last 12 months

3. Request reverse due diligence.
The larger a seller is in comparison to the buyer and the more stock a seller is asked to take, the more there is a need for reverse due diligence. Boards and management should require the opportunity to dig into the books and records of the buyer, when appropriate, to make sure the stock investment will provide the returns and values promised by the buyer. However, the request for reverse due diligence may be denied if the transaction is fairly small in scale for the buyer or only token amounts of stock are offered.

Reverse due diligence tends to be abbreviated compared to typical due diligence, and it’s more focused on the items that can materially affect stock price. Reverse due diligence tends to focus on items such as earnings and credit performance, regulatory issues that the risk committee is monitoring, pending litigation or other potential unrecorded liabilities, review of board and committee minutes, and dialogue around future performance and initiatives. Also, sellers should review a buyer’s stock characteristics, including reading equity analyst reports, transcripts of earnings calls, conference presentations and other public sources of information that could help to develop a holistic view of how the market might react to the transaction once it’s announced.

While no one can predict what will happen with stock prices over the next 12 months, it does seem that many believe the current run-up in bank stock prices is the result of the general election, the Federal Reserve’s increase in interest rates and expected additional rate increases. Stocks are trading at high levels, but bank sellers still need to be cautious about which stock they take in a deal.

Fifth Third CEO Says Pace of Bank Industry Change Is Fastest He’s Ever Seen


growth-6-14-17.pngWhile the audience was largely optimistic at Bank Director’s Bank Audit & Risk Committees Conference in Chicago yesterday, many of the speakers, including Fifth Third Bancorp President and CEO Greg Carmichael, hit a note of caution in a sea of smiles.

During an audience poll, 51 percent said the nation will see a period of economic growth ahead but 28 percent said the nation has hit a high point economically. Bank stock prices soared following the presidential election. Credit metrics are in good shape and profitability is up. Capital levels are higher than they’ve been in decades. And political power in Washington has turned against bank regulation, as evidenced by the U.S. Treasury Department’s recent report on rolling back the Dodd-Frank Act.

“It’s unlikely we will have increasing regulatory burdens and instead, we’ll go regulatory light,” said Steve Hovde, an investment banker and chairman and CEO of Hovde Group.

Although there’s a sense that bank stocks may be overvalued at this point, or “cantilevered over a pillar of hope,’’ as Comerica Chief Economist Robert Dye put it, the economy itself is resilient. “We’ll have another recession and we’ll get through it fine,” he said.

But financial technology is transforming the industry and creating entirely new business models, said Carmichael. That won’t be a problem for banks as long as they adapt to the change. “The volume and pace of what’s emerging is amazing,’’ he said. “I’ve never seen it before in our industry.”

Carmichael, who has an unusual background as a bank CEO—he was originally hired by the bank in 2003 to serve as its chief information officer—is working hard to transform Fifth Third.

Sixty percent of the bank’s transactions are now processed through digital channels, such as mobile banking. Forty-six percent of all deposits are handled digitally. And the bank has seen an increase of 17 percent in mobile banking usage year-over-year.

To meet the needs of its customers, Fifth Third recently announced it had joined the person-to-person payments network Zelle, an initiative of several large banks. It has a partnership with GreenSky, which will quickly qualify consumers for small dollar loans, and which Fifth Third invested $50 million into last year. Consumers can walk into a retailer such as Home Depot, order $17,000 worth of windows, and find out on the spot if they qualify for a loan.

Fifth Third is gradually reducing its branch count, and new branches are smaller, with fewer staff that can handle more tasks. Carmichael is trying to make the organization more agile, with less bureaucracy, and less cumbersome documentation.

Automation will allow the bank to automate processes “and allow us to better service our customers instead of focusing on processes that don’t add value,” he said.

Banks that are going to do better are those that can use the data they have on their customers to better serve them, he said. But when it comes to housing enormous amounts of personal and financial data on their customers, the biggest worry for bank CEOs is cybersecurity risk, Carmichael said–not the traditional commercial banking risk, which is credit.

When he was a chief information officer, executives often asked how the bank could make its network secure, and his completely honest response was, “when you turn it off.”

Adding to the cybersecurity challenge, returns on capital are low for the industry compared to other, more profitable sectors, and measures of reputation are middling for banks compared to more popular companies such as Apple, Nordstrom, Netflix and Netflix.

Carmichael encouraged banks not to get mired in pessimism.

“There’s a lot of change but we can step up and embrace it and leverage it to better serve our customers and create more value for our shareholders and contribute to the success of our communities,” he said.

Rising Stock Prices Could Impact Deal Market


stock-prices-1-19-17.pngThe year 2016 was filled with tumult and that had a negative impact on activity in the bank mergers and acquisitions (M&A) market, while higher bank stock prices are adding to the uncertainty. Will higher stock prices last? Will they lead to higher valuations in the months ahead? This article takes a look at M&A activity in 2016 with an eye toward how the environment could impact pricing and trends in 2017.

After posting 285 healthy bank acquisitions in 2014 and 279 deals in 2015, the market slipped back to 241 last year, according to data provided by S&P Global Market Intelligence. There are several reasons for this, but they can all be summed up in a single word—uncertainty. And bankers hate uncertainty like dirt hates a bar of soap.

In the first quarter of 2016, the sharp decline in the price of oil and economic softness in China and in Europe led to concerns about how that might impact the U.S. economy. There was even some talk that economic weakness abroad could result in a recession here in the United States by the end of 2016. “When oil fell off, combined with the China thing, it really took the bloom off of the rose,” says Dory Wiley, president and chief executive officer at Commerce Street Holdings, a Dallas-based investment bank. The Southwest, where Wiley works, saw a drop off in deal-making following the fall-off in oil prices. “It kind of froze all the buyers and a lot of deals, and of course sellers are always very reluctant to change their price expectations, so it slowed the amount of deals.”

The U.S. economy did not in fact slip into a recession in the second half of 2016, growing 2.9 percent in the third quarter, according to the U.S. Commerce Department. (Data for the fourth quarter was not available when this article was written.) But there was still plenty of uncertainty entering the second half of the year, which perhaps had an even more paralyzing effect on the M&A market. Once the presidential election campaign between Democrat Hillary Clinton and Republican Donald Trump had gone into full swing (both parties held their nominating conventions in July), it seems that some bank boards decided to hold off on a possible acquisition or sale in hopes that a Trump victory would create a better economic environment for banks, and have a positive impact on bank stocks.

Stocks, indeed, rose. The KBW Nasdaq Bank Index, a compilation of large U.S. national money center and regional bank stocks, expanded from 63.24 on January 19, 2016, to 75.42 on November 7, for an increase of 16 percent. However, immediately following the presidential election the index shot up from 75.42 on November 7 to 92.31 as of January 12 of this year, an increase of 22 percent. While Donald Trump’s election victory might have been received as good news by many bankers, it seems to have brought about a slowdown in M&A activity precisely because bank stock prices were going up. With valuations on the rise, some boards were reluctant to sell out if their franchise could fetch a higher price later on by waiting.

Johnathan Hightower, a partner at the law firm Bryan Cave LLP, supports this theory with data that shows a noticeable slowdown in deal flow in the fourth quarter of 2016. There were 88 announced deals in the fourth quarter of 2014 and 82 in the fourth quarter of 2015. In the final quarter of last year, the number of announced deals dropped off to 62. “I think a good bit of that can be attributed to uncertainty on the political scene,” says Hightower.

As we head into 2017, the biggest question might be how high bank stock prices will go, because continued increases may discourage M&A activity as buyers and sellers alike try to work out how deals should be valued, and what kind of structure should be used. “I think whenever you see a sharp change in valuation like we’ve seen over the past eight weeks or so, it does cause some complication in working out exchange math and exchange mechanics,” says Hightower. For example, does the seller want to lock in a fixed exchange ratio or opt for a structure that would allow the deal price to float higher if its stock price continues to rise? “The seller is doing that same sort of math on its end, so it can be hard to reach agreement, or at least require some creativity in structuring a deal,” he says.

How much higher can bank stock prices go? Jim McAlpin, who heads up the financial services practice at Bryan Cave, says he recently led a strategic planning session for the board of a Texas bank. “I was talking to the CEO about where the board was on a possible sale,” McAlpin recalls. “He said that given the recent changes [in the bank’s stock price], they’re now thinking that three times book value is possible. A year ago I would have laughed hard at that. I only chuckled this time because he said there was a bank across the street that went for 2.3 times book value. We just recently saw a bank in Georgia go for almost 2.7 [times book value] in part because of rising valuations.”

For an industry that has been dogged by low interest rates, margin pressures and economic sluggishness for several years now, the future suddenly seems very bright. But will it last? “The interesting question that no one can answer right now is, will we see a real shift in economic growth that would support an overall lift in those valuations?” asks Hightower. “Can we expect banks to have healthy, sustainable growth because we’ve got healthy, sustainable growth in the overall economy?”

Prices remained fairly steady from 2014 through 2016. According to S&P, average deal pricing was 1.42 times tangible book value in 2014, then went up slightly to 1.43 in 2015 before dipping back down to 1.35 in 2016, despite the steady run up in stock prices through the year. But we’ve now entered a period where, as the mutual fund industry likes to say, past performance may not be indicative of future results. “When you look at what the market has done in the last three to four months, with the election behind us … I don’t know that past pricing is going to be as relevant as it was,” says Wiley.

Other factors that impacted the M&A market last year include a kind of speed control that bank regulators exercise over the pace of deals. While the regulators are generally more receptive to acquisitions than they were in the years immediately after the financial crisis, and are approving deals much faster now, they still limit the frequency of deals for even experienced acquirers. “You’d be lucky to get somewhere between one and three [deals a year now],” according to Wiley. And that has added a layer of complexity to the M&A process, particularly for investment bankers. “So a guy calls you up and says, ‘Hey, run some comps, figure out what I’m worth.’ That’s not enough,” he says. “The investment banker running the deal has to know who’s in the market, who isn’t in the market and when they’re going to be in the market because it’s not an easy answer anymore.”

And because they are limited as to the pace they can string deals together, many acquirers have become more selective in what they are willing to buy. “Even with stock prices rallying like they have the last three or four months … it doesn’t mean that the acquirer can run around and just give his stock away because he’s got to be picky,” says Wiley. “He’s like, ‘Hey, I only get a couple shots at this because the regulators aren’t going to let me do anything.’’’

Does that mean it is now a buyer’s market? “I thought it was a buyer’s market for the last eight years,” says Wiley. “The only thing now is that the buyers are starting to realize it. They’ve got a big stock price now and they’re feeling good about themselves. Somebody told them they were pretty.”

Is there a Sweet Spot for Bank Stock Pricing?


stock-valuation-7-8-15.pngWhat drives bank stock valuations? Is it asset size, growth, profitability—or a combination of factors acting in concert? Keefe Bruyette & Woods Managing Director Jeffrey Wishner presented an extensive study recently at the Crowe Horwath Bank Growth & Profitability Conference in San Diego in which he examined how a variety of factors influenced the stock prices of 381 publicly held banks traded on the Nasdaq or NYSE exchanges during the first quarter of 2015.

For starters, size would seem to have a positive impact on valuations—although it is by no means a linear relationship. Wishner divided the universe of public banks into seven asset size categories, beginning with institutions having $500 million in assets or less, and ending with $50 billion in assets and above. Banks in the $5 billion to $10 billion category traded on average 1.8 times their tangible book value (TBV) in the first quarter of this year, which was the highest of any of the asset groupings. Interestingly, banks in the $10 billion to $50 billion and $50 billion and above categories had lower price-to-TBV (P/TBV) ratios—1.69x and 1.56x on average, respectively—an indication that the benefits of size dissipate as banks grow larger.

Wishner also looked at the impact that profitability had on stock prices.  Banks that had a return on average assets (ROAA) of 1 percent or better traded on average 1.59 times TBV in the first quarter. Those that had lower ROAAs had correspondingly lower P/TBV ratios. The same relationship was observed with return on tangible common equity (ROTCE): Banks that had a ROTCE of 10 percent or better traded at 1.6 times TBV while those institutions below that mark all had lower valuations.

As one might expect, banks that had solid loan growth also tended to have higher stock prices. Those that grew loans by at least 10 percent also had P/TBV ratios on average of 1.55x, while those that had lower loan growth also had lower P/TBV ratios. Loan growth became even more powerful when combined with higher efficiency, which only makes sense since more of the economic benefits are falling to the bottom line. Banks whose five-year loan compound annual growth rate (CAGR) was 10 percent or better, and also had an efficiency ratio of 60 percent or lower, traded on average 1.9 times their TBV.

Strong loan growth combined with a high ROAA produced the highest returns of all. Banks that had a five-year loan CAGR of 10 percent or higher, and a ROAA of at least 1 percent, had a median P/TBV ratio of 2.09x.

Wishner’s study uncovered some other interesting findings as well. Commercial real estate has accounted for a significant percentage of commercial loan growth in recent years, but too much of a good thing can depress valuations. Banks that had between 25 percent and 50 percent of their loans in commercial real estate traded at 1.61 times TBV, but banks that had higher concentrations also had significantly lower P/TBV ratios. Capital is another factor where having too much can negatively impact a bank’s stock price. Institutions whose ratio of tangible common equity (TCE) to tangible assets ranged between 6 and 8 percent had a P/TBV of 1.58x. Bump the TCE ratio up to a range of 8 to 10 percent and the P/TBV ratio drops to 1.4x. Increase it to 10 percent or greater and the P/TBV ratio plummets to 1.2x. Why? The higher the TCE ratio, the less leverage the bank has—which in turn drives down return on equity.

Although the banking industry tends to be obsessed with growth, it’s not what investors value the most. “The market values efficiency and profitability a little more than growth,” says Wishner.

It would be possible from Wishner’s study to construct the ideal bank from a valuation perspective. That would be a bank with assets of $5 billion to $10 billion, with strong loan growth, high efficiency, enough commercial real estate exposure to help drive profitability but not so much that it distorts the bank’s risk profile, and a TCE ratio of between 6 percent and 8 percent. Any bank that has these characteristics occupies a sweet spot in the bank stock market and should enjoy a higher valuation than many of its peers.

Investors Weigh In On Growth



A panel of three leading banking analysts from top research and brokerage firms share their insights and views on trends specific to financial institutions during Bank Director’s 2014 Acquire or Be Acquired conference in January. Moderated by Gary R. Bronstein, partner with law firm Kilpatrick Townsend & Stockton LLP, the panel discusses what bank investors consider key in terms of building a strong and profitable business.

Video Length: 46 Minutes

About The Speakers

Gary Bronstein is a partner with Kilpatrick Townsend & Stockton LLP. Gary provides a broad spectrum of strategic advice to financial institution and public company clients. He concentrates on initial public offerings and other specialized public and private capital raising transactions, M&A, proxy contests and a host of other corporate and securities law matters that arise during the life of clients.

Jefferson Harralson is the managing director, financial institutions research at Keefe, Bruyette and Woods a Stifel Company. Mr. Harralson joined KBW in 2002 and is responsible for its small and mid cap bank research groups. In 2012, Mr. Harralson was ranked as the nation’s 2nd leading regional bank analyst according to a Greenwich survey of 216 buy side firms. Mr. Harralson also heads Keefe Bruyette Woods’ southeastern bank research team, writing on 15 banks, ranging from community banks to Bank of America.

Ken Usdin is a managing director and senior research analyst at Jefferies LLC covering the U.S. banking industry. Mr. Usdin joined Jefferies LLC in 2010 and has over eighteen years of experience within the financial services industry, including fifteen years in equity research. Prior to joining Jefferies LLC, Mr. Usdin spent six years at Bank of America Merrill Lynch covering regional banks and trust/custody banks.

William Wallace is the vice president, equity research at Raymond James & Associates, Inc. He joined Raymond James in April 2011 through the acquisition of Howe Barnes Hoefer & Arnett, which he joined in October 2010. Mr. Wallace is responsible for coverage of banks and thrifts primarily located in the Mid-Atlantic and Southeast. Previously, he was an assistant vice president at FBR Capital Markets, where he assisted in the coverage of primarily mid and large cap regional and super-regional banks and thrifts. Mr. Wallace began his equity research career in 2004 at BB&T Capital Markets.

Analyst Forum Interview: Jim Sinegal


Sinegal_4-22.pngJim Sinegal, an analyst at the independent research firm Morningstar Inc., in Chicago, talked with Bank Director magazine Managing Editor Naomi Snyder in March about the recovery in bank stocks and why he likes Wells Fargo & Co., Capital One Financial Corp. and FirstMerit Corp.

There has been a huge recovery in big bank stocks in the last six months or so. How long can we expect this to last?

I think we could see a pullback. The market has gone up a lot. I wouldn’t be surprised if most of the gains are here to stay, though. The banks are in really a good position to deal with another downturn. They really have high capital levels. Earnings power has recovered. It is hard to see people getting as pessimistic as they were a year or two ago.

In November, you said the big banks were a good deal because they were trading at less than 10 times earnings, and you expected revenues to go up and expenses to come down. Their stock prices have since gone up a good deal. What do you think about that prediction?

I do think a lot of these banks were trying to cut expenses for a few years now and it will get tougher going forward. JPMorgan [Chase & Co.] recently announced additional layoffs and that’s something they are still trying to do. But we could see revenues rebound even faster than we expected.

I have heard that investors treat all the big banks the same, based on how they feel about the economy, rather than what’s happening at the individual banks. Do you agree, and do you see that changing?

I think there is a little bit of that. The banks that have had less trouble [after the financial crisis], JPMorgan and Wells Fargo, haven’t done as well [with their stock prices lately] as the banks that had trouble. The high-quality banks that didn’t have a lot of problems to fix were trading based on the economy. Bank of America Corp. and Citigroup Inc. had a lot of problems to fix so that’s one of the reasons they have performed so well. There could be a little more upside, but I would be surprised to see them rally too much.

What is your favorite stock and why?

Of the big four banks, I think we like Wells Fargo the best. It’s still the most traditional bank. It is majority funded by deposits and they have an excellent deposit base. They have funded themselves about 20 percent cheaper than their peers. Further down in size, we like [McLean, Virginia-based] Capital One Financial Corp. and [Akron, Ohio-based] FirstMerit Corp.

Capital One is a half-bank, half-credit card lender. It has really expanded so that it’s as much a bank as anything. Its reputation might have been tarnished by its past as being somewhat into subprime lending [with its credit card business]. We think it’s one of the more undervalued stocks that we cover. It’s the same story with FirstMerit. It bought Citizens Republic Bancorp [in Flint, Michigan], which had been troubled and turned itself around a lot. I think people hadn’t realized the extent that bank had improved. No one likes the Michigan economy. It’s easy to see why investors didn’t like it. The whole Midwest is the rust belt. But we think [FirstMerit is] doing a pretty good job expanding.  

What Wall Street Thinks About the Banking Industry



A panel of three leading banking analysts from top research and brokerage firms share their insights and views on macro-economic trends specific to financial institutions during Bank Director’s Acquire or Be Acquired conference in January. Moderated by Gary R. Bronstein, partner with law firm Kilpatrick Townsend & Stockton LLP, the panel discusses the impact that a slow economy and increased regulatory pressures are having on bank stocks.

Video Length: 45 Minutes

Highlights include:

  • Comparing banks to utilities
  • Regulatory impact on M&A activity
  • Future of branching 

About The Speakers

Gary Bronstein is a partner with Kilpatrick Townsend & Stockton LLP. Gary provides a broad spectrum of strategic advice to financial institution and public company clients. He concentrates on initial public offerings and other specialized public and private capital raising transactions, M&A, proxy contests and a host of other corporate and securities law matters that arise during the life of clients.

Anthony Polini is a managing director with Raymond James & Associates, Inc. Equity Research. Anthony follows banks and thrifts primarily located in the Northeast and Mid-Atlantic, as well as several large-cap banks. He began following the banking industry in 1985, when he joined Pru-Bache Securities.

Jim Sinegal is the director of financial services research at Morningstar, overseeing equity and credit coverage of more than 250 companies in the financial services industry. Jim has covered a wide range of U.S. banks, specialty finance companies and Asian financial institutions since joining Morningstar in 2007. Fred Cannon is the director of research and chief equity strategist for Keefe, Bruyette and Woods Inc. He joined KBW in 2003, providing equity research on banks and thrifts with a specialization in the mortgage sector. Over his years at KBW, Fred’s coverage has included a diverse universe of financial institutions, ranging from community and regional banks to mortgage finance companies, and has included some of the country’s largest financial institutions, including Fannie Mae, Countrywide Financial and Wells Fargo.