A Challenging Deal Environment In 2023

Written by

The year ahead is likely to present a challenging environment for M&A. According to Dory Wiley, president and CEO of Commerce Street Holdings, the rising interest rate environment, possible deposit runoff and economic uncertainty are likely to tamp down deal activity in 2023. Nonbank deals could be more attractive to some buyers, in part because they draw less regulatory scrutiny. And banks focused primarily on organic growth need to shore up capital at the holding company level to make sure they have options, too.

Topics include:

  • Interest Rates’ Impact on Valuations
  • Appeal of Nonbank M&A
  • Emphasis on Capital

Banks Are Letting Deposits Run Off, but for How Long?

Written by

In September, the CEO of Fifth Third Bancorp, Tim Spence, said something at the Barclays investor conference that might have seemed astonishing at another time. The Cincinnati, Ohio-based bank was letting $10 billion simply roll off its balance sheet in the first half of the year, an amount the CEO described as “surge” deposits.

In an age when banks are awash in liquidity, many of them are happily waving goodbye to some amount of their deposits, which appear as a liability on the balance sheet, not an asset.
Like Fifth Third, banks overall have been slow to raise interest rates on deposits, feeling no urgency to keep up with the Federal Reserve’s substantial interest rate hikes this year.

Evidence suggests that deposits have begun to leave the banking system. That may not be such a bad thing. But bank management teams should carefully assess their deposit strategies as interest rates rise, ensuring they don’t become complacent after years of near zero interest rates. “Many bankers lack meaningful, what I would call meaningful, game plans,” says Matt Pieniazek, president and CEO of Darling Consulting Group, which advises banks on balance sheet management.

In recent years, that critique hasn’t been an issue — but that could change. As of the week of Oct. 5, deposits in the banking system dipped to $17.77 trillion, down from $18.07 trillion in August, according to the Federal Reserve. Through the first half of the year, mid-sized banks with $10 billion to $60 billion in assets lost 2% to 3% of their deposits, according to Fitch Ratings Associate Director Brian Thies.

This doesn’t worry Fitch Ratings’ Managing Director for the North American banking team, Christopher Wolfe. Banks added about $9.2 trillion in deposits during the last decade, according to FDIC data. Wolfe characterizes these liquidity levels as “historic.”

“So far, we haven’t seen drastic changes in liquidity,” he says.

In other words, there’s still a lot of wiggle room for most banks. Banks can use deposits to fund loan growth, but so far, deposits far exceed loans. Loan-to-deposit ratios have been falling, reaching a historic low in recent years. The 20-year average loan-to-deposit ratio was 81%, according to Fitch Ratings. In the second quarter of 2022, it was 59.26%, according to the Federal Deposit Insurance Corp.

In September, the Federal Reserve’s Board of Governors enacted its third consecutive 75 basis point hike to fight raging inflation — bringing the fed funds target rate range to 3% to 3.25%. Banks showed no signs of matching the aggressive rate hikes. The median deposit betas, a figure that shows how sensitive banks are to rising rates, came in at 2% through June of this year, according to Thies. That’s a good thing: The longer banks can hold off on raising deposit rates while variable rate loans rise, the more profitable they become.

But competitors to traditional brick-and-mortar banks, such as online banks and broker-dealers, have been raising rates to attract deposits, Pieniazek says. Many depositors also have figured out they can get a short-term Treasury bill with a yield of about 4%. “You’re starting to see broker-dealers and money management firms … promot[e] insured CDs with 4% [rates],” he says. “The delta between what banks are paying on deposits and what’s available in the market is the widest in modern banking history.”

The question for management teams is how long will this trend last? The industry has enjoyed a steady increase in noninterest-bearing deposits over the years, which has allowed them to lower their overall funding costs. In the fourth quarter of 2019, just 13.7% of deposits were noninterest bearing; that rose to 25.8% in the second quarter of 2021, according to Fitch. There’s a certain amount of money sitting in bank coffers that hasn’t left to chase higher-yielding investments because few alternatives existed. How much of that money could leave the bank’s coffers, and when?

Pieniazek encourages bank boards and management teams to discuss how much in deposits the bank is willing to lose. And if the bank starts to see more loss than that, what’s Plan B? These aren’t easy questions to answer. “Why would you want to fly blind and see what happens?” Pieniazek asks.

What sort of deposits is the bank willing to lose? What’s the strategy for keeping core deposits, the industry term for “sticky” money that likely won’t leave the bank chasing rates? Pieniazek suggests analyzing past data to see what happened when interest rates rose and making some predictions based on that. How long will the excess liquidity stick around? Will it be a few months? A few years? He also suggests keeping track of important, large deposit relationships and deciding in what circumstances the bank will raise rates to keep those funds. And what should tellers and other bank employees say when customers start demanding higher rates?

For its part, Fifth Third has been working hard in recent years to ensure it has a solid base of core deposits and a disciplined pricing strategy that will keep rising rates from leading to drastically higher funding costs. It’s been a long time since banking has been in this predicament. It’s anyone’s guess what happens next.

Will We Ever See Three Times Book Again?

Written by

Mergers and acquisitions are examined as part of Bank Director’s Inspired By Acquire or Be Acquired. Click here to access the content on BankDirector.com.

In the late 1990s, the economy was doing well.

Bank stocks traded at such rich multiples that no one batted an eye when a management team sold their bank for two times book. That valuation meant you were a mediocre bank.

Take Fifth Third Bancorp in Cincinnati. In the ‘90s, its stock traded at more than five times book value. A well run and efficient bank, it had the currency to gobble up competitors and it did.

It announced a deal in 1999 to buy Evansville, Indiana-based CNB Bancshares for 3.6 times tangible book value and 32 times earnings. “That was not completely unheard of,” says Jeff Davis, managing director at consultancy Mercer Capital. Fifth Third announced a deal in 2000 to buy Old Kent Financial Corp for a 42% premium.

In fact, Fifth Third was a little late to the M&A premium game. The average bank M&A deal price reached a peak of 2.6 times tangible book value in 1998. The median price was 24 times earnings that year.

M&A Pricing Peaked in 1998

Source: Mercer Capital, S&P Global Market Intelligence and FDIC.

It was such a hot market for bank acquisitions, investors rushed into bank stocks in order to speculate on who would get purchased next. I remember sitting down with then-president of the Tennessee Bankers Association, Bradley Barrett, in the mid-2000s. He predicted the market would fall and many banks would suffer.

Boy, was he right. He was probably the first to school me in banking cycles.

Fast forward two decades. The industry is in a relatively depressed trough for bank valuations. Selling a bank for three times book value in the 2020s seems a remote fantasy. And it is. The pandemic and the economic uncertainty that kicked off this decade took a huge chunk out of banks’ earning potential and dragged down shares. As of Feb. 2, the KBW Nasdaq Bank Index was down 4% compared to a year ago. The S&P 500 was up 18% in the same time frame.

Granted, bank stock valuations have improved during the last six months. Investors tie bank stocks to the health of the economy: When the economy is improving, so will bank stocks, the thinking goes. As pricing improves, bankers should be more interested in doing deals in 2021, Davis says. Much of bank M&A pricing is dependent on the value of the acquirer’s stock, since most deals have a stock component.

But rising stock prices haven’t translated into higher prices for deals — at least not yet. The average price to tangible book value for a bank deal at the end of 2020 was 116%, according to Davis, presenting slides during a session of Inspired by Acquire or Be Acquired.

Improved stock valuations alone can’t alleviate the pressure holding down M&A premiums. Newer loans are pricing lower as companies and individuals refinance or take on new loans at lower rates, slimming net interest margins.

Plus, investors have also been less receptive recently to banks paying big premiums for sellers, says William Burgess, co-head of investment banking for financial institutions at Piper Sandler, during an Inspired By presentation.

There’s usually a rise of mergers of equals in times after an economic crisis, and that’s exactly what the industry is experiencing. The rollout of the vaccine and improving economic conditions could lead to more confidence on the part of buyers, higher stock prices and more bank M&A. Sellers, meanwhile, are under pressure with low interest rates, slim margins and the costs of rapidly changing technology.

“We think there’s going to be a real resurgence in M&A in late spring, early summer,” Burgess says.

To see M&A pricing rise to three times book, though, interest rates would have to rise substantially, Davis says. But higher interest rates could pose broader problems for the economy, given the heavy debt loads at so many corporations and governments. Corporations, homeowners and individuals could struggle to make debt payments if interest rates rose. So would the United States government. By the end of 2020, America’s debt reached 14.9% of gross domestic product, the highest it has been since World War II. In an environment like this, it might be hard for the Federal Reserve to raise rates substantially.

“The Fed seems to be locked into a low-rate regime for some time,” Davis says. “I don’t know how we get out of this. The system is really stuck.”

Solving the Deposit Dilemma with an Unconventional M&A Strategy

Written by


merger-11-19-18.pngWe are in unprecedented times. The Fed is reversing both its zero-interest rate policy and quantitative easing (QE). Many banks have excessive loan-to-deposit (LTD) ratios, which are crimping growth and profitability. Rates on interest-bearing deposits are beginning to move upward, while deposits are starting to leave.

As banks grapple with their deposit issues, they must consider several hard truths, all of which suggest an unconventional strategy might be the best option.

M&A as a Solution?
While there is no panacea for the deposit challenge, affected banks must explore acquisitions. M&A is the one strategy that can significantly alter the balance sheet and the LTD ratio virtually overnight. M&A is an especially effective strategy in an environment in which organic growth is tough, if not impossible. However, while this strategy seems good in theory, there are three practical problems:

  1. Most banks with an LTD problem are in growth markets, yet growth markets have few banks with low LTD ratios.
  2. Those handful of banks with low LTD ratios are not for sale.
  3. Conventional valuation methods (EPS accretion, TBV dilution, etc.) won’t work, either because the acquiring bank doesn’t have strong enough currency, or the seller (if it exists) wants a valuation that appears excessive relative to recent comparable transactions.

An Unconventional Approach to M&A
Unprecedented times call for unconventional strategies. And that means community banks should consider out-of-market acquisitions, with a particular focus on lower-growth and rural markets.

This strategy can increase the number of viable targets and create significant financial value for the acquirer because of the potential deposit growth. There is also strategic value since a bank can increase its deposit portfolio, add loans in a new market, helping diversify the loan portfolio from a credit risk perspective. The bank can then deploy excess deposits into its legacy market where deposits are a scarce commodity, essentially optimizing its role as a financial intermediary.

While the acquiring bank might be concerned about its unfamiliarity with the target’s market, this is more than offset by, a more conservative lending culture, the lower “beta” of its market relative to the overall economy, and the opportunity to retain the target’s key leadership and employees, who understand the market and customers.

However, the need to retain more personnel and the absence of branch overlap also means less opportunity for cost reductions. In addition, many of these banks will demand valuations that might appear excessive if enticed to sell.

Banks lucky enough to have a fungible equity currency trading at an attractive multiple can solve this problem, but banks with out-of-balance LTD ratios are less likely to be in that situation. They must use more cash or a weaker equity currency to fund the transaction.

Conventional techniques such as EPS accretion and TBV dilution analysis cannot properly measure the impact of these transactions on shareholder value. One problem is banks often make rosy, unrealistic assumptions about loan growth, deposit growth, loan yields, and cost of funds. This sets the bar way too high, leading to lower EPS accretion, greater TBV dilution and a slower payback period.

Different analytics are required to properly value the balance sheet components of a prospective acquisition. The valuation of a target’s deposits must capture the ability to replicate such deposits with organic growth (which is just about impossible in this environment), the increase in capacity and impact on profitability to preserve or make loans with those deposits, and the downside protection the target’s deposits provide against a deposit drain caused by QE reversal.

Management teams must begin educating directors and shareholders on these challenges. Management will need to prepare their argument carefully because this strategy is counterintuitive. If the case is laid out properly, the vast majority of directors and shareholders will recognize how these types of acquisitions can ultimately maximize shareholder value.

Remember: This unconventional M&A strategy requires a first-mover advantage. A handful of banks in growth markets are already pursuing this kind of plan. In six to 12 months, expect more banks to follow suit, creating a mad rush to the proverbial rural door. By then it will be too late, as those low LTD ratio banks willing to sell will have already been picked off. Waiting until the “big fish” in your market announces an out-of-market acquisition to make it easier for you to pursue such a strategy is a mistake. This is where the CEO’s courage and leadership come in.

Many banks, especially banks in growth markets, are finding themselves at a crossroads. The urgency to grow deposits is increasing, yet the pie for deposits in the market is either not growing or shrinking. While out-of-market acquisitions might still be a long shot, they must be explored as a potential solution.

Motivating Buyers & Sellers in 2018

Written by



Several factors will drive M&A in 2018, but shareholder lawsuits will remain a fact of life for the banking industry. In this video, Josh McNulty of Bracewell LLP explains how market stability and more de novo activity could drive more deals. He also addresses how boards can minimize the risk of shareholder lawsuits.

  • Three Factors Driving Buyers
  • Barriers for Sellers
  • Outlook for Shareholder Lawsuits

Bank M&A: Pricing Considerations for 2018

Written by



Forty-four percent of the bank executives and directors responding to Bank Director’s 2018 Bank M&A Survey indicate that rising bank valuations made it more difficult to compete for acquisition targets, and higher prices didn’t result in a significant increase in deal activity in 2017. Rick Childs, a partner at survey sponsor Crowe Horwath LLP, explains how today’s environment fuels his expectations for the year, and why he thinks regulatory relief could result in fewer transactions.

  • Bank Valuations and Pricing
  • Impact of Regulatory Relief on M&A

In accordance with applicable professional standards, some firm services may not be available to attest clients. © 2018 Crowe Horwath LLP, an independent member of Crowe Horwath International. crowehorwath.com/disclosure

The M&A Limitations of Privately-Held Banks

Written by


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.

Drivers of Bank Valuation, Part II: Growing Loans and Becoming More Efficient

Written by


4-10-13_CK_Lee.pngBanks are in business to drive value—for the community, for customers and for shareholders. In our previous article we explored the concept of tangible book value (TBV) and its importance as a baseline for defining shareholder value. Growing TBV inspires confidence in the bank’s relative strength among shareholders, customers and regulators. 

We recommend boards regularly assess their internal operations and take affirmative steps to ensure more of a bank’s revenue production capability turns into TBV growth. In this article, we’ll explore two critical areas that can drive greater earnings and greater growth in the bank’s value. 

Become More Efficient

It is a truism that more efficient companies are more attractive—to investors as well as potential purchasers. If it takes less to make a dollar, greater earnings result. The earnings are then available to provide shareholders a current return on investment, through dividends or to enhance capital and support future growth. Looking at the industry data, there is a direct relationship between banks’ efficiency ratios and their earnings. In the third quarter of 2012, for example, banks with efficiency ratios of 80 percent to 100 percent earned an average of 35 basis points on assets. This compares with 84 basis points on average for banks with efficiency ratios between 60 percent and 80 percent, and a whopping average of 148 basis points on assets for banks with efficiency ratios less than 60 percent. This same pattern holds true going back several years. 

The obvious benefits to earnings of running an efficient organization is certainly payback enough for the effort involved. But controlling this process within your own boardroom is preferable to having inefficiencies dealt with through pressure from third parties, whether they are disgruntled investors, analysts or regulators. This sort of pressure can result in disruptive cost-cutting that could result in the company taking a step backwards before it can move forward. Addressing efficiency on an ongoing basis can head off these challenges, drive greater shareholder value and improve the organization’s overall strength and discipline. 

Grow Loans

The current yield curve has had a painful impact on margins at smaller banks, particularly banks with lower loan-to-deposit (L/D) ratios. So, how do you drive margin in this challenging rate environment? One answer is to make loans.

The disparities within the margin data are interesting. If you look back to the third quarter of 2009, there was little disparity in average margin between banks with higher loan balances and those with lower L/D ratios. Since then, however, margins have expanded, on average, for banks with more than 50 percent L/D (driving margins well above 4 percent), while the banks with less than 50 percent suffer margins in the low 3 percent range. This incremental disparity is a key driver of the industry’s depressed earnings profile and the low valuation placed on banks with lower loan balances.

Now, the interesting question is how to grow loans? The overall economy isn’t exactly helping. But there are steps boards and management can take to improve their ability to grow loans. These include growing the overall bank to allow access to additional customers and products through a higher legal lending limit. Other options include acquiring loan portfolios through M&A, aggressively pursuing lending staff with solid track records and books of business, partnering with nearby institutions on participations, and upgrading your pursuit of loan business within the reach and scope of the bank. Like anything else in the bank, growing loans must be a priority if the board desires to drive margin and earnings, and the managers need to be held accountable in this regard, as in any other bank priority. 

In our final article on the drivers of bank valuation, we will explore the impact of size and business diversification on bank valuation.

Lee’s comments are strictly his views and opinions and do not constitute investment advice.