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.
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.
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.
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.