Deciding Whether to Sell or Go Public

10-15-14-Al-MA.pngThere is no for banks—finding and attracting the right merger partner takes time, effort and skill. While the decision to sell a company weighs heavily on every CEO, there comes a point where a deal makes too much financial and cultural sense to ignore.

Finding the right merger partner means being realistic, as two bank leaders shared with me during a recent Bank Director conference in San Francisco. David R. Brooks, the chairman and CEO at $3.7-billion asset Independent Bank Group based in McKinney, Texas, and Jim Stein, the former CEO of the Bank of Houston and now vice chairman of Independent Bank, talked about their experiences and decision to merge their banks.

While there has been an increase in bank IPOs in 2014, as Hovde Group described in a recent article, credit might be paid to one of the few banks to take the path in the wake of the financial crisis. The story of Independent Bank Group’s combination with its peer, BOH Holdings Inc. and its subsidiary bank, the Bank of Houston, begins in the summer of 2012, when Independent Bank decided to do an IPO based upon a belief that many banks would have to consider strategic alternatives coming out of the Great Recession and possibly sell.

At the time, the bank’s board placed a bet that this would result in an opportunity to consolidate significant market share in the major Texas metro areas. Brooks and his team had successfully completed four smaller bank acquisitions in the previous three years, from 2010 to 2012, ranging in assets from $40 million to $180 million—paid primarily in cash.

As Brooks explained to an audience of CEOs, CFOs and board members at the Ritz-Carlton San Francisco during Bank Director’s Valuing the Bank conference, he wanted to buy larger institutions in the $300-million to $1.5-billion asset range, but the purchase price would be significantly higher and would exceed the company’s ability to pay using cash. There also was significant resistance to sellers taking privately held stock as consideration. So, his objective was to have a strong public stock “currency” to use as a tool to execute strategy. Since the IPO, it has been clear he and his team have had success with this strategy.

The IPO raised $100 million at 2.2 times tangible book value in 2012, and the stock rose from $26 per share at issue to more than $45 per share as of last week. The company has announced eight acquisitions since 2010.

While this was going on, Jim Stein observed the success of Brooks and his team. Indeed, Stein was plotting a similar path. A de novo in March 2005, the Bank of Houston’s board found the lack of a liquid currency proved to be an impediment to successful M&A. Like Independent Bank, BOH Holdings considered an IPO in the spring of 2013 and began the process of gearing up to go public. Concurrently, Stein’s conversations with Brooks became more frequent.

For Stein, the rationale behind joining Brooks as opposed to pursuing an IPO or another suitor was simple: As Independent Bank was already public and well received, Bank of Houston could grow faster, and return better shareholder value, by teaming up with Independent Bank. Indeed, Stein knew the bank needed to expand in markets outside of Houston to achieve the highest franchise value. Doing so, however, would necessitate rebranding and loss of focus on the Houston market the bank knew very well. Thinking about the execution risks of entering new, unknown markets, the timing seemed to be ideal for the two to join forces.

Based on their relative sizes and geographic locations, Brooks and Stein both believed a deal would represent a game changing event, as adding the Metro Houston market to Independent’s existing footprint in Texas would be a huge driver of franchise value. Bank of Houston would add more than $1 billion in assets to Independent Bank when the deal closed in April 2014. The acquisition was valued at $170 million and included $34 million in cash and 3.6 million shares of Independent Bank Group’s stock at roughly $37 per share. Most importantly, the two shared similar cultures and that was vital in sealing the deal. This was especially true at the leadership level, where the two banks had similar goals and ideas and the two teams’ recognized each other’s strengths. Two Bank of Houston directors joined the board of Independent Bank Group.

It was not an easy decision to sell Bank of Houston but it has turned out well. As in dating, knowing the qualities you are looking for and being patient helps a lot.

Finding Inspiration From CIT’s Acquisition of OneWest

The key is being big enough so that you can support all of the costs of regulation.

8-15-14-al-ma.pngThat is John Thain, the CEO of the $35-billion asset CIT Group, after he announced the biggest bank M&A deal of the year, the purchase of Pasadena, California-based OneWest Bank for the equivalent of $3.4 billion in cash and stock.

Isn’t it curious that a bank that large would want to get bigger in part because of the costs of regulation? There are other benefits to the deal:

  • The transaction is immediately accretive to CIT’s earnings per share;
  • CIT’s total assets will increase to $67 billion and its total deposits will increase to $28 billion; and
  • The deal combines CIT’s national lending platform with OneWest’s 73 regional branch banking network in Southern California.

CIT has no plans to become a “serial acquirer,” of financial firms, Chief Executive Officer John Thain said on Bloomberg Television last week. Still, could this be the beginning of more traditional M&A activity, as banks try to get bigger to manage costs better, including the costs of regulation such as the Dodd-Frank Act? Thain seems to think so.

Every year, we have our mergers and acquisitions conference in Phoenix in January, Acquire or Be Acquired, the biggest event on our calendar in terms of attendance. Last year, the topic that returned again and again was the so-named mergers-of-equals (MOEs). As we discussed from the stage in Arizona, the market for such strategic mergers appeared ideal. With many noting that banking is an economy of scale business, historically low valuations meant less opportunity for a premium in a sale. With a lack of organic growth plaguing many institutions, I wasn’t surprised to see other MOEs announced in the subsequent months. (Good examples include the merger of $2-billion asset VantageSouth Bancshares and $2-billion asset Yadkin Financial Corporation, which will result in North Carolina’s largest community bank with more than 80 branches). But that environment is changing. Bank valuations are increasing, asset quality has improved, and deal premiums are making a come-back, along with the banks able to pay them.

Of course, no two deals are alike—and as the structure of certain deals becomes more complex, bank executives and boards need to prepare for the unexpected. The sharply increased cost of regulatory compliance might lead some to seek a buyer; others will respond by trying to get bigger through acquisitions so they can spread the costs over a wider base. So as I consider last year’s MOE with this summer’s CIT deal, I see a real shift happening in the environment for M&A.

I see larger regional banks becoming more active in traditional bank M&A following successful rounds of regulatory stress testing and capital reviews. Also, it appears that buyers are increasingly eyeing deposits, not just assets. This may be to prepare for an increase in loan demand and a need to position themselves for rising interest rates.

In the end, no one knows what will happen with bank M&A in the coming months, but we can guess. As Crowe Horwath LLP pointed out in a recent post, 2014 may actually turn out to be the year of M&A.

Key Ingredients for a Deal Done Right

7-21-2014-Als-Deal-Me-In-1.pngThere is a lot of talk right now about merger transactions becoming more expensive. As prices to acquire a bank rise, so too do the short and long-term risks incurred by the board of an acquiring institution. Today’s column, based on feedback from bank directors and officers, looks at the ingredients for a successful M&A deal three years down the road.

Deal Activity on the Rise
The year is shaping up to be the strongest since 1998 in terms of M&A deal flow activity as a percentage of institutions in the market, according to investment bank Raymond James. Investment bankers tout this as a wonderful development, with the Darwinian spirit of “only the strong survive” cited frequently. Efficiency and productivity continue to appear as key elements in positioning a bank for continued success. Not surprisingly, most industry insiders agree that mergers and acquisitions remain the principal growth strategy for banks today.

While we have had a few notable transactions this year, the majority of deals have been relatively small in size. Nonetheless, “it seems as though valuations have increased nicely, with the average Price to Tangible Book Value multiple standing at 1.8x today versus just 1.1x at the end of June last year. The increase in both deal multiples, and volume, is likely driven by stronger buyer currencies, improving economic conditions, and increased need for scale,” according to a research report by investment banking firm Keefe, Bruyette & Woods.

What Not to Do
This is all well and good, but what positions a deal today to look smart a few years after it closes? If you are a frequent flier, I think you might agree on what an airline merger should not look like. To see for yourself, go sit in any airport and observe the integration of American Airlines and US Airways. You will find demoralized gate agents, technologies that do not sync, marketing messages that look similar, but not the same. Does this reflect a deal done right?

Did You Know

In the first half of 2014, there were 136 acquisitions announced versus 115 announced in the first half of 2013. Moreover, total deal value is reported at $6.1 billion versus $4.6 billion in the first half of 2013.
Source: Raymond James

In many ways, the answer to what makes a good buy depends on the acquiring board’s intent. For those looking to consolidate operations, efficiencies should provide immediate benefit and remain sustainable over time. If the transaction dilutes tangible book value, investors expect that earn back within three to five years. However, some boards may want to transform their business (for instance, a private bank selling to a public bank) and those boards should consider more than just the immediate liquidity afforded shareholders and consider certain cultural issues that might swing a deal from OK to excellent.

Retaining Key Employees
Regardless, what is clear for a long-term win is the absolute need to keep a strong, committed and cohesive team in place. Living in Washington, D.C., I have seen repeated examples of a bank announcing an in-market acquisition that precipitates an almost immediate departure of key staff. Be it a star employee or an entire lending team, retention of the most valuable team members is the number one characteristic, in my opinion, of a well-done deal. These can be accomplished with retention measures and contracts for key employees, but those employees must be identified ahead of time. A close second is the ability of the newly combined leadership team to successfully balance “new” products, platforms, distribution, funding and asset generation capabilities.

Yes, the need and desire to grow exists at virtually every bank, so I anticipate more deals in the coming months. But what if you lose the staff you just paid for, right out of the gate? That is a recipe for disaster.