Will 2014 Be the Year of M&A?


8-13-14-crowe.pngMany bank merger and acquisition (M&A) experts have predicted for years that consolidation would increase significantly due to pressures from regulatory burdens, lack of growth in existing markets, and aging boards and management teams that are ready to exit.

2014 might be the year when these expectations are realized. While activity the first quarter of 2014 was only slightly ahead of prior years, the second quarter saw a dramatic increase—74 deals were announced, which is the highest of any quarter since the credit crisis of 2008. Annualized, the total number of announced transactions will exceed 260, which is on par with many of the pre-crisis years of the 2000s.

The level of deal volume is below many expectations. However, historical perspective might help clarify why 2014 is shaping up to be a pretty strong year for M&A. From 1991 through mid-2014, the absolute number of deals declined over time, as has the number of available charters to acquire. The percent of charters acquired in any given year fluctuates from between 2.0 percent and 4.5 percent, with a 3.3 percent average over this period. On an annualized basis, 2014 will be close to the high of 4.5 percent, which means that 2014 could be a very good year based on the number of available charters. Regardless of any future predictions, one fact seems clear: The banking system has a capacity for a certain number of transactions in any given year, and it might be that the industry’s current pace is the maximum number of deals in a year given the number of available targets.

What has been driving deal volume in 2014? The first focus is credit quality in the industry. As illustrated in the following chart, credit quality has continued to improve industrywide, which is directly correlated to deal volume. When credit quality is poor, deal volume decreases; when credit quality improves, deal volume follows suit.

Pricing is another issue that affects deal volume. Obviously, when prices are high more sellers consider a transaction as opposed to when the prices are depressed. Over the past six years, pricing has been lower than prior to the credit crisis. It seems unlikely given accounting rules for acquisitions and the related impact on capital that the heady prices realized in the late 1990s will be reached again. There are indications of improvement in pricing, however, as many have reconciled to the new norm.

While the largest concentration of prices is slightly below tangible book value, the total percentage of deals with prices below tangible book values is smaller than in prior years and a strong band of deals with pricing of between 140 percent and 150 percent of tangible book value has emerged. In general, prices have increased from one year ago. Credit quality affects pricing, and because industrywide credit quality has improved, it should come as no surprise that pricing also has improved and that some deals that had been stalled by low pricing are seeing renewed movement.

Reviewing deal characteristics by region also shows improved credit quality and improved pricing.

The Midwest experienced the largest number of transactions, but it also includes the largest number of charters. Additionally, the average size of selling banks in the Midwest is the lowest of all regions, which is reflected in the pricing. One region that changed significantly from prior years was the Southeast. Previously, the average return on assets (ROA) of the sellers in that region was negative, and average nonperforming asset levels were very high compared to other regions. This trend has reversed, and for the first time since the credit crisis, the Southeast experienced positive average ROA and improved levels of nonperforming assets. The result is an average price-to-tangible book value in excess of 100 percent. Previously, this ratio was less than 100 percent (from 2012 through June 30, 2013). The West experienced the highest average price-to-tangible book value for the period.

*Note: Median deal values are in millions. Median assets are in thousands.

FDIC Transactions Continue to Decline
The Federal Deposit Insurance Corp. (FDIC) reported that as of March 31, 2014, there were 411 banks on the agency’s Problem Bank List—almost half of the 813 banks included at year-end 2011. As a result, the number of FDIC closures also has declined dramatically, and it appears that about 25 problem banks will be resolved through a sale in an FDIC-assisted transaction. Based on anecdotal experiences, the FDIC has been very patient with a number of the banks it is closely monitoring as many of these institutions have been able to complete recapitalizations or their credit issues have improved enough to be acquired in a non-FDIC-assisted transaction. This trend likely will continue, and the level of available transactions should be modest.

Branch Transactions Continue at Consistent Pace
Branch deal volume has been fairly consistent over the past four years and is on pace to be similar to 2012. Deposit premiums have held fairly steady at approximately 2.5 percent of deposits. For many community banks, small one- or two-branch networks are the only feasible acquisition opportunities. As larger and regional bank holding companies continue to evaluate their branch networks, there likely will continue to be acquisition opportunities available.

The Consolidation Wave That Wasn’t


wave-crash.jpgThe past three years have seen bankers and industry pundits anxiously awaiting the so-called and highly anticipated wave of consolidation in the banking industry. There are many reasons why increased consolidation is expected, including sellers with less access to capital and, therefore, less opportunity to grow independent of a merger, a belief that banks must be larger to compete and absorb the cost of regulation, a lack of organic growth in existing markets, and compressed earnings.

Despite all of these reasons —some real and some perceived—the pace of consolidation has been modest, at least compared to the predictions of the past several years, begging the question: Where is all the M&A? According to the recently released Bank Director & Crowe Horwath LLP 2013 M&A survey, two of the primary barriers to buying other banks are concerns over credit quality and unrealistic pricing expectations of sellers, both of which we’ll examine in more detail.

Credit Quality Concerns

There is a direct correlation between the level of nonperforming loans and the number of deals that are realized. The following graph illustrates the pattern between nonperforming assets (NPAs)/loans and other real estate owned (OREO) and the number of deals announced in any given year. As the graph indicates, when the level of nonperforming assets is high, the number of announced deals is low.

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The period most similar to that of the past several years is the early 1990s, when the savings and loan crisis occurred and the government established the Resolution Trust Corporation to resolve a number of failed institutions. Today, the level of nonperforming assets is still too high for many acquirers to accept. While the level has improved from its high in 2010, it is still higher than historical norms. Until loan quality significantly improves, buyers will find it difficult to pay the prices sellers are requiring.

Unrealistic Pricing Concerns

Pricing concerns from sellers is another frequently mentioned reason for deals not occurring. While sellers are not expecting the high levels that occurred pre-crisis, they aren’t willing to sell for a low price. The following graph illustrates the distribution of price to tangible book value achieved by sellers for the period beginning in January 2011 and going through Dec. 7, 2012.

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While deal prices have improved and sellers in some regions have been able to achieve prices in excess of 200 percent price to tangible book value, the majority of the deals have closed at below 110 percent price to tangible book value, and almost 40 percent of the deals have been below 100 percent price to tangible book value. For many markets, a price to tangible book value of 140 to 150 percent would be the new “gold standard.” Until this pricing ratio average improves, though, it doesn’t seem likely that the number of deals will increase dramatically.

Looking Ahead

So where will the number of deals be in 2013? Any prediction is worth the ether it’s posted in, but all indications suggest that deal volume will continue to be steady but well below the significant levels of consolidation predicted. Through Dec. 2, 2012, the number of announced whole bank deals was at 209. During the pre-crisis years of the 2000s, the number of whole bank deals per year was approximately 225 to 250. So 2012 will finish with levels below the pre-crisis normative levels, but up from 2011. In the M&A survey, we asked respondents to provide us with their expectations as to where deal volume will be in 2013. The following chart shows that the majority of the respondents believe that deal volume will be less than 200 deals, with 80 percent estimating deal volume will be less than 225 deals in 2013.

Deal Volume Expectations for 2013

>225

20%

200-225

16%

175-200

35%

<175

29%

While the wave of consolidation might eventually occur, all indications, including banks’ own expectations, suggest consolidation levels likely will remain status quo for the time being.