The 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.”