Due to the Covid-19 pandemic, related economic downturn and recent presidential election, 2020 was a historic year characterized by high levels of uncertainty. These circumstances resulted in a significant drop in M&A activity in the banking sector, as stock prices dropped and bankers’ focused on serving customers and supporting their staff.
Bank Director’s 2021 Bank M&A Survey, sponsored by Crowe LLP, explores this unique environment. Rick Childs, a partner at Crowe, offers his perspective on the survey results — and what they mean for 2021 — in this video.
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.”
Bank mergers and acquisitions fall apart for any number of reasons. Try doing one in a pandemic.
In March, Kenneth Mahon, CEO of $6.6 billion Dime Community Bancshares, was on the edge of announcing a major deal in the New York metropolitan area. His Brooklyn, New York-based executive team and that of $6.3 billion Bridge Bancorp in Bridgehampton, New York, had agreed to a $489 million merger of equals. Each had fully vetted the other’s balance sheets.
Then came the body bags. It was late March in New York City, which had become ground zero for one of America’s first Covid-19 death waves. Mahon remembers hearing the news that morgues were overflowing and body bags were being delivered to the city.
“We had a conversation in the next day or so about whether that was really the right time [to announce a deal],” he says.
M&A took a nose-dive in 2020, with only 112 announced deals — less than half of the announced deals from the year before, according to S&P Global Market Intelligence. That may be changing. Deal volume increased in the fourth quarter last year as stock prices improved and banks felt more comfortable about asset quality, which could lead to even more M&A ahead. But those who did get deals done during the pandemic learned a whole lot about remote consolidation and online negotiation, skills they were forced to learn quickly.
In Dime’s case, Mahon knew that putting a deal on hold is never a good thing. Rumors can spread and the news may leak, causing uncertainty among staff and impacting the value of the transaction. But this was not a good time to shake hands, in person or not. As the pandemic suspended life in New York City midstream, so it did the bank’s announcement.
It wasn’t until July that the two institutions announced the deal, after the exchange ratio of Dime stock to Bridge stock came back to the agreed upon 0.648%. Bridge CEO Kevin O’Connor will serve as CEO of the combined institution when the deal closes, which is expected within weeks. The merged banking company will have $11 billion in assets and go by the name Dime Community Bancshares. Mahon will serve as executive chairman.
Doing a deal remotely over video conferencing software hasn’t been easy. Mahon logs onto Zoom Video Communications meetings from a 400-square-foot studio apartment in Brooklyn. What is it like to build trust with a mask concealing your face? Not easy.
Mahon says he meets in person regularly with four other executives where they sit apart in a conference room and lift the masks. “Body language is important,” he says.
Curtis Carpenter, a senior managing director at investment bank Hovde Group, is amazed at how many executives and board members are still willing to travel to meet in person, jumping on private planes or flying commercially. He mostly serves banks in the Texas and Oklahoma region. One meeting was called off when one of the attendees got Covid. But mostly, people could still get together, he says.
“Everyone would wear a mask when entering the bank and when entering the conference room. In most cases, the mask would come off,” he adds. “It’s hard to have a discussion about buying and selling and executive contracts, of such an important personal nature; you want to see the person’s face.”
Others say they got a deal done without shedding the masks. “We were following appropriate safety measures,” says Keene Turner, executive vice president and CFO of $8.4 billion Enterprise Financial Services Corp. in Clayton, Missouri, which bought Seacoast Commerce Banc Holdings in San Diego for $169 million in November 2020.
The bank had already started discussions pre-pandemic with Seacoast. Executives knew each other, having first met attending a Bank Director conference years ago, Turner says. “That familiarity was built up over time,” he says. “In this case, we were comfortable with each other already.” The bank has gathered employees, all wearing a mask, to go over processes and procedures, but most meetings are remote.
Training new employees online is tricky — and so is data conversion. “It’s kind of like baptism by fire,” says Mark Tryniski, CEO of $13 billion Community Bank System in Dewitt, New York. “We had never done it that way.”
Tryniski says the bank used a lot of screen sharing and software collaboration tools in its merger with Steuben Trust Corp., which was completed in June 2020.
The pandemic created time delays and additional work for everybody.
Tupelo, Mississippi-based BancorpSouth Bank has managed two deal announcements during the pandemic. Dan Rollins III, chairman and CEO of the $24 billion bank, says his executive team ended up doing due diligence on a seller three times.
Several bankers say they think remote work is less efficient and that meetings take longer over video conferencing software, despite saving travel time. Most are eager to get back into the office again.
“If I had a choice, I wouldn’t choose to do a deal in a pandemic,” Mahon says. “It hasn’t been impossible. We have professionals who are getting it done.”
What if you answered the call to deliver two pizzas for 10,000 bitcoins in 2010?
What if Hillary Clinton lost the popular vote but won the electoral college in 2016?
Thought exercises like these can take you down the rabbit holes that many opt to avoid. But how about asking “what if” type questions as a way to embrace change or welcome a challenge?
Mentally strong leaders do this every day.
In past years, such forward-facing deliberations took place throughout Bank Director’s annual Acquire or Be Acquired conference. This year, hosting an incredibly influential audience in Phoenix simply wasn’t in the cards.
So, we posed our own “what ifs” in order to keep sharing timely and relevant ideas.
To start, we acknowledged our collective virtual conference fatigue. We debated how to communicate key concepts, to key decision makers, at a key moment in time. Ultimately, we borrowed from the best, following Steve Jobs’ design principle by working backward from our user’s experience.
This mindset resulted in the development of a new BankDirector.com platform, which we designed to best respect our community’s time and interests.
This new offering consists of short-form videos, original content and peer-inspired research — all to provide insight from exceptionally experienced investment bankers, attorneys, consultants, accountants, fintech executives and bank CEOs. Within this new intelligence package, we spotlight leadership issues that are strategic in nature, involve real risk and bring a potential expense that attracts the board’s attention. For instance, we asked:
WHAT IF… WE MODERNIZE OUR ENTERPRISE
The largest U.S. banks continue to pour billions of dollars into technology. In addition, newer, digital-only banks boast low fees, sleek and easy-to-use digital interfaces and attractive loan and deposit rates. So I talked with Greg Carmichael, the chairman and CEO of Cincinnati-based Fifth Third Bancorp, about staying relevant and competitive in a rapidly evolving business environment. With our industry undergoing significant technological transformation, I found his views on legacy system modernization particularly compelling.
WHAT IF… WE TRANSFORM OUR DELIVERY EXPECTATIONS
Bank M&A was understandably slow in 2020. Many, however, anticipate merger activity to return in a meaningful way this year. For those considering acquisitions to advance their digital strategies, listen to Rodger Levenson, the chairman and CEO of Wilmington, Delaware-based WSFS Financial Corp. We talked about prioritizing digital and technology investments, the role of fintech partnerships and how branches buoy their delivery strategy. What WSFS does is in the name of delivering products and services to customers in creative ways.
WHAT IF… WE DELIGHT IN OTHER’S SUCCESSES
The former chairman and CEO of U.S. Bancorp now leads the Make-A-Wish Foundation of America. From our home offices, I spent time with Richard Davis to explore leading with purpose. As we talked about culture and values, Richard provided valuable insight into sharing your intelligence to build others up. He also explained how to position your successor for immediate and sustained success.
These are just three examples — and digital excerpts — from a number of the conversations filmed over the past few weeks. The full length, fifteen to twenty minute, video conversations anchor the Inspired By Acquire or Be Acquired.
Starting February 4, insight like this lives exclusively on BankDirector.com through February 19. Accordingly, I invite you to learn more about Inspired By Acquire or Be Acquired by clicking here or downloading the online content package.
The nationwide pandemic and persistent economic uncertainty hasn’t slowed the growth of Idaho Central Credit Union.
The credit union is located in Chubbuck, Idaho, a town of 15,600 near the southeast corner, and is one of the fastest growing in the nation. It has nearly tripled in size over the last five years, mostly from organic growth, according to an analysis by CEO Advisory Group of the 50 fastest growing credit unions. It also has some of the highest earnings among credit unions — with a return on average assets of 1.6% last year — an enviable figure, even among banks.
“This is an example of a credit union that is large enough, [say] $6 billion in assets, that they can be dominant in their state and in a lot of small- and medium-sized markets,” says Glenn Christensen, president of CEO Advisory Group, which advises credit unions.
Unsurprisingly, growth and earnings often go hand in hand. Many of the nation’s fastest growing credit unions are also high earners. Size and strength matter in the world of credit unions, as larger credit unions are able to afford the technology that attract and keep members, just like banks need technology to keep customers. These institutions also are able to offer competitive rates and convenience over smaller or less-efficient institutions.
“Economies of scale are real in our industry, and required for credit unions to continue to compete,” says Christensen.
The largest credit unions, indeed, have been taking an ever-larger share of the industry. Deposits at the top 20 credit unions increased 9.5% over the last five years; institutions with below $1 billion in assets grew deposits at 2.4% on average,” says Peter Duffy, managing director at Piper Sandler & Co. who focuses on credit unions.
As of the end of 2019, only 6% of credit unions had more than $1 billion in assets, or 332 out of about 5,200. That 6% represented 70% of the industry’s total deposit shares, Duffy says. Members gravitate to these institutions because they offer what members want: digital banking, convenience and better rates on deposits and loans.
“The only ones that can consistently deliver the best rates, as well as the best technology suites, are the ones with scale,” Duffy says.
Duffy doesn’t think there’s a fixed optimal size for all credit unions. It depends on the market: A credit union in Los Angeles might need $5 billion in assets to compete effectively, while one in Nashville, Tennessee, might need $2 billion.
There are a lot of obstacles to building size and scale in the credit union industry, however. Large mergers in the space are relatively rare compared to banks — and they became even rarer during the coronavirus pandemic. Part of it is a lack of urgency around growth.
“For credit unions, since they don’t have shareholders, they aren’t looking to provide liquidity for shareholders or to get a good price,” says Christensen.
Prospective merger partners face a host of sensitive, difficult questions: Who will be in charge? Which board members will remain? What happens to the staff? What are the goals of the combined organization? What kind of change-in-control agreements are there for executives who lose their jobs?
These social issues can make deals fall apart. Perhaps the sheer difficulty of navigating credit union mergers is one contributor to the nascent trend of credit unions buying banks. A full $6.2 billion of the $27.7 billion in merged credit union assets in the last five years came from banks, Christensen says.
Institutions such as Lakeland, Florida-based MIDFLORIDA Credit Union are buying banks. In 2019, MIDFLORIDA purchased Ocala, Florida-based Community Bank & Trust of Florida, with $743 million in assets, and the Florida assets of $675 million First American Bank. The Fort Dodge, Iowa-based bank was later acquired by GreenState Credit Union in early 2020.
The $5 billion asset MIDFLORIDA was interested in an acquisition to gain more branches, as well as Community Bank & Trust’s treasury management department, which provides financial services to commercial customers.
MIDFLORIDA President Steve Moseley says it’s probably easier to buy a healthy bank than a healthy credit union. “The old saying is, ‘Everything is for sale [for the right price],’” he says. “Credit unions are not for sale.”
Still, despite the difficulties of completing mergers, the most-significant trend shaping the credit union landscape is that the nation’s numerous small institutions are going away. About 3% of credit unions disappear every year, mostly as a result of a merger, says Christensen. He projects that the current level of 5,271 credit unions with an average asset size of $335.6 million will drop to 3,903 credit unions by 2030 — with an average asset size of $1.1 billion.
CEO Advisory Credit Union Industry Consolidation Forecast
The pandemic’s economic uncertainty dropped deal-making activity down to 65 in the first half of 2020, compared to 72 during the same period in 2019 and 90 in the first half of 2018, according to S&P Global Market Intelligence. Still, Christensen and Duffy expect that figure to pick up as credit unions become more comfortable figuring out potential partners’ credit risks.
In the last five years, the fastest growing credit unions that have more than $500 million in assets have been acquirers. Based on deposits, Vibe Credit Union in Novi, Michigan, ranked the fastest growing acquirer above $500 million in assets between 2015 and 2020, according to the analysis by CEO Advisory Group. The $1 billion institution merged with Oakland County Credit Union in 2019.
Gurnee, Illinois-based Consumers Cooperative Credit Union ranked second. The $2.6 billion Consumers has done four mergers in that time, including the 2019 marriage to Andigo Credit Union in Schaumberg, Illinois. Still, much of its growth has been organic.
Canyon State Credit Union in Phoenix, which subsequently changed its name to Copper State Credit Union, and Community First Credit Union in Santa Rosa, California, were the third and fourth fastest growing acquirers in the last five years. Copper State, which has $520 million in assets, recorded a deposit growth rate of 225%. Community First , with $622 million in assets, notched 206%. The average deposit growth rate for all credit unions above $500 million in assets was 57.9%.
CEO Advisory Group Top 50 Fastest Growing Credit Unions
“A number of organizations look to build membership to build scale, so they can continue to invest,” says Rick Childs, a partner in the public accounting and consulting firm Crowe LLP.
Idaho Central is trying to do that mostly organically, becoming the sixth-fastest growing credit union above $500 million in assets. Instead of losing business during a pandemic, loans are growing — particularly mortgages and refinances — as well as auto loans.
“It’s almost counterintuitive,” says Mark Willden, the chief information officer. “Are we apprehensive? Of course we are.”
He points out that unemployment remained relatively low in Idaho, at 6.1% in September, compared to 7.9% nationally. The credit union also participated in the Small Business Administration’s Paycheck Protection Program, lending out about $200 million, which helped grow loans.
Idaho Central is also investing in technology to improve customer service. It launched a new digital account opening platform in January 2020, which allows for automated approvals and offers a way for new members to fund their accounts right away. The credit union also purchased the platform from Temenos and customized the software using an in-house team of developers, software architects and user experience designers. It purchased Salesforce.com customer relationship management software, which gives employees a full view of each member they are serving, reducing wait times and providing better service.
But like Idaho Central, many of the fastest growing institutions aren’t growing through mergers, but organically. And boy, are they growing.
Latino Community Credit Union in Durham, North Carolina, grew assets 178% over the last five years by catering to Spanish-language and immigrant communities. It funds much of that growth with grants and subordinated debt, says Christensen.
Currently, only designated low-income credit unions such as the $536.5 million asset Latino Community can raise secondary capital, such as subordinated debt. But the National Credit Union Administration finalized a rule that goes into effect January 1, 2022, permiting non-low income credit unions to issue subordinated debt to comply with another set of rules. NCUA’s impending risk-based capital requirement would require credit unions to hold total capital equal to 10% of their risk-weighted assets, according to Richard Garabedian, an attorney at Hunton Andrews Kurth. He expects that the proposed rule likely will go into effect in 2021.
Unlike banks, credit unions can’t issue stock to investors. Many institutions use earnings to fuel their growth, and the two measures are closely linked. Easing the restrictions will give them a way to raise secondary capital.
A separate analysis by Piper Sandler’s Duffy of the top 263 credit unions based on share growth, membership growth and return on average assets found that the average top performer grew members by 54% in the last six years, while all other credit unions had an average growth rate of less than 1%.
Many of the fastest growing credit unions also happen to be among the top 25 highest earners, according to a list compiled by Piper Sandler. Among them: Burton, Michigan-based ELGA Credit Union, MIDFLORIDA Credit Union, Vibe and Idaho Central. All of them had a return on average assets of more than 1.5%. That’s no accident.
Top 25 High Performing Credit Unions
Credit unions above $1 billion in assets have a median return on average assets of 0.94%, compared to 0.49% for those below $1 billion in assets. Of the top 25 credit unions with the highest return on average assets in 2019, only a handful were below $1 billion in assets, according to Duffy.
Duffy frequently talks about the divide between credit unions that have forward momentum on growth and earnings and those who do not. Those who do not are “not going to be able, and have not been able, to keep up.”
Three large bank acquisitions announced in the closing quarter of 2020 may signal a fundamental shift in how a growing number of regional banks envision the future.
While each deal is its own distinct story, there is a common thread that ties them together: the growing demand for scale in an industry undergoing a technological transformation that accelerated during the pandemic. Even large regional banks are hard pressed to afford the kind of technology investments that will help them keep pace with mega-banks like JPMorgan Chase & Co. and Bank of America Corp., which spend billions of dollars a year between them on their own digital transformation.
In October, First Citizens BancShares acquired New York-based CIT Group. Valued at $2.2 billion, the deal will create a top 20 U.S. bank with over $100 billion in assets, and combines the Raleigh, North Carolina-based bank’s low-cost retail funding base with CIT’s national commercial lending platform.
The two companies are a good strategic fit, according to H. Rodgin Cohen, the senior chair at Sullivan & Cromwell, who represented CIT. “If you look at it from CIT’s perspective, you can finance your loans at a much-cheaper cost,” says Cohen in an interview. “From a First Citizen perspective, you have the ability to use that incredible funding base for new categories of relatively higher-yielding loans.”
But digital transformation of banking was an underlying factor in this deal, as increasing numbers of customers shift their transactions to online and mobile channels. The fact that the pandemic forced most banks to close their branches for significant periods of 2020 only accelerated that trend.
“There is enormous pressure to migrate to a more digital technology-driven approach — in society as a whole — but particularly in banking,” Cohen says. “The key is to be able to spread that technology cost, that transformational cost, across the broadest possible customer base. It doesn’t take a lot of direct savings on technology, simply by leveraging a broader customer base, to make a transaction of size really meaningful.”
A second scale-driven deal is PNC Financial Services Group’s $11.6 billion acquisition of BBVA USA, the U.S. arm of the Spanish bank Banco Bilbao Vizcaya Argentaria. Announced in mid-November, the deal will extend Pittsburgh-based PNC’s retail and middle-market commercial franchise — now based in the Mid-Atlantic, South and Midwest — to Colorado, New Mexico, Arizona and California, with overlapping locations in Texas, Alabama and Florida. In a statement, PNC Chairman and CEO William Demchak said the acquisition provided the bank with the opportunity to “bring our industry-leading technology and innovative products and services to new markets and clients.”
The deal will create the fifth-largest U.S. bank, with assets of approximately $566 billion. But Demchak has made it clear in past statements that PNC needs to grow larger to compete in a consolidating industry dominated by the likes of JPMorgan and Bank of America.
Lastly, in a $6 billion deal announced in mid-December, Columbus, Ohio-based Huntington Bancshares is acquiring Detroit-based TCF Financial Corp. to form the tenth largest U.S. bank, with assets of approximately $170 billion. Chairman and CEO Stephen Steinour says the two companies are an excellent fit with similar cultures and strategies.
“It’s a terrific bank,” Steinour says in an interview. “I’ve known their chairman for a couple of decades. Many of our colleagues have friends there, or family members. We compete against them. We see how they operate. There’s a lot to like about what they’ve built.”
The acquisition will extend Huntington’s retail footprint to Minnesota, Colorado, Wisconsin and South Dakota, while deepening its presence in the large Chicago market. And with extensive overlapping operations in Michigan, Huntington expects the deal to yield approximately $490 million in cost saves, which is equivalent to 37% of TCF’s noninterest expense.
But this deal is predicated on much more than just anticipated cost saves, according to Steinour.
“What Apple and Google and Amazon are doing is teaching people how to become digitally literate and creating expectations,” he says. “And our industry is going to have to follow that in terms of matching those capabilities. This combination is an opportunity to accelerate and substantially increase our digital investment. We have to do more, and we have to go faster, because our customers are going to expect it.”
Steinour hedges on if these recent deals also signal that banking is entering a new phase of consolidation, in which regionals pair off to get bigger in a new environment where scale matters. But last year’s $66 billion merger of BB&T Corp. and SunTrust Banks Inc. to form Truist Financial Corp. — currently the fifth-largest U.S. bank, although the post-merger PNC will drop it down a peg — was also driven by a perceived need for more scale. Senior executives at both companies said the primary impetus behind the deal was the ability to spread technology costs over a wider base.
But clearly, the need for scale was a factor for Huntington as well. “We’re investing heavily in this opportunity to combine two good companies, get a lot stronger, accelerate our investments and spread that over a much bigger customer base,” he says. “That makes eminent sense to us.”
As Steinour comments later, “We’ll be stronger together.”
Bank deals have been in deep freeze due to Covid-19 and the related economic downturn, but most of the executives and directors responding to Bank Director’s 2021 Bank M&A Survey, sponsored by Crowe LLP, say their bank remains open to doing deals.
More than one-third say their institution is likely to purchase a bank by the end of 2021; this represents a significant decline compared to last year’s survey, when 44% believed an acquisition likely in 2020. Branch and loan portfolio acquisitions also look slightly less attractive compared to a year ago.
The barriers to dealmaking may prove difficult to surmount in today’s uncertain economic and political environment.
With pressures on small businesses and the commercial real estate market exacerbated by remote work and social distancing measures, the recovery of the U.S. economy — and bank M&A — may hinge on conquering the coronavirus. In response, bank leaders are focused on credit quality: 63% point to concerns about the quality of a potential target’s loan book as a top barrier to making an acquisition, up significantly from last year’s survey (36%).
Despite concerns about credit quality and profitability, 85% say their bank is no more likely to sell due to Covid-19, and just 7% regret that they didn’t sell before the current downturn, when target banks could expect to command a higher price.
This willingness to carry on and weather these challenges may find its foundation in respondents’ long-term expectations. More than half anticipate a slow rebound for the U.S. economy. Twenty-eight percent don’t expect to return to pre-crisis levels in 2021, and 7% believe the recession will deepen.
Still, half believe that when the crisis abates, their bank will be just as strong as it was earlier this year. Forty-four percent express even greater optimism, believing they’ll emerge even stronger.
Loan Losses More than half (57%) believe their bank’s loan loss allowance will be sufficient to cover expected losses over the next 12 months. Two-thirds say that less than 5% of residential mortgages will default and 64% that less than 5% of commercial loans will default.
Willing to Pay for Quality When describing their bank’s acquisition strategy, 44% indicate that they seek strategic acquisitions, regardless of price. One-quarter look for low-priced acquisitions of historically well-run banks; 27% are comfortable paying a premium for well-managed banks.
Tech Acquisitions Rare Just 11% believe they’ll purchase a technology company. Of these, 63% express interest in buying a business or commercial lending platform; 63% are open to acquiring a consumer deposit-gathering platform. Almost half seek data analytics capabilities.
Price Remains a Barrier Potential acquirers’ concerns about pricing as a barrier to dealmaking have dropped significantly — from 72% last year to 60% in this year’s survey. However, more respondents express concern about their ability to use stock as currency in a deal, as well as demands on their capital should they acquire.
Effects on Capital Most believe their bank’s capital levels are sufficient to weather the economic downturn, assuming a rapid (98%) or slow (98%) recovery in 2021, or mild recession (97%). Eighty-one percent believe they can weather a deeper recession. Just one-quarter plan to raise capital over the next six months.
High Marks for Trump An overwhelming majority award President Trump’s administration positive marks for the rollout of Paycheck Protection Program loans (90%) and stimulus payments (91%), and its support of the U.S. economy (88%). Two-thirds believe the administration has effectively responded to the pandemic.
To view the full results of the survey, click here.
The number of bank M&A transactions completed in 2020 represent a stark decline compared to those that have closed in recent years. Dory Wiley of Commerce Street Capital believes that deal activity will rebound in 2021 — but notes that buyers and sellers may find it even more difficult to come to terms on price. In this video, he provides guidance on how banks can meet their goals.
It’s a rule of banking that an economic crisis always creates winners and losers. The losers are the banks that run out of capital or liquidity (or both), and either fail or are forced to sell at fire-sale prices. The winners are the strong banks that scoop them up at a discount.
And in the recent history of such deals, many of them have been transformative.
The bank M&A market through the first six months of 2020 has been moribund – just 50 deals compared to 259 last year and 254 in 2018, according to S&P Global Market Intelligence. But some banks inevitably get into trouble during a recession, and you had better believe that well-capitalized banks will be waiting to pounce when they do.
One of them could be PNC Financial Services Group. In an interview for my story in the third quarter issue of Bank Director magazine – “Surviving the Pandemic” – Chairman and CEO William Demchak said the $459 billion bank would be on the lookout for opportunistic deals during the downturn. In May, PNC sold its 22% stake in the investment management firm BlackRock for $14.4 billion. Some of that money will be used to armor the bank’s balance sheet against possible losses in the event of a deep recession, but could also fund an acquisition.
PNC has done this before. In 2008, the bank acquired National City Corp., which had suffered big losses on subprime mortgages. And three years later, PNC acquired the U.S. retail business of Royal Bank of Canada, which was slow to recover from the collapse of the subprime mortgage market.
Together, these deals were transformational: National City gave PNC more scale, while Royal Bank’s U.S. operation extended the Pittsburgh-based bank’s franchise into the southeast.
“We’re more than prepared to do it,” Demchak told me in an interview in late May. “And when you have a safety buffer of capital in your pocket, you can do so with a little more resolve than you otherwise might. The National City acquisition was not for the faint of heart in terms of where we were [in 2008] on a capital basis.”
One of the most profound examples of winners profiting at the expense of the losers occurred in Texas during the late 1980s. From 1980 through 1989, 425 Texas banks failed — including the state’s seven largest banks.
The root cause of the Texas banking crisis was the collapse of the global oil market, and later, the state’s commercial real estate market.
The first big Texas bank to go was actually Houston-based Texas Commerce, which was acquired in 1986 by Chemical Bank in New York. Texas Commerce had to seek out a merger partner after absorbing heavy loan losses from oil and commercial real estate. Through a series of acquisitions, Chemical would later become part of JPMorgan Chase & Co.
Two years later, Charlotte, North Carolina-based NCNB Corp. acquired Dallas-based First Republicbank Corp. after it failed. At the time, NCNB was an aggressive regional bank that had expanded throughout the southeast, but the Texas acquisition gave it national prominence. In 1991, CEO Hugh McColl changed NCNB’s name to NationsBank; in 1998, he acquired Bank of America Corp. and adopted that name.
And in 1989, a third failed Texas bank: Dallas-based MCorp was acquired by Bank One in Columbus, Ohio. Bank One was another regional acquirer that rose to national prominence after it broke into the Texas market. Banc One would also become part of JPMorgan through a merger in 2004.
You can bet your ten-gallon hat these Texas deals were transformative. Today, JPMorgan Chase and Bank of America, respectively, are the state’s two largest banks and control over 36% of its consumer deposit market, according to the Federal Deposit Insurance Corp. Given the size of the state’s economy, Texas is an important component in their nationwide franchises.
Indeed, the history of banking in the United States is littered with examples of where strong banks were able to grow by acquiring weak or failed banks during an economic downturn. This phenomenon of Darwinian banking occurred again during the subprime lending crisis when JPMorgan Chase acquired Washington Mutual, Wells Fargo & Co. bought out Wachovia Corp. and Bank of America took over Merrill Lynch.
Each deal was transformative for the acquirer. Buying Washington Mutual extended JPMorgan Chase’s footprint to the West Coast. The Wachovia deal extended Wells Fargo’s footprint to the East Coast. And the Merrill Lynch acquisition gave Bank of America the country’s premier retail broker.
If the current recession becomes severe, there’s a good chance we’ll see more transformative deals where the winners profit at the expense of the losers.
The coronavirus pandemic has tossed any strategic plans for 2020 — which bank management teams created in late 2019 — out the window.
The banking industry has been directly affected by unprecedented challenges stemming from the Covid-19 crisis, and have quickly addressed emerging issues and adapted their procedures and operations. Revisiting the strategic plan will require executives to holistically reassess risks, challenges, potential opportunities and future goals. While banks will need to re-examine their strategic plans for operational initiatives, it is prudent to also reassess their plans for capital adequacy and approach to M&A.
Capital Planning for Defense and Offense When reassessing the strategic plan and the impact of Covid-19, banks should consider if current capital ratios provide enough flexibility to both play defense by protecting the balance sheet in a prolonged adverse scenario, and play offense with enough capital to execute on growth opportunities. We believe it is prudent to evaluate multiple scenarios and raise capital when you can — not when you need to.
The capital markets are open today, and many banks have proactively raised subordinated debt in the second quarter. Sub-debt is an attractive form of capital due to its regulatory treatment, no dilution to ownership and relatively low cost in the current rate environment. From a regulatory perspective, sub-debt can qualify as Tier 2 capital at the holding company; proceeds can be down streamed to the bank subsidiary, which qualifies as Tier 1 capital at the bank level, strengthening regulatory capital ratios. The interest expense is tax-deductible, which reduces the effective cost.
The market appetite for sub-debt has been robust: since the beginning of April, commercial banks have raised over $3.5 billion at an average interest rate of approximately 5.50%. Historically, institutional investors were the most active buyers of sub-debt, but the buyer mix has shifted to rely on community and regional banks, insurance companies and asset managers — all looking for attractive yields.
Mergers and Acquisitions M&A activity has come to a screeching halt as banks prioritized an internal focus to assess risk. Only nine whole-bank M&A transactions were announced in the second quarter, compared to 67 transactions during the same timeframe in 2019. It seems reasonable to expect valuation multiples will trend lower and deal activity will be subdued until acquirers’ currencies rebound and parties have more visibility and confidence with credit quality and earnings.
On a more positive note, we expect banks to warm to the idea of mergers as strategic partnerships to strengthen the combined company with operational scale and synergies. Of course, these transactions can be challenging to complete and dependent upon similar cultures and management compatibility; however, suppressed M&A valuations provide a window of opportunity since the usual bank buyers aren’t paying rich premiums in the current environment. Economic consideration in a strategic partnership is typically majority stock, not cash, so both parties are reinvesting and have potential to increase the combined company’s value for a more-advantageous positioning when the market recovers.
If you were planning on being a buyer in the next 12 to 18 months, it is important to evaluate how your M&A strategy and priorities may have changed. Buyers with a strong public currency or excess capital will maintain their competitive advantage, but need to be highly selective and strategic for their next deal. Among other things, acquirers will need to bolster the due diligence process to address new challenges and risks.
If you were planning on being a seller in the next 12 to 18 months, focus on identifying your potential buyers, how your valuation may have changed and how you can position the bank to improve the valuation. It is prudent to engage with external advisors in this process, including an investment banker and legal counsel to evaluate these scenarios in detail, even if there is no urgency for a transaction.
These are unprecedented times, and every day seems to bring a new challenge. While it is impossible to predict what will transpire in the next six to 12 months, it is important to update the strategic plan to position your bank to protect shareholder value and take advantage of opportunities.
Information contained herein has been obtained by sources we consider reliable, but is not guaranteed and we are not soliciting any action based upon it. Any opinions expressed are based on our interpretation of data available to us at the time of the original publication of the report. These opinions are subject to change at any time without notice.