Takeaways from the BB&T-SunTrust Merger

merger-2-27-19.pngIn early February, BB&T Corp. and SunTrust Banks, Inc. announced a so-called merger of equals in an all-stock transaction valued at $66 billion. The transaction is the largest U.S. bank merger in over a decade and will create the sixth-largest bank in the U.S. by assets and deposits.

While the transaction clearly is the result of two large regional banks wanting the additional scale necessary to compete more effectively with money center banks, banks of all sizes can draw important lessons from the announcement.

  • Fundamentals Are Fundamental. Investors responded favorably to the announcement because the traditional M&A metrics of the proposed transaction are solid. The transaction is accretive to the earnings of both banks and BB&T’s tangible book value, and generates a 5-percent dividend increase to SunTrust shareholders. 
  • Cost Savings and Scale Remain Critical. If deal fundamentals were the primary reason for the transaction’s positive reception, cost savings ($1.6 billion by 2022) were a close second and remain a driving force in bank M&A. The efficiency ratio for each bank now is in the low 60s. The projected 51 percent efficiency ratio of the combined bank shows how impactful cost savings and scale can be, even after factoring in $100 million to be invested annually in technology.
  • Using Scale to Leverage Investment. Scale is good, but how you leverage it is key. The banks cited greater scale for investment in innovation and technology to create compelling digital offerings as paramount to future success. This reinforces the view that investment in a strong technology platform, even on a much smaller scale than superregional and money center banks, are more critical to position a bank for success.
  • Mergers of Equals Can Be Done. Many have argued that mergers of equals can’t be done because there is really no such thing. There is always a buyer and a seller. Although BB&T is technically the buyer in this transaction, from equal board seats, to management succession, to a new corporate headquarters, to a new name, the parties clearly went the extra mile to ensure that the transaction was a true merger of equals, or at least the closest thing you can get to one. Mergers of equals are indeed difficult to pull off. But if two large regionals can do it, smaller banks can too.
  • Divestitures Will Create Opportunities. The banks have 740 branches within 2 miles of one another and are expected to close most of these. The Washington, D.C., Atlanta, and Miami markets are expected to see the most branch closures, with significant concentrations also occurring elsewhere in Florida, Virginia, and the Carolinas. Deposit divestitures estimated at $1.4 billion could present opportunities for other institutions in a competitive environment for deposits. Deposit premiums could be high.
  • The Time to Invest in People is Now. Deals like this have the potential to create an opportunity for community banks and smaller regional banks particularly in the Southeast to attract talented employees from the affected banks. While some banks may be hesitant to invest in growth given the fragile state of the economy and the securities markets, they need to be prepared to take advantage of these opportunities when they present themselves.
  • Undeterred by SIFI Status. The combined bank will blow past the new $250 billion asset threshold to be designated as a systemically important financial institution (“SIFI”). While each bank was likely to reach the SIFI threshold on its own, they chose to move past it on their terms in a significant way. Increased scale is still the best way to absorb greater regulatory costs – and that is true for all banks.
  • Favorable Regulatory Environment, For Now. Most experts expect regulators to be receptive to large bank mergers. Although we expect plenty of public comment and skepticism from members of Congress, these efforts are unlikely to affect regulatory approvals in the current administration. It is possible, however, that the favorable regulatory environment for large bank mergers could end after the 2020 election, which could motivate other regionals to consider similar deals while the iron is hot.
  • Additional Deals Likely. The transaction may portend additional consolidation in the year ahead. As always, a changing competitive landscape will present both challenges and opportunities for the smaller community and regional banks in the market. Be ready!

Four Drivers of Banking M&A in 2018

merger-5-28-18.pngAfter several years of false starts, 2018 may be the year that banking merger and acquisition (M&A) truly gets in gear. Financial stocks have rallied and stabilized and boosted the value of companies’ capital war chest.

Add to that new favorable policy developments easing regulatory constraints, interest rates steadily rising, the tax reform bill’s potential boost to bottom lines, loan growth projected to increase, and abundant capital is available to invest. Still, positive developments are sometimes accompanied by challenges. Deloitte’s 2018 banking and securities M&A outlook identifies four trends and drivers that are worth watching for their potential catalyzing or hindering effect on industry M&A activity.

1. Regulatory and legislative changes. Business-friendly legislation and regulatory policy changes may act as a flywheel to concurrently control and increase the M&A machine’s momentum in 2018. Of the potential regulatory changes, raising the statutory $50 billion asset thresholds for systemically important financial institutions, or SIFIs, designation and stress tests may have the most impact on M&A, especially within the ranks of $10 billion-$50 billion and $50 billion-$250 billion institutions. Higher thresholds could bring some regulatory relief around deal-making, opening the door to merger activity by small and midsized banks.

2. U.S. tax changes. Will the 2017 tax cuts be a boon for banking M&A? The outlook is encouraging, with some caveats. Banks and other financial services organizations may have more available capital but they also have numerous ways to use it: employee bonuses or raises, stock buybacks, pay down debt, increase dividends, invest in financial technology (fintech) and other operating improvements, or engage in cash-based M&A. And as of January 2018, sellers’ net operating losses (NOLs) became less attractive as an M&A trigger because, going forward, they will be applied at the new, lower 21 percent tax rate. On a positive note, while foreign banking organizations (FBOs) still face significant regulatory headwinds and some new burdens coming out of last year’s tax laws, tax reform may make U.S. banks on the margin more attractive to foreign-owned institutions looking to offset slow in-country growth and to expand their U.S. footprint where, historically, the tax rates made those investments less desirable from a post-tax earnings perspective.

3. Rising interest rates and higher valuations. Interest rates’ influence on 2018 banking M&A could be mixed: Rising rates may spawn competition in both lending and deposits, prompting an organization to rely more on organic growth and less on inorganic levers like acquisitions or alliances. Conversely, if an organization has loan origination or liquidity challenges, an acquisition could provide more stable access to deposits. Similarly, higher financial industry valuations may both grease and clog the gears of 2018 M&A.

Some banks—especially regionals and super-regionals—that have benefitted from the “Trump Bump” and have enhanced stock currency may engage in strategic deal-making to beef up their asset base, market presence, or fintech capabilities. However, those banks should remember that all valuations have gone up—while their acquisition currency may be higher so is the cost of what they want to buy. And, sellers may be hesitant in stock deals to accept perceived inflated currency. They may, as a result, seek higher deal multiples to protect their shareholders from any post-deal downside value risk.

4. The changing face of fintech. We expect that fintechs will continue to be a strategic investment area for financial services organizations of all types and sizes. Large and regional banks may look for technology assets to help improve their efficiency ratio, while smaller banks having difficulty growing their digital presence may acquire or partner with fintechs to fill critical gaps.

Regardless of their size, banks continue to struggle with diminishing brand value and reputation among certain customer segments including attracting and serving younger demographics in a manner they desire. Embracing the rapid adoption of cutting-edge financial technology, therefore, is not just a short-term means to boost revenues or eliminate cost inefficiencies; it’s a way for banks to repair and enhance their brand and value perception.

With banks likely to ride the wave of tax gains (outside of the impact on deferred tax asset values), increasing interest rates, higher valuations, and easing regulations during the first six months of 2018, they may see less need to push the inorganic lever of M&A to grow earnings. Still, with significant momentum in the system, the second half of the year could see some strategic and financial deal-making on par with or in excess of 2016. We expect larger banks to continue to acquire fintech capabilities and evaluate which businesses are core to their strategy and divesting those that no longer fit, smaller banks continuing to consolidate and private equity firms to continue to monetize remaining crisis-era investments.

A Modest Yet Welcome Thaw for Banking M&A and Financial Stability

mergers-4-18-17.pngAs part of approving the merger of $40.6 billion asset People’s United Financial Inc., with $2 billion asset Suffolk Bancorp, the Federal Reserve stated that, “[t]he [Federal Reserve] Board’s experience has shown that proposals involving an acquisition of less than $10 billion in assets, or that result in a firm with less than $100 billion in total assets, are generally not likely to create institutions that pose systemic risks” and that the Federal Reserve Board now presumes that such a proposal does not create material financial stability concerns, “absent evidence that the transaction would result in a significant increase in interconnectedness, complexity, cross-border activities, or other risk factors.”

Before the recent action, the Federal Reserve had since 2012 imposed very low thresholds under which it would presume no financial stability concerns exist. It only exempted acquisitions of less than $2 billion in assets or where the resulting firm would have less than $25 billion in total assets. Only a small number of transactions met these thresholds. The Federal Reserve reiterated its position, however, that it maintains the authority to review the financial stability implications of any proposal, specifically noting any acquisition regardless of size involving a global systemically important bank.

Through this action, the Federal Reserve has not only liberalized the key asset thresholds it previously established in 2012 for its evaluation of the financial stability factor in banking M&A, but also delegated authority to approve applications and notices that meet the newly revised thresholds to the Federal Reserve Banks. This revision has obvious parallels to recent statements from Chair Janet Yellen, Governor Tarullo and other Federal Reserve officials over the past few years (including as recently as December 2016) that the current $50 billion threshold for designation of a financial company as a systemically important financial institution (SIFI) may be too low. We believe that the delegation of authority to the Federal Reserve Banks could be at least as important, if not more important, as revisions to the financial stability thresholds because delegation should increase the chance that M&A transactions would proceed without the long delays that have recently been the norm in Federal Reserve Board reviews. Of course, all of the other requirements for delegation would also have to be met.

In support of this liberalization, the Federal Reserve cited its approval of a number of transactions over the past two years, including several transactions where the acquirer and/or resulting firm were over $100 billion or where the firm being acquired was over $10 billion and thus exceeded the newly revised financial stability thresholds. The increased thresholds and the delegation of authority to Federal Reserve Banks to process filings are welcome developments, especially for regional and community banking organizations that may be looking to acquire or be acquired. We would not, however, read the Federal Reserve’s actions as a strong signal that it expects or desires increased financial industry acquisitions or consolidation. The financial stability factor is only one of many that must be evaluated and questions will persist over how Community Reinvestment Act or fair lending concerns, anti-money laundering compliance, competition, general supervisory issues or public comment may affect a particular transaction. This action may, however, represent more formal support from the Federal Reserve for efforts to raise the $50 billion thresholds for SIFI designation and other purposes with a financial stability component under the Dodd-Frank Act.

Note: Another version of this article was initially published as a blog post on the Davis Polk FinRegReform blog on March 18, 2017.

Did Regulatory Concerns Torpedo the New York Community/Astoria Merger?

merger-1-6-17.pngIt’s highly unusual for the partners in a bank merger to terminate an agreement that they’ve already made public, so the recent announcement that New York Community Bancorp in Westbury, New York, and Astoria Financial Corp. in Lake Success, New York, would abandon their proposed $2 billion deal led to immediate speculation that the regulators had secretly torpedoed the proposed transaction. The banks did not give a reason in their joint statement in December 2016.

Announced in October 2015, the deal was supposed to close in December 2016. But New York Community issued a statement in November 2016 that “based on discussions with its regulators, it does not expect to receive the regulatory approvals required to consummate the proposed merger …by the end of 2016.” Instead, the banks agreed to terminate the merger agreement effective January 1, 2017.

The voluntary termination of a publicly announced bank merger because of regulatory complications is unusual because acquirers generally do their best to anticipate any possible roadblocks before entering into a formal merger agreement. This generally includes informal discussions with their primary regulator about any potential issues that could be problematic. Although these discussions should not be construed as a kind of pre-approval, it would be unusual for an acquirer to proceed with a proposed merger if its principal regulator expressed serious concern about any aspects of the deal in private.

It is unknown whether New York Community and Astoria decided to pursue their merger despite concerns that might have been voiced privately by their regulator, or if serious regulatory issues surfaced later upon a formal review. However, according to the investment banking firm Keefe Bruyette & Woods, the percentage of M&A applications to the Federal Reserve that have later been withdrawn have been on the rise in recent years, jumping from 15 percent in 2013 to 23 percent in 2015, and to 22 percent in the first six months of 2016. This increase occurred while annual M&A deal volume was growing at a much slower rate, which would suggest that the Fed has been taking a more critical perspective during its review process.

Issues that could have complicated the New York Community/Astoria deal include a high concentration of commercial real estate assets that would have comprised the combined entity’s balance sheet. New York Community is one of the top multifamily housing lenders in the country, while commercial real estate, multifamily and residential mortgages account for the majority of Astoria’s total loan portfolio.

Another factor that most likely complicated the deal’s regulatory approval process is that the combined bank would have crossed the $50 billion asset threshold level—New York Community had $49.5 billion in assets as of September 30, 2016, while Astoria had $14.8 billion. At this point, it would have become a Systemically Important Financial Institution, or SIFI, which would have exposed it to higher capitalization requirements and tougher regulatory scrutiny than are applied to smaller banks. The regulators generally require banks to have a SIFI compliance plan in place before crossing the $50 billion threshold, so New York Community most likely had already been preparing for this transition. However, the elevated SIFI requirements, combined with the bank’s significant commercial and residential real estate concentrations, might have made it difficult to gain regulatory approval in a timely manner.

In a research report published subsequent to the announced termination, KBW expected both banks to continue to seek out a merger combination. New York Community would seem to face the greater challenge in terms of finding an acceptable partner that won’t magnify its own commercial real estate concentration issues, and also because the bank’s organic growth trajectory will probably take it past the $50 billion threshold in 2017. Life as a SIFI grows more challenging—merger or no merger.