Private Banks Can Get Deals Done

The vast majority of the banking industry is composed of privately owned stock banks. Of the 794 non-FDIC assisted bank M&A deals that were announced in 2013 through 2015, almost two-thirds involved a non-exchange traded buyer. Non-publicly traded banks are clearly getting deals done. There are several key facets that FinPro Capital Advisors (FCA) works on with its non-exchange traded bank clients in order to get an M&A transaction done.

1. Know Your Value
Value for a bank is driven by earnings per share (EPS) and tangible book value per share (TBVS). A bank’s stock price is equal to TBVS multiplied by a TBVS market multiple and EPS multiplied by an EPS market multiple. Those market multiples are the market’s perception of the risk profile of the bank, and a bank can influence that market multiple by changing its risk profile and communicating the appropriate risk profile to the public. As seen below in the table, a lower risk profile bank will likely have a higher TBVS market multiple, resulting in a much higher value.

Tangible Book Value Per Share – Range of Market Multiples 2016Q1
    High Risk Average Risk Low Risk
A Tangible Common Equity $150,000 $150,000 $150,000
B Common Shares Outstanding $5,000 $5,000 $5,000
C=A/B Tangible Book Value Per Share $30.00 $30.00 $30.00
D Price/TBVS Multiple 80.00% 100.00% 120.00%
C x D Stock Price $24.00 $30.00 $36.00

Value is measured primarily by stock price, which means that for both potential nonpublic buyers and sellers it is critical to conduct a quarterly valuation. A private bank can actually have more control over its valuation and the communication around the bank’s value proposition. A private bank controls its message, whereas a publicly traded bank’s message is heavily influenced by the market. FCA believes banks must continue to fix their risk profile, enhance value creators and reduce value detractors in order to increase inherent value. Then, this inherent value must be conveyed to the potential partner involved in the transaction.

2. Know Your Opportunities
In order to reflect all strategic options available, FCA periodically analyzes for each of its clients a full range of buy-side and sell-side options to reflect the full universe of options available to the institution. The detailed process includes:

  1. Comprehensive screening based on strategy
  2. Prioritizing the initial screen to approximately 10 potential targets (or buyers/strategic partners)
  3. Modeling to ensure appropriate assumptions with pro forma financials
  4. Rankings reflecting long-term strategy and multiple pro forma analyses

Once this preliminary list is established, further refinement and prioritization of both buyers and targets can be conducted based on M&A parameters, strategic rationale, and market knowledge as established by your institution’s board of directors. Once you have a prioritized list of strategic partners, be active in staying in contact with those institutions. You can never be sure when another institution on your list will seek a strategic partner.

3. Model Transactions Based On Quantitative and Qualitative Factors
After a short-list is established, comprehensive pro forma financials can be modeled. A buy-side institution needs defined parameters before modeling to maintain discipline. Exceptions to parameters require a strong qualitative rationale behind the deal. Whether you are a buyer or target, a more sophisticated understanding of modeling assumptions directly relates to unlocking greater value in the transaction and recognizing synergies. Regardless of whether you are a buyer or a seller, remember that banking is a people business so make sure to lock up key people as part of the transaction.


4. Understand Key Issues for Consideration
Though a deal must work financially, it is not just about the numbers. FCA spends a great deal of time working with its clients on nonfinancial aspects of the deal:

  • Choosing the correct legal, corporate and operating structure
  • Maintaining or reducing the risk profile of the combined entity
  • Understanding the regulatory view of the transaction
  • Understanding synergies (not just financial synergies) for the combined entity
  • Establishing the branding and marketing of the combined entity
  • Recruiting and retaining key talent is vital to any transaction
  • Establishing the corporate culture going forward
  • Effectively integrating the target to ensure future value

Just because an institution doesn’t trade on a national exchange, doesn’t mean it can’t be involved in M&A. Know your value, know your opportunities and understand the process. Whether you engage in a transaction or not, the organizations which move the quickest to capitalize on these opportunities are the ones which follow these four steps on a regular basis. Just make sure to choose your strategic M&A partner based upon the long term value of the combined entity.

Is there a Sweet Spot for Bank Stock Pricing?

stock-valuation-7-8-15.pngWhat drives bank stock valuations? Is it asset size, growth, profitability—or a combination of factors acting in concert? Keefe Bruyette & Woods Managing Director Jeffrey Wishner presented an extensive study recently at the Crowe Horwath Bank Growth & Profitability Conference in San Diego in which he examined how a variety of factors influenced the stock prices of 381 publicly held banks traded on the Nasdaq or NYSE exchanges during the first quarter of 2015.

For starters, size would seem to have a positive impact on valuations—although it is by no means a linear relationship. Wishner divided the universe of public banks into seven asset size categories, beginning with institutions having $500 million in assets or less, and ending with $50 billion in assets and above. Banks in the $5 billion to $10 billion category traded on average 1.8 times their tangible book value (TBV) in the first quarter of this year, which was the highest of any of the asset groupings. Interestingly, banks in the $10 billion to $50 billion and $50 billion and above categories had lower price-to-TBV (P/TBV) ratios—1.69x and 1.56x on average, respectively—an indication that the benefits of size dissipate as banks grow larger.

Wishner also looked at the impact that profitability had on stock prices.  Banks that had a return on average assets (ROAA) of 1 percent or better traded on average 1.59 times TBV in the first quarter. Those that had lower ROAAs had correspondingly lower P/TBV ratios. The same relationship was observed with return on tangible common equity (ROTCE): Banks that had a ROTCE of 10 percent or better traded at 1.6 times TBV while those institutions below that mark all had lower valuations.

As one might expect, banks that had solid loan growth also tended to have higher stock prices. Those that grew loans by at least 10 percent also had P/TBV ratios on average of 1.55x, while those that had lower loan growth also had lower P/TBV ratios. Loan growth became even more powerful when combined with higher efficiency, which only makes sense since more of the economic benefits are falling to the bottom line. Banks whose five-year loan compound annual growth rate (CAGR) was 10 percent or better, and also had an efficiency ratio of 60 percent or lower, traded on average 1.9 times their TBV.

Strong loan growth combined with a high ROAA produced the highest returns of all. Banks that had a five-year loan CAGR of 10 percent or higher, and a ROAA of at least 1 percent, had a median P/TBV ratio of 2.09x.

Wishner’s study uncovered some other interesting findings as well. Commercial real estate has accounted for a significant percentage of commercial loan growth in recent years, but too much of a good thing can depress valuations. Banks that had between 25 percent and 50 percent of their loans in commercial real estate traded at 1.61 times TBV, but banks that had higher concentrations also had significantly lower P/TBV ratios. Capital is another factor where having too much can negatively impact a bank’s stock price. Institutions whose ratio of tangible common equity (TCE) to tangible assets ranged between 6 and 8 percent had a P/TBV of 1.58x. Bump the TCE ratio up to a range of 8 to 10 percent and the P/TBV ratio drops to 1.4x. Increase it to 10 percent or greater and the P/TBV ratio plummets to 1.2x. Why? The higher the TCE ratio, the less leverage the bank has—which in turn drives down return on equity.

Although the banking industry tends to be obsessed with growth, it’s not what investors value the most. “The market values efficiency and profitability a little more than growth,” says Wishner.

It would be possible from Wishner’s study to construct the ideal bank from a valuation perspective. That would be a bank with assets of $5 billion to $10 billion, with strong loan growth, high efficiency, enough commercial real estate exposure to help drive profitability but not so much that it distorts the bank’s risk profile, and a TCE ratio of between 6 percent and 8 percent. Any bank that has these characteristics occupies a sweet spot in the bank stock market and should enjoy a higher valuation than many of its peers.