The IPO Market is Red Hot. What’s Driving It?

The market for bank initial public offerings (IPOs) has become scorching. In fact, through the first three quarters of this year, nine initial public offerings of commercial banks have been successfully completed. Based on the current pipeline, this year will mark the most bank IPO activity in the last decade.


Source: SNL Financial; Year-to-date through September 30,2014

During September, Citizens Financial Group Inc. (NYSE: CFG) completed the largest bank IPO on record, at $3.4 billion in gross proceeds. To put the size of this offering into perspective, the second largest offering this year was approximately $232 million for Talmer Bancorp Inc.

Given the active IPO market, bank directors and investors alike have asked us: What has spurred the pick-up in IPOs? What characteristics do great IPO candidates have in common? Are there more to come? Will this have an effect on M&A activity? To shed some light on these, we will address each question.

What Has Spurred the Pick-Up in IPOs?
A number of factors that have contributed to or helped facilitate the pick-up in activity such as higher valuations, the emerging growth company provisions in the JOBS Act, the need to repay Troubled Asset Relief Program money or another form of capital, as well as supportive capital markets. Bankers have referenced a combination of pent-up demand for liquidity from some shareholders and the need to fund future growth. Going public provides shareholder liquidity for those who want it while allowing management teams and committed investors alike to continue to pursue the long-term strategic plan. Furthermore, having access to the public markets is a significant advantage for growth-minded companies regardless of whether the growth is organic or through acquisitions. 

Characteristics of Good IPO Candidates
So what makes a good IPO candidate?

  • Management: Investors are interested in banks led by an exceptional management team with a proven track record.
  • Size: While a few have fallen outside of the range, most banks are between $1 billion to $5 billion in assets at the time of their IPO. 
  • Profitability: Investors want to see both a solid profitability trend and earnings growth— top line growth while managing expenses to improve the bottom line.
  • Clean balance sheet: Especially at this point in the cycle, balance sheets should be in good shape.
  • Growth: A growing bank in a high-growth market is the ideal situation, but solid growth prospects are  key, whether organic or through acquisition opportunities.

Are Rising Valuations Justified?
While IPO valuations are up on average, the pricing of recent deals has been reasonable relative to the valuations of similar public banks. For example, of the thirteen banks that have completed an initial public offering during the last two years, nine of these were within $1 billion and $5 billion in assets at the time of their IPO. Three of the four others were within $350 million of this size range with Citizens Financial Group being the exception. We analyzed all publicly traded banks in this size range and found that the group currently trades at approximately 163 percent of tangible equity, which supports the pricing of recent offerings. Interestingly, banks in this size range are currently trading close to the same multiples they traded at roughly three and a half years ago; however, they have returned over 51 percent on average to investors during this same period.


Source: SNL Financial; Data from 1/3/2011-9/29/2014

Will This Affect M&A Activity?
Issuing stock in a merger or acquisition helps a buyer achieve the higher capital levels that regulators want on a pro forma basis while helping to ensure attractive payback periods for investors. In fact, during the past two years approximately 86 percent of deals where the purchase price was $25 million or more have included stock as a portion of the consideration. Accordingly, the majority of banks that have completed an IPO this year have stated the intent to evaluate acquisition opportunities.

We expect this pick-up in IPOs to continue into 2015. Furthermore, we expect this trend to drive more M&A activity as well. Current valuations are drawing more banks to access the public markets and investors are interested in profitable institutions with compelling growth prospects. Many of these newly public banks intend to pursue acquisitions which will be conducive to continued consolidation throughout the banking industry. Accretive acquisitions are a catalyst supporting higher stock prices for the buying banks, which will serve to further lure more growth-minded bankers to consider an initial public offering.

Top Three Recommendations for Valuing and Accounting for Acquired Loans

bsns-man-binoculars.jpgAs acquisitions of troubled and failed institutions continue, understanding the accounting for acquired loans is more critical than ever. The most often overlooked area in any transaction is the alignment of internal and external resources with accounting systems to facilitate a smooth transition of recordkeeping for loans—the most significant asset class acquired.

Acquired loans are accounted for at fair value at the date of acquisition, and accounting for those loans going forward presents a multitude of complexities for accounting personnel and senior management responsible for asset quality and financial reporting. Highlighted here are three best practices an acquirer can use to efficiently manage through acquired loan accounting and limit surprises.

1. Valuation Due Diligence

Many acquirers apply generic rules of thumb when valuing an acquired balance sheet and make broad assumptions about how earnings will be affected by valuation adjustments during the due diligence phase. When time permits, as part of the due diligence process, acquirers should perform a preliminary valuation of the loan portfolio being acquired. In a failed-bank acquisition, however, there typically is not sufficient time to conduct this level of valuation. Given the recent slowdown in closings, though, potential acquirers are finding themselves with more time.

In a normal bank transaction, there typically is enough lead time to perform a preliminary valuation since the acquirer has more control over the timing of the transaction closing. By performing a preliminary valuation, management is able to work through vendor selection prior to closing and can align expectations on valuation methodologies and deliverables to eliminate surprises after an acquisition. Third-party audit firms can review overall methodologies and deliverables well in advance of closing.

By doing this dry-run valuation work ahead of time, accounting personnel can start formulating the appropriate accounting policies and gain a deeper understanding of the financial reporting effect of yet-to-be-made accounting policy elections. Well in advance of closing, the bank should determine how best to construct pools of performing and problem loans for efficient accounting going forward, how to effectively align acquired loans into the existing credit monitoring and allowance methodologies, and which loans are most effectively valued and accounted for individually as opposed to pooled.

2. Early Assessment of Capabilities

Acquirers should identify resources that will be needed within the accounting, loan operations and credit administration functions in order to support the appropriate day-to-day application of accounting for the acquired loan. In addition to assessing personnel, acquirers should evaluate existing accounting systems to identify potential weaknesses in facilitating acquired loan accounting going forward. The acquiring institution’s current software vendor should know its system limitations in applying acquired loan accounting, and these discussions should start early in the process.

Acquirers should also address conversion protocols and timelines for a particular acquisition while discussing system capabilities. This assessment and education process should help determine resources and systems needed to perform the accounting going forward. It also will result in more accurate projections of the value of any particular acquisition since information systems and personnel costs can be more accurately forecast by assessing these areas early.

3. Post-Closing Valuation

Acquirers should perform another review of the acquired portfolio prior to providing final data for the loan valuations. This review should allow acquirers to revisit loan grades and take into account changes in collateral value and credit scores following the initial due diligence. Loan grading and collateral values change over time, and given the limited scope for review under due diligence timelines and the potential for credit deterioration or improvement, acquirers should strive to provide the most up-to-date information to be used in valuing the portfolio. Starting off with an accurate set of assumptions will help minimize surprises going forward.

Originally published on April 23, 2012.

Drivers of Bank Valuation, Part III: Size and Diversification

6-5-13_Commerce.pngA critical function of any bank’s board of directors is to regularly assess whether their activities and those of the bank’s management are driving value. This may be defined as value for shareholders, value for the community and the perception of strength among the bank’s customers and regulators. 

In the last two installments of this series, we explored the concept of tangible book value (TBV) and its relationship with bank valuation. We also looked at internal steps, such as promoting efficiency and growing loans, which boards could take to drive more revenue to the bottom line and drive bank value. 

In this final installment, we’ll look at two additional factors that drive value in both earnings production and market perception. 


The first of these is size. A bank’s size has a direct bearing on its value. The data show clearly that larger banks are perceived to be more valuable, according to the tangible indicators of open market trades of bank stocks and in bank merger pricing. In 2012, for example, there was a clear disparity in the public markets between banks with less than $1 billion in total assets (which traded below tangible book value on average) and those above $1 billion (which traded, on average, at a substantial premium to TBV). Regarding whole bank sales in 2012, banks with more than $500 million in assets sold  at a higher valuation, as a function of price to TBV, than banks smaller than $500 million in total assets (122.3 percent of TBV versus 113.6 percent). Likewise, banks with more than $1 billion in total assets sold at 129.3 percent of TBV versus 113.1 percent of TBV for banks below $1 billion in assets.

There are a number of reasons for this. Certainly greater scale means greater efficiencies, the ability to expand the customer base through a higher legal lending limit, the ability to spread the cost of carrying regulatory compliance over more assets, and the ability to offer products that smaller banks cannot afford to offer. 

A key consideration for a bank’s board should be a regular assessment of the institution’s size relative to market and the steps needed to achieve a critical mass that drives value. Small banks can achieve scale through raising capital and expanding the balance sheet organically—or pursuing mergers with compatible institutions. Either approach allows banks to grow in size, improve efficiency and grow value.


Another approach to growing value is to diversify the balance sheet and the income statement. The data shows that more diversified banks earn more and grow TBV faster. In 2012, banks with a real estate concentration of less than 60 percent earned as much as 90 basis points more on assets than peers more concentrated in real estate. 

Community banks, in particular, are more heavily concentrated in real estate by their very nature. The recent crisis points out the limits to this business philosophy, however, and should prompt some soul searching at the board level on how to avoid putting all the bank’s eggs in lower margin baskets. Commercial and industrial loans along with consumer lending have risks, to be sure, but prudent diversification into these areas offer opportunities for higher margins, more fee business, and more low cost deposits, all of which increase a bank’s overall valuation.

The Role of the Board

Driving shareholder value, whether on an ongoing basis or in a sale, is the key rationale for running the bank in the first place. Boards should aggressively work on all fronts to drive earnings, drive efficiency, drive margin and drive value. This is hard work and not without risks. But managing risk is central to a bank board’s obligations. Setting limits and managing tradeoffs within the market environment should be active rather than passive board activity. 

This work is hard and requires careful planning and execution. But the benefits to boards, management and—importantly—shareholders, of such efforts are considerable. 

Lee’s comments are strictly his views and opinions and do not constitute investment advice.

Drivers of Bank Valuation, Part I: Defining Value

3-4-13_Commerce_Street.pngWhen looking at a bank’s value, whether as a going concern or through the merger process, the headline is the price.  This can be expressed as a dollar value per-share or as a multiple of earnings or tangible book value (“TBV”).  Either way, price is the critical metric for boards to assess management’s performance, for shareholders who must approve merger transactions, or for financial advisory firms who must opine on a transaction’s fairness.

It follows, then, that boards should spend time during the strategic planning process evaluating what drives bank value and what steps they and the bank’s management can take now to improve the organization’s overall valuation and worth in the marketplace. This process pays dividends in growing share value, improving the bank’s perception in the marketplace (especially important for banks with publicly listed stock), and ultimately receiving a satisfactory price in a merger or sale transaction.

Defining Value

The baseline for valuation is the net worth or book value of the company.  Typically, buyers and investors look to the bank’s TBV—or the bank’s net worth after all intangibles and hybrid capital instruments are netted out.  After TBV, the most critical factor in assessing value is earnings. Earnings grow TBV and they allow boards flexibility in providing benefits to shareholders through stock buybacks and dividends. Plus, they allow management the flexibility to invest in people, processes and new lines of business.  Also, in a sale of the company, buyers rely on the acquired company’s earnings to repay them for the dilution they take as a result of paying a control premium.  More earnings, more premium—and more benefit to shareholders.  

In the first of a three part series, we will examine some of the attributes that drive tangible book value and are perceived as valuable to prospective acquirers and merger partners.  In this issue’s installment, we will look at the TBV metric in detail and how focusing on TBV is critical to driving shareholder value.

Growing Tangible Book Value

Since the financial crisis in 2008, regulators, investors and prospective purchasers have all migrated toward discounting the capital benefits of so-called Tier 2 capital and other intangibles that make up a bank’s “book value.”  The use of TBV as the standard metric for assessing a bank’s equity and pricing deals should drive boards toward placing a premium on growing TBV through organic growth.  This isn’t necessarily an argument not to do deals, but deals involve premiums and thus are dilutive—even if only for a time—to the organization’s TBV. If boards are eyeing an exit in the short-to-medium term, growing TBV should be an overriding priority.  

Consider a simplistic example.  If a bank organizes and raises capital at $10 per share and runs a five-year business plan that yields growth in TBV of 15 percent per year, the share value at the end of the business plan will be approximately $20 per share.  Assuming an exit at 2 times TBV, the bank’s investors will realize a 4 times return on their original investment of $10. Fair enough. Now, take that same bank and grow the TBV at 20 percent instead of 15 percent and the investor will exit at $50—moving the return from 4 times cash-on-cash to 5 times.  

The point here is that incremental changes in TBV over the life of a bank’s business plan can have a significant beneficial impact on the bank’s shareholders.  Likewise, poor capital planning—including raising capital at significant premiums or poor M&A strategy—can erode TBV and significantly erode the return to shareholders.  

So, how to grow TBV?  This is certainly a challenge given the compressed margins and lower earnings in the current banking market.  But running the bank efficiently, allocating capital to higher margin businesses, controlling cost of funds, expanding fee income opportunities and careful pricing in the M&A markets can all help push more of the bank’s earnings capacity into the company’s net worth—and yield a better price for the bank’s shares in the open market or in an outright sale.  

In the next article in this series, we will explore several operating metrics that assist in TBV growth and drive higher valuations in open market stock sales and the merger markets.

Lee’s comments are strictly his views and opinions and do not constitute investment advice.

Avoiding Valuation Problems During an Acquisition

Crowe_WhitePaper.pngAll too often after an acquisition, an acquirer’s management team is surprised by the difference between its pro forma balance sheet projections and the final independent, third-party valuations. These unexpected changes in valuation could have a significant impact on the acquiring institution’s regulatory capital requirements and future earnings potential.

To avoid such last-minute surprises, more institutions are involving their third-party valuation teams earlier in the process—during the due diligence phase—in order to provide preliminary valuations. Involving valuation teams earlier in the process has grown more popular as the pace of Federal Deposit Insurance Corporation-assisted acquisitions has slowed and as banks accelerate the pace of open-bank transactions, which allow more time for planning and due diligence.

An acquiring bank’s management team needs a clear understanding of the valuation issues that are likely to arise during the due diligence process.  Read more from Dan McConaughy and Chad Kellar from Crowe Horwath LLP on the benefits of making valuation an early part of the due diligence process.

Building Momentum: How Community Banks Can Compete on More Than Price

Raymond P. Davis, president & CEO of Umpqua Holdings Corp. and keynote presenter at Bank Director’s 2013 Acquire or Be Acquired Conference in Scottsdale, Arizona, shares his insight on how community banks can remain competitive during this challenging economic environment.

Video Length: 45 minutes

Presentation Highlights:

  • Creating a meaningful value proposition
  • Differentiating yourself from the competition
  • What does a strong culture look like?
  • Advice and warnings about valuations

About the Speaker

Ray Davis is the president and CEO of Umpqua Holdings Corporation. Mr. Davis pioneered a new approach to the delivery of financial products and services built on the development of innovative store designs that engage and excite customers. Mr. Davis joined Umpqua Bank in 1994 and has grown the bank from six banking locations and $140 million in assets to nearly 200 stores and $12 billion assets today.

The Changing Public Markets for Banks

2-15-13_OTC_Markets.pngIn April of last year, Congress enacted the JOBS (Jumpstart Our Business Startups) Act with the purpose of easing the capital raising process for small and growing companies.  While only some of the provisions have been put into effect, many small banks have already taken advantage of the new registration and deregistration threshold. According to the latest numbers released by SNL Financial, more than 100 banks have deregistered with the Securities and Exchange Commission (SEC) following the passage of the enactment of the JOBS Act. Most of the attention has been placed on the amount of money and resources banks save as a result of deregistration, but what has not been addressed is the flip side, the new threshold that will require registration. Going forward, banks won’t need to register until they have 2,000 shareholders of record. This change opens the door for small to mid-sized banks that in the past were reluctant to raise capital or merge in fear of increasing their regulatory burdens. What’s important to note is that for non-bank and non-bank holding companies, the statutory shareholder threshold remains the same. In writing the new laws, Congress purposefully carved out banks, acknowledging not only the need for banks to access capital but also the highly regulated environment that banks already face.

SEC Registration Versus Public Markets

Even with this statutory easing, many banks still view the capital markets with caution and often the hesitation comes from a dearth of information and misunderstanding of how the public markets function for small companies.  The common perception is that a bank must undergo a costly and time-consuming process to become public, one that requires underwriting, SEC registration, and compliance with Sarbanes-Oxley. While that process still exists, it only applies to banks seeking to do an Initial Public Offering (IPO) and trade on a registered national securities exchange such as NASDAQ.  As long as there are freely tradable shares, banks can have broker-dealers quote and trade those shares on OTC Markets without filing with the SEC.

With greater demand and regulatory pressure to hold more capital, it is no longer efficient for banks to sell stocks by pulling out a list of interested buyers from desk drawers.  However, as a company enters the capital markets, the information gap also begins to widen and it becomes infeasible for companies to know each shareholder and conversely, investors become removed from the daily ins and outs of the companies they are investing in. The classical definition of markets assumes that information is widely available, allowing buyers to make informed decisions, and sellers to have access to the capital they need to grow and expand their businesses. Yet, information is not always widely accessible, or the information availability is asymmetric, meaning that one side has more information than the other, making a marketplace inefficient.

An Efficient Marketplace

There are three elements that make a stock market efficient:

  1. Access for investors with widespread pricing and the ability to easily trade through any broker
  2. Availability of publicly disclosed information to allow for fair valuation of the stock
  3. Confidence from investors that companies are reputable and information is trustworthy

All three elements above address the problem of asymmetric information in a marketplace by bridging the knowledge gap between company management and investors. Transparent pricing facilitates the assessment process, letting companies and investors determine whether the valuation is fair and actionable. Markets are self-regulating, and when information is widely available, prices will adjust to reflect a combination of company performance, investor demand, and overall economic conditions. Intrinsically, SEC filings are meant to eliminate the discrepancy of information between companies and their investors, yet the high cost associated with registration doesn’t always seem to match the intended benefits. Banks on a quarterly basis already produce call reports to their regulators, and many of them also publish additional financials and disclosures to their shareholders via public portals such as, through SNL, or on their own shareholder relations page. For a small bank, the cost of SEC reporting typically ranges from $150,000 to $200,000 per year, and on annual net income of $1 million, that’s a very significant amount.

The Implication

In the U.S., there are roughly 7,000 banks, a majority of which are small community banks with under $1 billion in assets.  Of the 7,000, about 15 percent are publicly traded, around 450 on registered national securities exchanges such as New York Stock Exchange and NASDAQ, and 600 over-the-counter, primarily on the OTCQB marketplace operated by OTC Markets Group. Fifteen percent is a relatively small fraction, especially given the current economic climate and disposition towards mergers and acquisitions. In general, banks are viewed more favorably and are in better positions to be acquired when the bank’s stock is publicly traded. There is always going to be greater confidence in a deal when valuation is publicly derived (even if the price/book is less than 100 percent).

However, should banks become publicly traded solely for the fact that they would be “more attractive” in an acquisition? Without a doubt being traded on a public market exposes the company to potential market volatility, and there are inherent risks and costs associated with being publicly traded, even with the recent changes outlined in the JOBS Act. A common impediment delaying and preventing companies from going public is the fear that the public valuation will be less than the management’s internally perceived price.  A parent will believe that his or her child is the best, but unfortunately we live in society where individuals are subject to comparison and ability is often determined by some form of standardized testing or arbitrary measurements.  Public scrutiny is hard to swallow, but public acknowledgement can be equally, if not more, gratifying.

Since the financial crisis in 2008, markets have been perceived as the big bad wolf, the visible scapegoat for why companies go bankrupt and why shareholders lose millions of dollars in their investments. However, despite the recent ups and downs, they still remain the best indicator of good investments and the most efficient way to access capital. If the company has a sustainable and profitable business, if a bank’s loan portfolio has consistently provided high returns with minimal default risks, then the well-informed markets should adjust to reflect those successes. 

Small Banks See Small Gains in Valuation: An Update on the Little Guys

where-u-stand.pngSmall bank stocks that don’t trade on the big exchanges have missed out on the price gains of the big bank stocks lately. During the third quarter, the Monroe Securities community bank stock index rose .7 percent and its thrift index climbed 4.1 percent, while the SNL Bank and Thrift Index climbed 7.1 percent, according to the firm, which is a market maker for more than 1,000 community bank stocks.

That’s a change from the second quarter, when big banks were sucking wind and community stocks saw slight gains.

Valuations for community banks improved slightly during the third quarter. The average price to tangible book value for community banks, defined as banks below $1 billion in assets, was 78 percent, according to Monroe Securities. That was an improvement from about 76 percent in the prior quarter but a big climb from end of 2011, when community bank stocks sunk to a low of about 66 percent price to tangible book value.

The number of small bank mergers or acquisitions improved slightly in the quarter, at 49, compared to 45 the quarter before, and 50 deals in the first quarter. M&A deal values fell a bit, from 125 percent of tangible book value to 95 percent in the third quarter.

Monroe Securities uses stock values based on OTC Markets and OTC Pink, an electronic bulletin board for stocks that don’t trade on the New York Stock Exchange or NASDAQ OMX.

For the full report, click here.

* Trends are based off banks with less than $1 billion in assets.
* Source: Monroe Securities

What Is Your Bank’s Number?

The banking industry is poised for a rebound in merger and acquisition activity, which raises the fundamental question of what a bank is worth and how the board and its advisers should derive that number. The art of valuation can be mystifying and the terminology confusing. Every director at one time or another has seen industry data on values, but converting that data into a meaningful picture of a bank’s value requires an understanding of what drives value and how the process works. Understanding the valuation process can help bank directors and top managers better understand the valuation report.
Levels of Value 

When determining the value of your bank, you need to consider the purpose of the valuation and the type of value you need for that purpose.

controlling interest value is what an outside party would pay for ownership of the bank. It is often defined as ownership of more than 50 percent. In banking, however, control is typically the result of an acquisition or, in more recent years, a significant recapitalization.

marketable minority interest is the value of a bank’s publicly traded stock on an exchange or other over-the-counter market. A marketable minority interest can be traded without restrictions. Since it is a minority interest, the ownership level is below 50 percent or is such that the owner can’t effect changes that a controlling owner would be able to.

non-marketable minority interest does not have a readily traded market, and transferring the shares takes time and, potentially, can result in a price reduction. To determine a valuation for a non-marketable minority interest, some sort of discount for lack of marketability is applied to the marketable minority interest.

To arrive at this discount, two sources of data are often relied on. The first set of data stems from restricted stock studies. Restricted stocks are shares of public companies that are restricted from public trading under SEC Rule 144. Although they cannot be sold on the open market, they can be bought by qualified institutional investors. Restricted stock studies compare the price of restricted shares of a public company with the freely traded public market price on the same date. Price differences are attributed to liquidity. Many consider the discounts a reliable guide to discounts for the lack of marketability.

A second set of commonly used reference data for determining lack-of-marketability discounts is derived from pre-IPO stock studies. A pre-IPO transaction is one involving a private company stock prior to an initial public offering. Pre-IPO studies compare the price of the private stock transaction with the public offering price. The percentage below the public offering price at which the private transaction occurred is a proxy for the discount.

Valuation Methodologies 

There are several approaches to determining a valuation.

The income approach to valuation indicates the fair value of a bank based on the value of the cash flows that it can be expected to generate in the future. A discounted cash flow (DCF) analysis is one widely accepted method of the income approach.

The DCF technique measures intrinsic value by reference to a bank’s expected annual free cash flows. Typically, this involves the use of revenue and expense projections and other sources and uses of cash. Factors that form the basis for expected future financial performance include the bank’s historical growth rate, business plans, anticipated needs for capital, and historical and expected levels of operating profitability.

An alternative method is the market approach, where a bank is valued by comparing it to publicly traded banks as well as market transactions involving banks with similar lines of business. Factors to consider when determining the comparability of publicly traded banks include asset size, products, markets, growth patterns, relative size, earning trends, loan quality and risk characteristics.