Bank M&A: Strike while it is hot?
Now is the time to buy a bank! Or is it?
There are mixed messages coming from industry experts since bank stocks began surging after the presidential election. Some are advising banks to strike now since their stocks are high, while others are warning institutions to avoid getting caught up in the hype and overpaying.
Potential sellers are also being advised to take certain steps to protect shareholders in case the stock market reverses course.
“We’re telling buyers to be aggressive and sellers to be thoughtful,” said Jonathan Hightower, a lawyer at Bryan Cave. “The potential for legislative changes, lower corporate taxes, higher rates and reform to Dodd-Frank … are already priced into bank stocks. There could be a pullback if any of those things don’t occur.”
The 25 bank mergers announced through Feb. 13 of this year had an average premium of 190% of the seller’s tangible book value, based on data from Keefe, Bruyette & Woods. That compares with 136% last year, including 123% in the first quarter.
The KBW bank stock index is up more than 20% since the election.
“We think it is a good time for management teams and boards to talk about their strategic plans,” said Matthew Veneri, co-head of investment banking at FIG Partners. “We’re in a good market right now and pricing has been elevated. There are strong currencies out there.”
Banks must carefully think through pricing before signing a deal. Though it rarely happens, deals can be jeopardized because of fluctuations in the stock market.
PrivateBancorp last year postponed a shareholder vote for its pending sale to Canadian Imperial Bank of Commerce after some investors and proxy-advisory firms deemed the offer as insufficient after the post-election jump in bank stocks.
Basswood Capital Management, an investor that once pushed Astoria Financial to consider selling itself, reversed its stance after the election, encouraging Astoria to call off its deal to be sold to New York Community Bancorp. The companies eventually agreed to go their separate ways.
Due to such a risk, it’s important for executives at selling banks to insist on protections against potential market volatility.
More banks could add walkaway provisions to allow the parties to terminate deals if stock prices decline before a transaction closes, said Thomas Michaud, president and CEO of Keefe, Bruyette & Woods. Such provisions can protect sellers against turmoil within the stock market.
Banks should also consider setting the exchange ratio 10 days before the closing date, said Tom Rudkin, a principal in mergers and acquisitions at DD&F Consulting. It also makes sense to incorporate collars that protect both parties.
“I think there are some swings still to come,” Rudkin said. “It is a good time for buyers and sellers because there is more liquidity and bank stocks are trading at a more active level than several months ago. Shareholders of the seller would be able to sell their stock after closing.”
Investors should be eager to have protections worked into a deal, said Jack Thompson, head of financial institutions investments at Gapstow Capital Partners. The post-election rise in bank stocks increases the likelihood that a buyer’s stock will drop between now and a deal’s completion.
“Good banks are always talking to buyers, but I think some bankers are trying to digest the implications of the [new] regime,” Thompson said. “That’s not clear yet.”
Protections do not protect shareholders from shocks that happen after a deal closes, so sellers must have faith in the buyer’s strategic vision and plan, said Greyson Tuck, an investment banking adviser at the law firm Gerrish Smith Tuck.
“The seller has to be very conscious and wary of big run-ups because that is a prime time for there also to be significant run downs,” Tuck said. “It’s fairly easy to get enamored with big numbers now that all of these buyers are dealing with inflated currencies.”
Risk of overpaying
Buyers also need to exercise discipline, industry experts said.
“Buyers need to focus on the [due] diligence of the underlying franchise value [and] the assets and capabilities of the seller,” said Vincent Hui, who leads the M&A and risk management practices at Cornerstone Advisors. “Sometimes there can be a disconnect between the intrinsic value of a seller and what the stock market values it at.”
Buyers are especially at risk right now of overpaying given ongoing changes in technology and customer preferences, said Tony Plath, a finance professor at the University of North Carolina at Charlotte. Management teams risk taking on too many branches or deposits at a time when they may not need them, he said.
“If you can come up with a good strategic reason for a target [such as] expanding your territory and buying customers, then that’s good,” Plath said. “You will overpay if the best you can come up with is [doing a deal] so you can add branches and bring in deposits.”
Kelly King, BB&T’s chairman and CEO, made a similar point during the Winston-Salem, N.C., company’s earnings call last month. He said BB&T would likely want to pay less for a bank with a large branch network, noting that a reliance on physical locations is “facing a near-term tipping point … as digital technologies really accelerate.”
Franchise value and actual earnings potential factored heavily into a recent decision by Midland States Bancorp in Effingham, Ill., to buy Centrue Financial in Ottawa, Ill.
The underlying metrics of recent deals may be largely unaffected by the November election, said Leon Holschbach, the company’s president and CEO. “A new president is elected and there’s a lot of talk about regulatory changes and … tax reform, but other than that not much has changed,” he said.
It is possible that meaningful regulatory reform and lower taxes could lead to improved financial metrics for deals. That, along with an extended period of elevated stock prices, could increase premiums and spur more activity, industry experts said.
That could be especially true for regional banks, Michaud said.
“We’re in a unique period where sellers are getting valuations that, from a historical perspective, are well above average,” Michaud said. “At the same time, buyers’ currencies have gone up as much or even more, which has put them in a position to do accretive deals that reward their shareholders. We’re in a particular sweet spot for more M&A activity.”