Bank Director’s 25th Acquired or Be Acquired conference concluded on Tuesday in Phoenix. Invictus was proud to again be a sponsor and presenter at the event, which gathered over 1,300 bank executives, directors, and vendors. One thing is clear to me from the various sessions I attended and the conversations I had with bankers: everyone is focused on deposits. In fact, in a general session survey, 71% of attendees said that a target’s deposit base was the most important factor in making the decision to acquire. This suggests that targets with excess liquidity (low loan/deposit ratios) will be highly valued in the market going forward. However, this strategic objective is out of whack with traditional deal valuation metrics.
The two primary traditional deal metrics are tangible book value (TBV) payback period and earning per share (EPS) accretion. In his “State of the Industry” presentation, KBW President & CEO Tom Michaud stated that investors expect every deal to meet the benchmarks of a low TBV payback period (ideally <3 years) and be accretive to EPS. These are earnings-based metrics, and targets with low loan/deposit ratios have lower earnings because they have larger securities portfolios relative to loans. Therefore, traditional consolidation modeling will undervalue those targets with longer payback periods and lower accretion. Potential acquirers will struggle to justify competitive prices for these highly valued targets.
Why are deals that clearly create shareholder value by strengthening the buyer’s deposit base not reflected by the deal metrics du jour? Because those metrics are flawed. How can you justify a deposit-driven deal to an investor base that is focused on TBV payback and EPS accretion? By abandoning traditional valuation methods and using forward-looking, common sense analytics that capture the true value of an acquisition.
Traditional consolidation methodology projects the buyer and seller independently, then combines them with some purchase accounting and cost savings adjustments. Maybe the analyst will increase consolidated loan growth generated from the excess deposits acquired. This methodology does not capture the true value of the acquired deposits.
The intelligent acquirer should first project its own financials under realistic scenarios, given current market trends. Industry deposit growth has already begun to slow, and the big banks are taking more and more market share. If the bank were to grow loans organically, it must be determined:
- How much of the funding would come from core deposits and how much would require brokered deposits or other borrowings like FHLB advances and repurchase agreements? This change in funding mix will drive up incremental interest expense.
- How many of the bank’s existing depositors will shift their funds from low cost checking and savings accounts to higher cost CDs to capture higher market rates? This process will increase the bank’s existing cost of funds.
- What will happen to my deposit rates when my competitors start advertising higher rates in a desperate play to attract deposits? This will put more pressure on the bank’s existing cost of funds.
- How many of my existing loans will reprice at higher rates and help overcome increasing funding costs? Invictus’ BankGenome™ intelligence system suggests that, while the average fixed/floating mix for all banks in the US is 60/40, the percentage of floating rate loans actually re-pricing at higher rates in the next 12 months is much lower because the weighted average time between loan reset dates is over 6 quarters.
Standalone projections for the buyer must reflect adequately the risks inherent in the current operating environment. These risks will affect a bank’s bottom line and, therefore, shareholder value. This process will create a true baseline against which to measure the impact of the acquisition. Management must educate its investors on the flaws in legacy analytics, so they can understand a deal’s true value.
In the acquisition scenario, the bank is acquiring loan growth with existing core deposit funding attached. And if the target has excess deposits, the acquirer can deploy those funds into additional loans grown organically without the funding risks due to current market trends. The cost differential between the organic growth and acquisition scenarios creates real, tangible savings. These savings translate to higher incremental earnings from the acquisition, which alleviate TBV payback periods and EPS accretion issues. Traditional deal metrics may be used as guideposts in evaluating an acquisition, but a misguided reliance on them can obscure the true strategic and financial shareholder value created in a transaction.
Invictus uses its BankGenome™ intelligence system to analyze every acquirable target in depth, coming up with price ceilings customized to the acquirer, which represent the maximum deal value at which shareholder value is created. These ceiling prices help the client prioritize potential targets and identify market inefficiencies.
Don’t pass on a great deal because of flawed traditional methodologies.
Andrew O’Keefe is the Director of M&A at Invictus.
