Bank Director’s annual Acquire or Be Acquired (AOBA) conference was marked by positive buzz. After all, bank M&A for 2019 came in at a four-year peak, the fastest pace in history. But community bank acquisition strategies can’t be explained with a business-as-usual mindset.
We all know that these are unprecedented times, marked by years of never-before-tested monetary policies. And unprecedented times call for unique and creative strategic thinking. The bankers that can embrace change and think outside the box will find success in navigating this new landscape. Some of the trends in M&A are reinforcing this point and may serve as a guide to success.
Three Points about M&A Trends
1. Mergers of Equals
Mergers of equals returned in a big way in 2019. Total MOE deal value increased more than 10x in 2019. That is not a typo. This is primarily due to deals completed by regional bank players, but it also speaks to the general approach being taken by smart acquirers. M&A is becoming more strategic in light of the issues facing banks in the current climate (as we told you in a previous Bank Insights article).
MOEs are being done to build bigger, more profitable banks. In short, a well-structured MOE doesn’t just solve problems, it can completely transform an institution. Scale is working to create shareholder value and if done right, an MOE can be the absolute best path to creating meaningful scale.
Opponents of MOEs cite the social issues involved in getting a transaction to the finish line. It’s true that trying to pull off a transformational merger could be a social disaster. Taking a proactive approach and building relationships is essential for effective communication.
But successful MOEs can be far more powerful than a straight-up acquisition. The impact on size is more meaningful and MOEs have better economics because they do not involve full control premiums, leading to shorter payback periods and a better ROI. Most importantly, they protect the interests of the rank-and-file employees, customers, and communities of both banks far more effectively than a bank sale. Shareholders for both institutions are also better positioned because the surviving stock is in a better position for both short and long-term appreciation, which more than compensates for any sacrifice in the change in control premium for the smaller of the two institutions.
2. Decreasing Transaction Prices
Price-to-tangible book value and price-to-earnings multiples were notably lower in 2019. Major factors are the sell-off in bank stocks that occurred at the end of 2018 and the one-time impact of recent tax changes. A cautionary note on price multiples is warranted. The value of a target should be a function of its financial and operating characteristics. Not only should a target’s value be a function of the bank specific characteristics, but you must also consider how those characteristics mesh into your characteristics as a buying institution. A buyer may “over-pay” relative to current averages but that doesn’t mean a deal isn’t good if it is an ideal partner. If industry loan growth doesn’t improve and/or bank stocks do not continue their recovery, then lower price multiples may continue into the near future. At the same time, look for the “bid/ask” spread between buyers and sellers to once again widen, which could slow down or stop certain deals from progressing.
3. The math must work
A trend that doesn’t appear to be changing anytime soon is what investors want. The long and short is that tangible book value earn-back is still very important, and most investors want to see 3 years or less. I’m not going to comment on the flaws of TBV payback because Invictus has already thoroughly addressed the issue. See our previous post on valuation and our prescient 2016 piece on why Wall Street was wrong about the KeyCorps deal. Funny enough, institutional investors agree that franchise value creation of the buyer is most important. However, they don’t commonly agree on the calculation of franchise value, and therefore TBV becomes the default metric of consideration.
Institutional investors also expressed some frustration due to the massive number of passive holdings in bank stocks, which makes it harder to evaluate a deal on its own merit. Passive holdings don’t have to be a complete negative, however. Public banks that grow from acquisitions can gain inclusion into index funds, which will result in more liquidity for stockholders and a potential second bite of the apple for shareholders. This can be a big sticking point for selling target shareholders on deals that have a stock consideration component.
Before parting with this topic, I want to make it clear that investors did express interest in the strategic merits of transactions. To sum up the investors’ perspective, I would say that you need to make the math work AND sell the daylights out of the strategic merit. You need to do both. To quote Jonathan Ashe from Wellington Management Company, LLC: “The true assets of the bank are its liabilities, its core deposits.” In other words, you need to quantify and sell the strategic aspects for your transactions because traditional metrics simply aren’t going to be enough for that job.
A Few Observations about Market Trends
Loan Growth continues to slow
A known trend that is hitting home for many bankers across the country is decelerating loan growth. One could go on endlessly discussing the causes and effects of this, but I want to focus on two aspects.
The first is that while this is an industry-wide problem, pockets of the country are densely populated with smaller community banks. When you couple that with decelerating loan growth, you will see a faster pace of consolidation in these areas. The rural Midwest is one of the most challenged areas for organic loan growth. It is also the area with the most banks and these markets are generally over banked. So, it’s not a coincidence that Midwest states are where we are seeing most bank deals taking place.
The second point is that decelerating loan growth only exacerbates NIM compression because you can’t use loan growth as an offset. M&A is the quickest route to pick up a few years of organic growth instantaneously. By seeking strategic acquisitions that fundamentally evolve your liability structure, you directly attack the root of the compression problem.
Fintech
It’s no surprise that digital technology is a hot topic of conversation, as fintech disrupts the consumer banking space. There are currently more than 250 banks that have onboarded Zelle to compete with the p2p giant Venmo. Varo Money just received preliminary approval for a national bank charter. Many more banks will be onboarding in the coming years. But what comes next? Where are the opportunities for banks to gain an edge? It seems that commercial banking customers could be the next wave of digital disruption. KBW President & CEO Tom Michaud reported that 95% of commercial customers want digital services and 85% of commercial customers already use digital banking products in their personal lives.
While the big banks can either outright buy fintech companies to utilize their technologies or invest heavily in IT to build systems internally, community banks don’t have this luxury. They need to develop strategic partnerships with the right fintech companies. Regardless of what strategic partnerships are made, banks are going to have to keep increasing IT spend to keep up competitively. The capacity will need to be created by M&A or reallocation of costs. The recent MOE between CenterState Bank and South State Bank announced in January cited this as a major driver for the transaction. Ditto for the MOE between BB&T and SunTrust that created Truist.
Wrap Up
Look for the MOE to become the en vogue transaction in 2020. A mundane low growth/low rate environment coupled with increased technology disruption is ideal for this type of transaction. Click here for more information on MOEs and how to avoid their pitfalls.
Jared Woods is a Senior M&A Analyst at Invictus Group, LLC. Jared is responsible for managing relationships with selected Invictus M&A clients and for helping those banks originate, analyze and close acquisitions.
