Recent articles have debated the pros and cons of bank M&A. The question defies an easy answer. M&A performance, not unlike most competitive endeavors, fails to add value from the buyer's perspective. Usually, this is the result of over paying relative to the benefits received. Other reasons include poor execution, integration and lack of strategic fit. This does not mean you should stop considering the merits of M&A, or that certain buyers do not possess the skills to execute successfully.
Bank M&A has been dormant since the 2008 financial crisis. Buyers were reluctant to engage in a high-risk activity following the near-death experience of the crisis. Nonetheless, the case for M&A is growing. Regulatory changes combined with a weak economy and low interest rates have altered industry value drivers. Asset generation, not deposits, has grown in importance. Also, the emphasis has shifted from financial to operating leverage. Banks seeking to adapt to these changes are exploring M&A to implement strategic adjustments as they reconfigure the asset bases.
Furthermore, bank stock prices have risen substantially this year. This has improved buyer confidence. Additionally, higher stock prices help minimize dilution concerns in funding higher-priced transactions. Investors have also signaled a greater openness towards acquisitions that make strategic sense and are appropriately priced. Added to this, many banks have grown frustrated with weak loan demand, rising costs and low equity returns. These developments are offsetting the financial crisis-related reluctance to acquire.
The changing climate was highlighted by two July transactions. The first was MB Financial's acquisition of Taylor Capital in Chicago for $680 million. The other was PacWest's $2.3 billion purchase of Capital Source in Southern California.
The transactions, besides being two of the largest transactions in recent years, share the following characteristics:
- They mark a shift from small fill-in bargain purchases of troubled sellers towards large, transformational deals of well-performing sellers.
- Experienced highly rated serial acquirers reduced execution and integration concerns. In fact, these M&A skills can serve as a source of competitive advantage for banks.
- Positive market reaction followed, reflecting the strong strategic rationale of the transactions. The market share improvements in the fragmented Chicago and Southern California markets are substantial. Alternative organic growth share increases in such mature markets would be expensive as competitors would fight to defend their positions.
- Both acquisitions involved substantial tangible-book-value premiums. The key to buyer success, however, is not just the price paid, but whether the expected cost and revenue synergies exceed the premium. Again, the strong strategic rationales support this belief.
- These were non-auction negotiated transactions done before the return of a more competitive merger wave. Research indicates acquisitions done after a dormant period in an industry tend to be more successful.
- Both acquirers enjoyed improved stock price performance and a multiple improvement this year. This provided an appreciated acquisition currency to help minimize dilution concerns, and served as an important catalyst for the transactions.
- The transactions were an extension of, and not a substitute for, a growth strategy. Thus, the model can be repeated.
The MB Financial and PacWest acquisitions are examples of how M&A can add value. Of course, they are not the only template. Nonetheless, they are likely to trigger a series of consolidating acquisitions in similar types of fragmented markets. Not everyone has the ability to get it right, and "duds" will occur. Duds will also occur for banks choosing not to acquire.
Banks trying to adjust to an evolving market environment through risky and costly organic changes will suffer eroding performance and investor unrest. The crisis-related mantra of just saying no to strategic acquisitions is coming to an end. M&A is returning as a valid alternative for implementing strategy that will reshape the industry. Thus, the real question is not whether bank M&A is good. Rather, what is your bank's response to developing M&A activity?
J.V. Rizzi is a banking industry consultant and investor. He is also an instructor at DePaul University Chicago.