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In Bank M&A, Pricing is the Big Hurdle Now

It almost felt like the return of the heyday for mergers and acquisitions.

Many of the companies that presented at Keefe, Bruyette & Woods' Boston Bank Conference in late February talked about deals they'd just done or the type of deals they hope to do soon. Those that didn't were inevitably asked about the possibility of selling.

With all the focus on M&A, you'd think there would be a lot more of it than there is. But the 227 mergers last year barely increased at all from 2012, and 2014 is expected to perform similarly.

Bankers say the problem is no longer a lack of buyers or sellers. Rather, pricing is the biggest hurdle.

Home BancShares (HOMB) is a recent buyer on the prowl for more deals, and Randy Sims, the Conway, Ark., company's chief executive, says a courtship is necessary to get potential sellers "back to reality" on pricing.

What Home has seen "which has been really interesting and entertaining to be honest," Sims says is that many of the would-be sellers went from losing money to making a small amount, yet project 50% growth in the coming year and expect to be paid on the pro forma numbers.

"Well, that's not going to work," says Sims. "How are you going to get there if you've never gotten there before?"

Still, sellers abound, particularly in Florida, where Home is most interested in doing another deal. "It's like being on a train with three seats left, and you pull into the station and there are 15 people in line," Sims says, quoting Johnny Allison, Home's colorful chairman. "Truly, it may not be that good, but it's close to it."

Some prospective sellers are worn out from the crisis. Others have investors who want liquidity. Still others are skeptical about their prospects for meaningful earnings growth.

But even with those eager to sell, "it really takes some time to get to know the people, let them get to know you, and come together on a reasonable price," Sims says.

Pricing is also one of the reasons why BOK Financial Group (BOKF), an active buyer of banks in the past, has not done any recent deals.

"You would think on the surface if you're looking at transactions that are two times book or less, that would be attractive," says Steve Bradshaw, the Tulsa, Okla., company's president and CEO.

But BOK focuses on internal rate of return as a metric for doing deals, and the pricing in markets such as Oklahoma and Texas is not so enticing from that perspective. "You are not seeing returns much above the cost of equity coming out of those deals," he says.

Another factor holding back many interested buyers including BOK is a lack of sellers they consider appealing. Many consolidators have highly specific criteria for the types of banks they want and how fast they expect to see a return on their investment.

Bradshaw says BOK is not interested in turnaround or distressed deals, because the repair work would require too much time and energy. "That's going to take away from your opportunity to grow the bank organically in other areas, which we have a good track record of doing."

But BOK is actively looking at deals, and Bradshaw says he expects good opportunities to arise, despite the fact that "our target group has not really been selling the last two or three years."

BOK is targeting banks with $500 million to $2 billion of assets and a strong customer base. The size criteria is a littler larger than in the past because, Bradshaw says, scale is needed these days to justify the amount of effort required for an acquisition.

"I think that the due diligence effort is a different ball game today," he says. In the past, buyers focused mainly on evaluating loan quality, but now the biggest challenge is understanding the operational risk.

"You've got to be able to get behind the scenes and understand what has been done, or the operating mode, if you will, from that organization, whether it's in the mortgage business or fair lending," Bradshaw says. "So to me, you have to have reasonable scale to make that worth your while."

It is a perspective that several other bankers echoed, including John Kanas, chairman, president and CEO of BankUnited (BKU) in Miami Lakes, Fla. For Kanas, the lengthy regulatory approval process is a key disincentive because it makes smaller deals much more inefficient.

"You better know what you're doing when you knock on the regulator's door and you better be ready to spend a year being distracted from your own business, because that's how long it takes today," Kanas says.

"You wouldn't want to tie yourself up with something that's $1 billion or $2 billion [in assets] when something bigger might come along," he adds.

Target size aside, Kanas says his $14.9 billion-asset company is enjoying so much organic growth that it sees no need to do acquisitions. The company added about $3 billion of assets last year.

"It's hard to find an M&A deal that holds a candle to that kind of growth rate on your own," Kanas says.

Still, BankUnited would consider a deal if it made sense. But good luck finding one of those. "The strategically sensible deals don't make financial sense today," Kanas says.

BankUnited bid "very aggressively" on City National Bank of Florida last May, Kanas says. The $4.9 billion-asset Miami bank was "right across the street," and BankUnited could have achieved cost savings of 50%, justifying what Kanas considered to be a "fully priced" offer.

A Brazilian suitor outbid BankUnited "by a crazy amount," then a Chilean buyer outbid the Brazilians, paying 30 times earnings with no cost saves, Kanas says. (Banco de Credito e Inversiones bought City National for $882.8 million from Spain's Bankia.)

On a $900 million deal, BankUnited "missed" by a whopping $100 million, Kanas says.

He doubts BankUnited's deal making prospects will improve anytime soon either. "There's always the potential that the stars could align," he says. But with pricing as it is, "I don't see it."