Some bankers and investors are looking back at the recent merger and acquisition boom and wondering, "Were we too late?"

Community banks once could sell themselves to larger organizations at three times their book value. Those days are long gone, and some bankers wonder if they made a major mistake by holding on to their banks.

If the buyers would have paid in cash, the answer is yes. But if the currency would have been the buyer's stock, as in most such deals, the answer is no - unless the recipient would have redeemed that stock before prices started to tumble two years ago.

In fact, most would have held on to that stock, for several reasons.

First and probably foremost is the desire to avoid capital gains tax payments.

Second, acquiring banks usually pay higher dividends. (It is pretty hard to sell shareholders on a merger if their dividends are going to be smaller, no matter how solid long-range potential appears to be.)

Third, the new stock, in a larger company, is more liquid. The old bank's shareholders figure it can be sold at any time - so why hurry?

But things have changed. Though bank stocks have rebounded of late, they are nowhere near the highs of two or three years ago. As a result, those who may think they missed a once-in-a-lifetime opportunity by not selling may have actually made the right decision.

After all, if you trade your stock at triple its book for the stock of another bank that is also selling at triple its book, you really haven't gotten so wonderful a deal. Conversely, if you didn't make such a trade, you didn't lose that much either.

David L. Martin, the managing director of Sandler O'Neill & Partners, presented this argument at a convention of the Pennsylvania Association of Community Banks last fall.

He said that something called the compensation ratio is far more important than price/earnings ratios and book value in evaluating a deal.

The compensation ratio compares the selling stockholders' new share in the combined bank with their old bank's contribution to the new bottom line.

For example, if the combined bank earns $120 million and the selling bank provides $20 million of that, then the shareholders of the selling bank must hold more than one-sixth of the shares outstanding to have a favorable compensation ratio.

When bank P/E ratios were producing triple-book acquisition offers, selling banks were dazzled by the high market value of the stock they were receiving and paid little attention to the compensation ratio, Mr. Martin said.

Now, with share prices back from the stratosphere, community banks are getting offers with better compensation ratios, he said. This is why he feels that community banks that didn't sell during the market highs did not lose as big an opportunity as many bankers think.

Here is a warning, though, for community bankers who look at today's compensation ratios and think this is the right time to be acquired:

Acquirers are not stupid.

They know what they are giving up when they make a share-for-share exchange, and they will accept dilution of earnings only if they think they can make it up through cost cutting and improved efficiency.

In other words, sellers who get a favorable compensation ratio should realize that their operations will be under pressure to justify the deal.

Mr. Nadler, an American Banker contributing editor, is a professor of finance at Rutgers University Graduate School of Management in Newark, N.J.

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