Deal activity in banking has been hot lately, but a continued decline in bank stocks is eroding the takeover premiums built into the prices of potential targets.
Though the drop has not yet resulted in a mergers and acquisitions slowdown, observers say a persistent bear market in the stocks might dampen sellers’ enthusiasm. This is more likely given that shares of what are usually the favorite targets — smaller companies — have fallen the most.
As of Friday the Nasdaq bank index, which consists primarily of smaller bank stocks, was down 3.7% for the year, compared with American Banker index of top 50 companies, which was down only 1.8%.
The stock market tanked Friday on weak employment numbers, and strategists and analysts said a slowdown in dealmaking is likely.
“The poorer the equity market, the harder it is to get a deal done,” said Andrew Senchak, vice chairman and the president of Keefe, Bruyette & Woods Inc. Market conditions probably will not kill the deals already in the works but may put a damper on informal discussions in the near-term, he said.
Joseph Morrissey, a co-head of bank stock trading at Boenning & Scattergood Inc., a West Conshohocken, Pa., market maker for small and midcap banks, said, “We have seen quite a bit of depreciation in the market value” of small stocks, because investors are skittish about the economy and trading volumes remain unimpressive.
“We have seen some price depreciation — some of them very dramatic — in the last three weeks,” Mr. Morrissey said. Some were stocks of banks that had been considered strong takeover targets.
He said they included the Pennsylvania banking companies Sterling Financial of Lancaster and Univest Corp. in Souderton, both of which have declined significantly this year. Sterling is off 16.7% from the start of the year and 6% from July 16; Univest is down 7.3% and 18.1%. Another, Pennrock Financial Services Group of Blue Ball, is down 15.2% and 8.3%.
Mr. Morrissey said those small-cap stocks, which have been trading in the range of 18 to 20 times earnings in the past six to eight months, will probably settle down to trade at 15 times earnings.
Myles Zyblock, the chief institutional strategist at Royal Bank of Canada’s RBC Capital Markets, suggested that there might be a pause in M & A as buyers wait for stocks of targets to fall further and sellers hold out to regain some of the losses. Small-cap bank stocks still have premiums built in, he said, and he expects them to drop more.
James Murray, the managing director of Houlihan Lokey Howard & Zukin, said sellers are reluctant to accept stock when the buyer’s shares are losing value. That leads to more cash being involved in transactions, investment bankers and traders said.
Mr. Morrissey said there will probably be an increase in the cash component, because it offers sellers protection against dilution in a buyer’s stock.
Analysts said that if the equity market continue to deteriorate, investors in bank stocks would be more interested in bigger companies with more diversified revenue streams, which would further erode the premium built into smaller companies’ stocks.
