What's a little hit to tangible book value, when there's an opportunity to boost earnings?
Tangible book value was considered nearly sacred in the aftermath of the financial crisis. Perhaps rightfully so book value was a sturdy measure that bankers and investors could rely on to value their companies when earnings were on a roller coaster.
With the economy improving, valuations for mergers and acquisitions rising and bankers again on the prowl for earnings, investors are becoming more tolerant of tangible book value dilution.
Or, at least they are when John Kanas, chairman, president and chief executive of the $19.2 billion-asset BankUnited in Miami Lakes, Fla., is asking.
"Give me a show of hands: If I told you I had a deal today that is accretive to earnings, but dilutive to book, would you like it?" Kanas asked the crowd during a recent presentation at Keefe, Bruyette & Woods' community bank conference in Boston. "Who weighs earnings more than book value?"
Kanas nodded, as most of the hands in the room went up. "That's what we suspected," he said. "We think that's a change."
The shift coincides with the market's return to valuing companies based on earnings, industry observers said. Given the operating environment, including persistently low interest rates, earnings are under pressure, which is becoming a more pressing impetus for acquisitions.
"We are transitioning from a tangible book valuation framework back to one based on price-to-earnings," said Joseph Fenech, an analyst at Hovde Group. "So the natural focus on deals is going to be the impact to price-to-earnings."
A tolerance for dilution of book value is limited, Fenech added. "There is still a certain threshold and anything perceived to be too destructive to long-term value is going to be viewed negatively," he said.
Kanas is mindful of that, too.
"Don't get me wrong. I'm not going to go out there and drive book value down," he said at the KBW conference. "But we think there is at least a subtle change in investor's attitudes, so we think about that as we look at deals."
The appropriate period to earn back the dilution is far from an exact science. But if banks previously could get investors to buy into a deal with less than a three-year earn-back period, the duration has perhaps been increased to five years or so.
Kanas' willingness to accept tangible book value dilution might also reflect the realities of current M&A pricing relative to BankUnited's valuation. BankUnited is trading at 167% of its tangible book value, but companies that trade at two to three times their tangible book value are buying in Florida. New York, BankUnited's other market, is also highly competitive.
"Early on in this cycle, the deals always worked really well for the buyers," Fenech said. "But as activity levels pick up and stock prices have increased, some banks are perhaps starting to overpay a bit. I'd say we are around the midpoint in that cycle, and we're starting to see the advantage go to the seller in some cases."
Sellers, from Kanas' perspective, may actually have the upper hand in a lot of cases.
With BankUnited's strong organic growth, Kanas hardly needs M&A as an earnings driver. But he is shopping nonetheless, in both Florida and the Northeast.
"We're vigilantly paying attention to the M&A market, but haven't been able to do anything," he said. "Pricing is in the way."
Shortly after the KBW conference, BankUnited agreed to buy CertusHoldings' small-business finance unit, paying $233 million for the business and a $203 million loan book. BankUnited, which expects the deal to be accretive to earnings, said it plans to earn back any tangible book value dilution in less than two years.
Kanas signaled during his presentation that nonbank deals were likely, noting that BankUnited had become more open to looking at such deals over the last five months.
"We expect to do a couple of those in the next year, year and half," Kanas said. "We will be disappointed if we don't."
Bonnie McGeer contributed to this report.