It’s a hostile merger and acquisition world out there and the depressed bank and thrift market has not been spared. M&A deal activity for banks and thrifts totaled a respectable $72.5 billion in 2007, compared with $108.6 billion in 2006. The number of deals rose to 356 from 285. But most of that business was booked before the subprime meltdown gathered momentum, and activity has shuddered to a near standstill since, analysts say.
“During the first half of last year there were seven deals worth over $1 billion and two deals valued at over $5 billion,” observes Craig Zander, principal and head of the core bank practice at Capgemini U.S. “In the second half we saw one deal worth $5 billion and just two worth more than $1 billion, and it hasn’t picked up,” he notes.
Indeed, the era of the easy transaction has clearly passed. Even the most conventional deals are on precarious ground this year. First Horizon National Corp. canceled the sale of its nine metro Atlanta branches to Fifth Third Bancorp in early February, for example, claiming that the “two parties had not reached agreement concerning a key term of the contract” unrelated to any quality or performance issues. Fifth Third has filed a lawsuit in U.S. District Court in Southern Ohio to force First Horizon to go through with the deal.
The seizing up of the credit markets, tumbling bank sector share prices, and declining profitability have all played a role in the abrupt decline in mergers and acquisitions as potential buyers and sellers have been distracted by their own woes. Banks and thrifts are “still trying to figure out what their exposures to subprime is and what shape they’re in,” according to Patricia Hines, senior analyst of wholesale banking at TowerGroup. “They are certainly so internally focused on returning to prior levels of profitability that nothing much will happen this year in terms of mergers and acquisitions.”
This need to focus internally makes the prospect of performing due diligence, or enduring it, unappetizing. “Due diligence is much more difficult for both sellers and buyers,” explains Zander. “It has to be much more comprehensive in the light of current market conditions.”
In this environment, some institutions may put off sales plans because of the intrusive nature of the due diligence process. “If there are multiple potential buyers, due diligence disrupts business,” he notes. The degree of detail can be problematic, especially “when it means looking into specific credit and specific customers.”
Even if both sides are willing to undertake due diligence, valuation in today’s climate is extraordinarily difficult. Bank share prices have eroded as a class, and both buyer and seller have to decide whether or not the target institution’s equity value has bottomed out. “The devaluation may be temporary,” says Zander. “Is the core business still strong? It may be difficult to attain the previous value of the institution.” These questions add another layer to the due diligence process.
And even if both sides agree to due diligence and come up with a valuation, financing is yet another hurdle, limiting the M&A market, says Hines. “Lead arrangers are facing this overhang. They’re stuck with a backlog that they haven’t been able unload, debt they haven’t been able to lay off as they had anticipated,” she adds. “Banks aren’t willing to do that leverage they had promised. They have stepped back from some handshakes,” notes Hines.
What can we expect in 2008? Banks will do some selective, strategic buying, say analysts. Institutions from outside the U.S. will take advantage of the cheaper dollar and pick up some bargains. “Banks won’t buy just to get bigger,” according to Zander. “They’ll look to geography or to business mix. There are a number of targets available, and deals can be done.”
The greatest opportunity will be for “those institutions recovering most rapidly, as their earnings improve and the markets recognize this. When that starts to happen the playing field won’t be as level, and that will create more buying opportunities.”
Despite Bank of America’s proposed acquisition of Countrywide for around $4 billion, analysts do not expect many acquisitions so focused on the mortgage market. Most will look to more diversified targets. “Yes, Countrywide is a large bank, but it’s a monoline kind of business. Other institutions with broader business lines could be more attractive in today’s market,” Hines says. Bank of America “had to keep its original investment whole,” she adds, because it had invested $2 billion last summer in Countrywide.
