In striking its second deal in a year, Harleysville National Corp. is expanding further in Pennsylvania's most attractive markets.
The $3.9 billion-asset Harleysville announced Wednesday that it is buying Willow Financial Bancorp Inc. in Wayne for $162 million in stock.
The combination would create the third-largest banking company based in the Philadelphia area, with $5.5 billion of assets and 84 branches.
Perhaps more significantly, it would give Harleysville a larger presence in Chester County, Pennsylvania's fastest-growing and most demographically attractive county. The county's median income is nearly $86,000, and buying Willow would add 13 branches to the two Harleysville has there, giving it a 5.8% deposit market share.
"There's a defensive component to this," said Paul D. Geraghty, Harleysville's president and chief executive officer. "With us getting this contiguous territory in Chester County, it helps keep other people out."
Donna M. Coughey, Willow's president and CEO, said that the company had been actively seeking a "strategic partner" for the past six months and that recent accounting problems had nothing to do with its decision to sell. Two weeks ago Willow restated earnings for its last two fiscal years because of a "material weakness" in its internal controls.
"This is a tough market," Ms. Coughey said of the increasingly challenging operating environment for small banks. "It's one that continually gets more and more regulated."
This would be Harleysville's second sizable acquisition within a year. It bought the $451 million-asset East Penn Financial Corp. in Emmaus, Pa., for $92.7 million in cash and stock in November.
The deal with Willow is set to close in the fourth quarter. Its Willow Financial Bank, with 29 branches, would be merged into Harleysville National Bank and Trust Co.
Harleysville operates in three of the four counties Willow is in, but Mr. Geraghty said none of the branches would be closed because there is no overlap. Still, Harleysville expects to cut $15 million to $20 million of expenses next year, or 10% to 13% of the two companies' total expenses.
Each Willow share would be exchanged for 0.73 Harleysville shares, giving Willow shareholders a 27% stake in the combined company. Based on Tuesday's closing prices, the deal values each Willow share at $10.28 — a 32.8% market premium.
The price is lower than for other deals in the Northeast over the past five quarters; it works out to 1.79 times Willow's tangible book value, versus a median of 2.28 for the other deals, according to Harleysville.
David Darst, an analyst at First Horizon National Corp.'s FTN Midwest Securities Corp., said most banks fetch at least two times their tangible book value, but Willow went for less because of its accounting problems and lack of earnings growth over the past few years.
"Obviously Willow is selling from a position of weakness," he said. "They waited too long."
Mr. Darst said investors expected Willow to sell three years ago, shortly after the third anniversary of the thrift's conversion to a public company.
Instead, Willow bought Chester Valley Bancorp, but under the Chester Valley management team Willow struggled to increase earnings and loans — and the recent accounting troubles only made matters worse. "The past three years have been disappointing for investors," Mr. Darst said.
Willow said it had to restate its earnings because material weaknesses in its financial controls caused an unreconciled difference of $6.2 million and forced it to write off $8.3 million.
The company said it could not determine the cause of the imbalance despite five months of "exhaustive efforts" and $2 million in fees paid to advisers and an accounting firm.
Still, Ms. Coughey said she is confident the issue would not have a lingering impact. "When you look out at this merger two to three years from now, I think you're going to see phenomenal growth in earnings," she said.
