M&A at midyear: Lackluster volume but attention-getting prices

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Deposits are becoming a more important aspect of bank M&A.

Funding costs were largely overlooked for years while the Federal Reserve kept interest rates artificially low and banks drowned in deposits. Many institutions remain flush with liquidity as consumers and businesses are reluctant to make big withdrawals.

Several catalysts are spurring banks to think more about deposits than they had in prior years. Interest rates are rising and many institutions continue to make more loans. Also, the Fed is poised to unwind policy that put excess reserves into the banking system.

Buying banks with stable, low-cost deposits is one way to stay ahead of the game.

“Not too long ago people almost took the funding side of the balance sheet for granted,” said Charles Crowley, managing director at Boenning & Scattergood. “We’ve heard from a few banks that their loan-to-deposit ratios are getting up there and they’d be happy to buy a [deposit-rich] bank in a smaller town.”

Premiums paid for deposits are rising. The average deal value divided by deposits was nearly 21% through June 19 of this year, based on data compiled by Keefe, Bruyette & Woods. That ratio was 16% in mid-2016 and just 12.9% in the first half of 2013.

The average core deposit premium was about 9% for deals announced through June 19, a meaningful increase from roughly 5% for all of last year’s bank acquisitions. Premiums paid in branch deals have also been climbing.

The banking industry is nearing an “inflection point” for deposits, KBW’s research team wrote in a Monday note to clients. “The quality of a bank’s deposits franchise could rise to become the No. 1 driver of bank valuations.”

“You’re seeing a lot of people looking for good, high-quality deposit relationships,” said Craig Miller, a lawyer in the financial services practice at Manatt, Phelps & Phillips. “Buyers are looking for core deposits.”

The financial crisis should have punctuated the importance of having a strong base of core deposits, said John Asbury, president and CEO of Union Bankshares in Richmond, Va. He said core deposits were a big reason his company agreed in May to buy the $3.2 billion-asset Xenith Bankshares.

The $8.6 billion-asset Union has struggled to reduce its loan-to-deposit ratio from 99% to a targeted 95% through organic means, Asbury said. Buying Xenith, another Richmond bank with an 88% loan-to-deposit ratio, should help.

“We’re always looking at ways to step up our pace of deposit growth,” Asbury said. “Deposits have been undervalued for a long time.”

Bank mergers announced this year have been, on average, larger and pricier than those announced in recent years. Average deal value through June 19 was 31% more than what it was in mid-2016, at $222 million, based on KBW data. The average price to tangible book value increased to 166% from 129%.

Those positives have been partly offset by low overall volume. Through June 19, banks had announced 110 deals, putting activity on pace to decline by 8.3% from 2016, based on KBW data.

A post-election run-up in bank stocks has contributed to higher premiums, which in turn could prompt more boards to consider selling, said Paula Johannsen, a managing director at Monroe Financial Partners.

Johannsen said her clients, typically banks with less than $500 million of assets, are getting better premiums for selling. That’s noteworthy because smaller banks typically have lower valuations and sell for lower premiums than larger institutions.

Buyers “are looking to take advantage of their currency,” Johannsen said. “They expect their earnings to be strong. Sellers’ earnings are starting to move a bit.”

First Foundation in Irvine, Calif., which recently announced its first bank acquisition in two years, could be open to another deal if “the right opportunity comes along,” said Lindsay Lawrence, the $3.7 billion-asset company’s chief banking officer.

There are several reasons M&A could accelerate, Lawrence said. Buyers are keen on accessing new markets and bringing in fresh talent, while potential sellers could be wary about regulatory constraints and the risks associated with rising interest rates.

Activity could also increase as banks find fewer regulatory delays closing deals, said Thomas Michaud, KBW’s president and CEO.

Michaud said he hopes the time between announcement and closing will continue to narrow, noting that it took only 145 days for Pinnacle Financial Partners in Nashville, Tenn., to complete its purchase of BNC Bancorp in High Point, N.C. In comparison, it took more than 230 days for F.N.B. Corp. in Pittsburgh to buy Yadkin Financial in Raleigh, N.C.

“The speed at which deals were approved by regulators has been a welcome development, but it’s hard to say that it is a new era,” Michaud said.

Michaud said a re-emergence of large regional banks in M&A could happen later this year. Many of those institutions have been hamstrung by regulatory orders addressing compliance issues with anti-money-laundering laws and the Community Reinvestment Act.

Large regionals have excess capital that exceeds what they are willing to return to shareholders through dividends and stock repurchases. That could lead to more acquisitions of banks, fintech firms and specialized lenders.

“The absolute price banks are getting over time is healthy,” Michaud said. “It is a flashing green light. … There are enough acquirers with superior share prices to make M&A continue.”

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