If the first quarter is any indication, 2005 could go down as the slowest year for bank acquisitions since the early 1990s.
Just 38 deals were announced in the three months, about half the number announced in last year's first quarter, according to Highline Banking Data Services.
They are smaller, too. After three months last year there were 14 deals in the works for banks with $1 billion of assets or more. This year there are three, the largest being Capital One Financial Corp.'s agreement to buy Hibernia Corp. for $5.3 billion.
Most observers had expected a slowdown in 2005, since the fourth quarter had none of the huge deals that tend to spur smaller ones. But few predicted the drop-off would be so dramatic.
Analysts point to a number of factors, including lower bank stock prices and higher interest rates. They also speculate that executives were preoccupied by a deadline for complying with a particularly onerous section of the Sarbanes-Oxley Act.
Charles Crowley, a managing director in the Cleveland office of Friedman, Billings, Ramsey & Co. Inc., said merger activity generally follows stock market activity - when bank stocks are up there are more mergers, and vice versa. The Nasdaq bank index fell 7.8% between Jan. 1 and March 31 after rising 8.1% in the fourth quarter and 2.3% in the third quarter.
For buyers that planned to use stock, a drop in the market means they would probably have to issue more stock than they had hoped to get a deal done. Most potential sellers' stocks have also dipped, Mr. Crowley said, but their expectations tend to lag because they are still mesmerized by past multiples. Consequently, no one can agree on price and few deals are made.
"It's a classic situation we go through," Mr. Crowley said. "There ends up being a mismatch between sellers' pricing and buyers' ability and willingness to pay."
So what happens is that the majority of sellers are small, privately held banks and thrifts. Seventeen of the 38 deals announced in the first quarter were for banks with assets of $100 million or less.
Unless the pace quickens, the number of deals announced in 2005 will be well below 200, against 286 last year and 545 in the peak year of 1998. Highline's numbers go back only to 1993, but in no other year have there been fewer than 234 deal announcements.
Mark Fitzgibbon, co-director of research at Sandler O'Neill & Partners LP in New York, said higher interest rates are also affecting the values buyers put on takeover candidates. Many banks want to get an idea of what the rates are doing to a potential merger partner's balance sheet before moving forward, he said.
"Buyers are unsure of the earning power of sellers, and they are playing the waiting game to see if they can strike a better deal," Mr. Fitzgibbon said.
Of course, this is hardly the first time in the last decade that interest rates have risen and stock prices have fallen. That is why analysts suggest that a third, one-time factor contributed to the historically slow first quarter: section 404 of Sarbanes-Oxley.
"Community banks have had a heavy regulatory focus on Sarbanes-Oxley and have been distracted from dealmaking," said John Blaylock, a senior associate with Alex Sheshunoff & Co. in Austin.
Under 404, banking companies that file with the Securities and Exchange Commission must have an independent auditor conduct a separate review of their management's internal controls. The deadline for most banks was March 15, and hundreds of community banks struggling to complete the audit missed the deadline.
Mr. Crowley said much of the Sarbanes-Oxley compliance burden has fallen on the chief financial officer, who is the main player in structuring mergers at most banks. With the compliance deadline looming in the first quarter, CFOs may have put deals on hold.
"The Sarbanes-Oxley 404 saga has weighed heavily on bank CFOs," Mr. Crowley said.
Nonetheless, he said he would not be surprised if the pace accelerated this quarter as bankers grow increasingly frustrated with their compliance workload and seek out buyers.
Mr. Blaylock added that with the 404 deadline past, and with sellers and buyers slowly coming to terms with pricing, he, too, expects dealmaking to pick up.
In fact, he said several bankers had told him in the last six weeks that they were looking to sell before the record-high multiples could drop too much and before interest rates could rise further and distract buyers.
"It looks like prices are going to peak out," he said. "And a number of sellers are going to get out now before the industry goes through another cycle."
