Ryan Beck & Co. analyst Collyn Gilbert is touting community bank stocks in the Northeast as good buys for investors.
Others say they understand her reasoning, but still favor stocks in the high-growth South.
Ms. Gilbert says Northeast banks offer better “margin and credit preservation” than those in the South, where competition is more heated.
“I’m personally of the belief that in this stage in the cycle we should be looking more toward the tempered growth regions of the country,” she said.
She singled out the $3.3 billion-asset S&T Bancorp Inc. in Indiana, Pa., and the $6.5 billion-asset Chittenden Corp. in Burlington, Vt., as particularly good values.
Year to date, S&T’s stock is down about 17% and Chittenden’s is down about 12%, while the Nasdaq Bank Index is flat. This selloff, the companies’ relatively inexpensive valuations, and the fact that their net interest margins and returns on assets and equity are generally higher than those of their Northeast peers make S&T and Chittenden attractive.
“They have a disciplined balance sheet management strategy from a credit standpoint and from a margin standpoint, and I think ultimately those two strategies will play out favorably over the next two years,” Ms. Gilbert said. “I don’t think they should have sold off as much as they have.”
She conceded that buyers still prefer high-growth markets. A Ryan Beck report, in fact, ranked Miami and Orlando among the most attractive M&A markets, pointing to statistics such as projected population growth (12.35% over the next five years, versus a 6.26% national average).
But banks in the Northeast could offer more upside for buyers than those in the deal-heavy South, where buyer desperation appears to be driving up prices, Ms. Gilbert said.
An M&A adviser said the Northeast is a more mature market with fewer start-up banks than the South, so deals are harder to come by.
“I think the people who wanted to develop a franchise and sell are already gone,” said Neal J. Curtin, co-head of the financial institutions and regulatory practice at the law firm Bingham McCutchen LLP in Boston.
But he agreed with Ms. Gilbert’s point about value. “It’s a more difficult market to do a deal, but if you get a deal, I think the fundamentals tend to be better,” he said.
Analysts said the merger-and-acquisition pace — already ahead of last year’s – will probably pick up the second half.
“Every bank is chasing growth at this point,” Ms. Gilbert said. “The organic prospects are limited. De novo is expensive. I think you’re going to see more banks turning to acquisition.
“What’s kept it from picking up to this point is you have some sellers with irrational pricing expectations. But I think as the environment deteriorates or stays flat, some of those seller expectations inevitably are going to come down.”
Richard Weiss, an analyst at Janney Montgomery Scott LLC in Philadelphia, said he expects rising short-term interest rates and increasing regulatory and accounting burdens to force more small banks to exit in the second half. He advised acquirers to wait for earnings stumbles to make the best deal.
Dealmaking should pick up in the second half, Mr. Weiss said, because “there are just too many companies that have earnings challenges right now.”
According to SNL Financial LC in Charlottesville, Va., 128 deals worth $65 billion were announced in the first half, against 113 worth $10 billion in the first half of 2005.
“I think there has been more pressure to do deals in the first half of ’06 given the current outlook for industry earnings in the face of the flat yield curve and the relatively high cost of deposits,” said John McCune, director of SNL’s financial institutions group. “Some have suggested that extended margin compression, like this, would act as a catalyst for increased activity.”
Mr. Weiss said the flat yield curve will probably stall earnings growth for buyers and sellers. He anticipates most deal prices will be under $1 billion, because fewer potential acquirers have market capitalizations over $3 billion.
The upswing will be concentrated in high-growth markets where buyers can accelerate earnings. Though core deposits make some banks in slow-growing markets desirable, rich valuations will probably keep acquirers from paying much more than current stock prices, Mr. Weiss said.
But Ms. Gilbert advised acquirers and investors alike to consider the upside of banks in Pennsylvania and western and central Massachusetts.
Higher-growth markets offer acquirers more short-term profit, but “the question longer-term is, Are you really getting the return on this investment?” she said. “As parts of that region start to slow, as credit starts to deteriorate, as margins compress, is your ultimate return just as good as it would have been if you paid a little bit less for an institution in a slower-growth market?”
Of 128 acquisitions announced this year, 30 have been in the Southeast, 23 in the Southwest, and 17 in the Middle Atlantic and New England regions, according to a Ryan Beck report. The southern deal prices average 2.87 times tangible book and 26 times earnings per share over the previous 12 months, with a 21% core deposit premium. In the quieter Northeast, pricing works out to 2.22 times tangible book and 29 times earnings per share over the previous 12 months, with an 18% core deposit premium.
Ms. Gilbert said that Pennsylvania might be overbanked and that many banks there are offering high-priced certificate of deposit promotions to attract deposits. Still, she said: “You don’t see crazy, irrational pricing in that market on the lending side. I do think in the next few years Pennsylvania is not a bad market to be in, because you haven’t seen that intense competition.”
