M&A will dip from 1994's record pace but pick up again after a year or two.

Nineteen ninety-four is on target to become the first- or second-busiest bank M&A year in history, both in terms of number of deals and total deal volume. At the current pace, we will have over 500 transactions this year, with total deal value falling somewhere between $22 billion and $25 billion

Total assets acquired, likely to be around $200 billion, will fall well short of the $275 billion that changed hands in 1991, but will still represent about 5% of total banking and thrift industry assets at the beginning of the year.

This year it is also quite possible that more thrift assets will be acquired than bank assets. The amount is likely to approach $100 billion and account for about 15% of the total thrift industry assets at the beginning of the year. Also, by virtually every measure, acquisition prices which have been rising steadily since 1991 are at their highest level ever.

Rising Prices 3Q '91 '93 '94Price/tangible 138% 167% 175%bookPrice/ 14.5x 75.0x 16.0xEarningPremium 2.8% 6.4% 8.0%

The banking industry has suffered from the herd syndrome for a long time. The bank M&A market is no exception in sticking to the follow-the-leader category. Perceptions are often more important than reality and fads prevail.

A period of consolidation that will last decades rather than years began in 1990. While the acquisition activity may ebb and flow, over the long run it will remain substantial. We believe that we are at the fourth and final stage of the current cycle.

Chronology of Current Cycle

1. 1988 and 1989: Supply exceeds demand. Big acquirers are the only game in town.

NationsBank and Banc One acquired First Republic and the MCorp Banks and, with only a few other bidders, snagged real bargains that propelled their franchises.

2. 1990-1991: Resolution Trust Corp. increases supply.

RTC sales commenced in 1990, but through the first half of 1991, only a handful of buyers participated. The deposit-to-premium ratio averaged 1% to 2% and many acquisitions fell below that level. Buyers like First Fidelity built their franchises off RTC and Federal Deposit Insurance Corp. deals and cheap premiums.

3. 1991-1992: Superregionals enter the market; demand builds up.

During the second half of 1991 and 1992 superregionals dominated the scene. Initially demand came from the big guys -- the Chemical/Manufacturers Hanover merger, the Bank of America/Security Pacific merger, and the NationsBank merger with C&S/Sovran were the major transactions.

In general, with a smaller number of buyers, prices were lower and deals made more sense than they have in 1994. However, megabank mergers soon were followed by superregionals and supercommunity banks such as KeyCorp, Comerica/NBD, First Union, and PNC, which entered the buyers' side with lots of capital and ravenous appetites.

4. 1993 and 1994: Demand exceeds supply.

A hoard of regional banks had entered this fray by this time and four things happened:

1) The number of deals increased from 302 in 1981 to 382 in 1992, to 467 in 1993, and a probable 500 deals in 1994.

2) Deal size declined.

3) Prices rose as competition among buyers increased.

4) Aggregate deal value remained at record levels.

The complexions of the deals have changed dramatically, however. What happened was that the marketplace adjusted the share prices of banks based on expectation of which were buyers and which were sellers. Regional, supercommunity, community, and thrift stock prices continued to rise after the spring of 1993, while superregional bank stocks took a nosedive.

In a recent supercommunity bank forum for companies with assets between $1 billion and $5 billion, the stock of four of the 12 publicly traded companies attending reached an all-time high in the past four months and another four were actively trading within 10% of their all-time high.

On the other hand, consider what happened to the big acquirers of 1991 and 1992. In those years, banks like Banc One, NBD, and NationsBank had the strongest currency, i.e. highest stock price. They were in a position to pay a premium and still do nondilutive deals by buying more cheaply priced regional banks.

Impact on Acquirers' Stock Price pald Assoclated as a percent stock priceAcquirer Target of book changeSummit Bankers Corp. 278% 15%TCF Great Lakes 216 4Meridian United Countries 16Boatmen's Worthen 376 10Firstar First Colonial 612 14Union Planters Grenada 313 14First of America 3 deals in '94 350 20

For example, Banc One had five deals over $100 million in 1991, four in 1992, two in 1993, and none in 1994. Banc One's stock hit a high of $44.375 in April 1993, and now trades at $28 a share.

Other big banks followed a similar pattern. NationsBank hit a high of $58 in April 1993 and now trades at $47 a share. Bank of America hit a high of $54 in March of 1993, and is now at $43 a share.

So, it's not surprising that the big players are sitting it out on the sideline in 1994 while high-priced regional players are going to town.

Some superregionals have also begun to focus on nondepository financial companies and are placing bank and thrift acquisitions on the bank burner.

Some of the big players have recently threatened to return to the acquisition scene. But their participation is unlikely to increase materially unless their share prices rebound significantly.

Chairman John McCoy said in early October that Banc One would be as busy an acquirer in the next five years at it has been in the past five years and would use cash rather than stock if its share price did not rebound.

We do not see as clearly the difference between stock and cash deals from a dilution standpoint. If viewed correctly, the consequences of a cash deal which burns up capital should be compared to a company's performance if it used that capital to buy back its own stock. If Banc One did that calculation, it would find that cash deals are just as dilutive as stock deals.

So where do these trends leave us in the short run?

We believe that we are going to see a noticeable decline in bank M&A activity in the next few quarters. The precipitating event may be a sharp decline in share prices of regional banking companies.

Wall Street investors bid up the prices of regional banks, supercommunity Banks, and thrifts largely on the premise that they would be acquired, mostly by Banc One and other major players.

But those players can't afford to buy high-priced supercommunity banks anymore, and the highpriced regionals, rather than accommodating Wall Street investors by selling, instead started making their own acquisitions. What's happened to the stock prices of regional supercommunity banks that made big acquisitions is interesting (See chart).

Investors don't like banks that do acquisitions; they want banks to sell, not to buy. We are not far from the point where investors will realize that most supercommunity banks and community banks are being priced in the marketplace as sellers, that there will be selloff and that, with few buyers, prices will fall sharply and the volume of deals will decline.

We believe the anticipated decline in deal volume is a one-to-two-year phenomenon. Over the longer term, consolidation will continue at a healthy pace, but it will be rationalized and centered around three criteria:

1) The more efficient will acquire the less efficient.

2) Many acquisitions will be designed to create a critical mass.

3) Smaller acquisitions of community banks will continue to relate to matters of succession and estate planning and will be less affected by market valuation.

We therefore, believe banks should attend to their efficiency ratios and create a lean and mean platform from which they can grow in the future.

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