The merger and acquisition scene has turned into a waiting game. M&A activity in the banking sector shriveled in the first half of 2009, as institutions scratched their heads over what the due diligence reports they ordered really mean, and whether a potential prize might turn into a booby trap down the road.

The dollar volume of deals announced or completed in the first six months of this year amounted to just under $1.1 billion, compared with $61.1 billion in second-half 2008, according to data from SNL Financial LC. Meanwhile, the list of top advisers by deal value shrank to nine from 50 in the second half. The reason: most of the 101 deals struck or announced were too small to need or attract many advisers, observers suggest. "There were not enough big deals," says Andy Senchak, president of Keefe, Bruyette & Woods Inc.

Investment bankers aren't optimistic that deal flow will pick up any time soon. A top executive at one advisory firm that represented buyers or sellers in several acquisitions last year said in July that his firm was working on six potential deals and only expects one of them to close because buyers are uneasy about what lurks in sellers' loan books. Plus, many prospective buyers are more interested in buying failed banks on the cheap, he says. Through July 31, 69 banks and thrifts had failed so far this year and most experts expect the pace to accelerate over the next couple of quarters.

Diminished access to capital and uncertainty over asset quality are other major factors in the low M&A numbers. "A lot of large institutions still lack the capital to fund acquisitions," says Kris Niswander, associate director of financial institutions at SNL. "And due diligence is infinitely more difficult." Potential buyers are unsure about what's on their own balance sheets, so "it's hard to measure [a target's] exposure to exotic, structured products," Niswander adds.

There are bargains out there: the price of acquired banks averaged 1.16 times tangible book value in the first half, down from 1.72 times book value in 2008. This reflects the reduced access to capital, Niswander believes. "Something has to give, and that something is pricing."

Senchak says that activity won't pick up until asset quality concerns are resolved. Buyers "have to know that the light they see in the tunnel is at the end of the tunnel. For now they're feeling their way along." Balance sheet concerns are focused on real estate as a proxy for overall credit, he notes, with commercial real estate the most troubling area at this point. Not all the losses embedded in the government-administered stress tests have been realized, according to Senchak, and that's hanging over the market too.

"Every day another bank has trouble with capital," says Kate Monahan, an analyst with Aite Group. The aftermath of the real estate market collapse continues to imperil banks in California, Florida, and Nevada in particular. "You can pick up branches or a state network from the FDIC as they fail, and that will continue," Monahan notes.

The pace of failures will eventually slow, and Senchak says he expects that, this time next year, traditional M&A activity will be strong. For now, though, "the risk/reward is clearly in favor of waiting," he says.

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