PNC Corp.'s deal to buy Midlantic Corp. has analysts worrying that bank acquisition prices may be spinning out of control.
The deal, announced Monday, was the latest in a flurry of deals in which buyers agreed to pay more than twice tangible book value. Some analysts think these buyers may have trouble recouping their investments.
"These are transactions that are highly dilutive," said Frank DeSantis, a bank analyst with Donaldson, Lufkin & Jenrette. "Management is trying to convince everyone they will earn the dilution back in one year, but I doubt that very much," .
"In the last few deals, there was clearly some permanent earnings dilution," he said.
First Union Corp. agreed to buy First Fidelity Bancorp. for nearly 275% of the bank's tangible book value three weeks ago. On Monday, PNC agreed to buy Midlantic for a hefty 227% of the bank's tangible book value.
In the week following First Union's announcement, its stock fell 5%, while other bank stocks soared. PNC stock has fallen $2.125 to $24.75, or 8%, since its deal was announced Monday.
Price-to-book multiples for all deals have risen 8% this year to 1.83 times book value. But for the four major multibillion-dollar stock transactions announced this year, the average multiple is 194% of book value, and a bulky 227% of tangible book value.
"History suggests that it would be very hard to make adequate returns when you are paying these huge multiples of tangible book," one investment banker said.
Faced by sliding revenues and a need to spend on technology, and with few cost-cutting opportunities left after years of downsizing, banks are either selling or trying to survive by buying asset mass.
"But it appears these acquiring bankers feel they have a birthright to pay up for large, strategic deals," said an investment banker who requested anonymity.
Most observers concurred that banks will continue to command these high prices at least through the end of the year, but said a further increase in the going rate is unlikely.
For banks in a marketplace affected by a blockbuster deal, prices may decline. For example, UJB Financial Corp. may not command as high a multiple because a bank buying the company would now be acquiring third place in New Jersey, behind PNC and First Union.
Still, the forces driving sellers are strong, said Gerard Smith, an investment banker with UBS Securities, which advised West One Bancorp. on its announced $1.6 billion sale to U.S. Bancorp earlier this year.
"As more and more banks are confronted by the cost of dramatically changing the delivery system, fewer and fewer think they can make it on their own," Mr. Smith said.
"There is a new imperative driving consolidation, it is not just overcapacity and inefficiency, but a new, massive need to invest in technology," he added.
Mr. Smith disputed the deals were necessarily pricey. Because bank earnings have increased in past years, price-to-earnings multiples in current deals are actually down from previous years, he said.
"Bank investors get excited about book-value multiples," he concluded, "but earnings multiples are more important."