Want a Meatier Sale Premium for Your Bank? Get Bigger
Scale is increasing in importance for banks that want to maximize the premiums they receive for selling.
Bigger institutions have historically commanded higher premiums for selling. Last year the gap between the premiums for larger sellers and their smaller counterparts widened meaningfully compared with prior years.
Sellers with more than $1 billion in assets, on average, received a 180% premium to tangible book value, compared with 118% for banks with less than $250 million in assets, based on data compiled by Keefe, Bruyette & Woods. In comparison, bigger sellers had an average premium of 163% in 2014, while the average for smaller banks was 125%.
A rough economy, regulation and evolving technology will keep forcing small banks to merge, said Richard Hunt, head of the Consumer Bankers Association. Hunt's position puts him at odds with bank advocates, including Camden Fine at the Independent Community Bankers of America, who believe small banks should ignore the drumbeat calling for more consolidation.
KeyCorp believes it can surpass cost-cutting projections tied to its purchase of First Niagara Financial, while BB&T believes market duress could present it with more acquisition opportunities.
KeyCorp and New York Community Bancorp are among a number of buyers pledging to aggressively cut costs at acquired banks. There are plenty of ways to go about it, but acquirers risk cutting too deeply in the effort to appease wary investors.
Bankers need to let investors know in advance what types of deals they are willing to pursue, along with the financial parameters. Doing so is a critical step in managing shareholder expectations at a time when consolidation is heating up.
As the banking industry puts the financial crisis further behind it, factors such as economies of scale, scarcity value, earnings potential and efficiency are becoming more critical, industry experts said. A return of larger acquirers has also increased demand for bigger sellers, which often contributes to higher prices.
"In general, larger banks are perceived to have a greater sales culture and a broader delivery system," said Charles Crowley, a managing director at Boenning & Scattergood.
"As a result, there's a greater perceived franchise value," Crowley said. "A deal for a larger bank would generally bring a greater impact on market share and perhaps a better lending team and management infrastructure."
Generally, $1 billion of assets is seen as the threshold that lets banks benefit from greater economies of scale for technology and compliance, said David Powell, president of the consulting firm Vitex. Other factors, such as a seller's performance and asset quality, are also considered when pricing a deal, Powell said, adding that overall premiums remain below precrisis levels.
"You can pick almost any ratio and banks with over $1 billion of assets usually have better performance, which drives these higher multiples," Powell said.
Deal pricing is based on several factors, including a seller's earnings and the earnings potential for the combined company once a deal closes, said Michael Iannaccone, managing director at FinPro. Sellers with a deep bench of talent or niche business lines, such as wealth management or equipment financing, can also command a higher premium, he said.
"Larger institutions, because of their size, tend to have more of these reasons than smaller institutions," Iannaccone said. "That's why you see them get better pricing. But you could see smaller institutions also get good pricing if they're a high earner in a growth market."
Geography and demographics also matter.
Many acquirers are looking for banks in metropolitan markets because they generally offer more growth opportunities.
Faster-growing markets also tend to create bigger banks, said Jeffrey Levine, a managing director and co-head of the financial institutions group at Houlihan Lokey.
Rural banks, and institutions in slower-growth markets, could become more valuable when interest rates rise substantially and deposits become attractive again, industry experts said. Still, it could take a while before that happens.
"There may come a time when some banks get a bit ahead of themselves on their loan-to-deposit ratios and would love to have some quality low-cost funding … from smaller banks in slightly less competitive markets," Crowley said. "Right now, with this prolonged interest rate environment, people aren't valuing deposits the way they did 10 or 20 years ago."
Larger banks can also help an acquirer reach certain objectives faster.
Banks with $1 billion to $10 billion in assets make up just 9.6% of all banks, based on data from the Federal Deposit Insurance Corp. Many of those banks could prove beneficial to institutions looking to make a significant leap across the $10 billion regulatory threshold that triggers higher compliance costs and lower revenue from interchange fees.
It is often more cost-efficient to integrate one large bank rather than several smaller ones, Levine said. "Scarcity value does come into play, but at some point there's a limit on how much a buyer is willing to pay," he added.
The $8.7 billion-asset Pinnacle Financial Partners will get a boost crossing $10 billion of assets when it buys the $1.2 billion-asset Avenue Financial Holdings. Pinnacle, which was prepared to cross the mark organically, said in January that it had agreed to pay $201 million for Avenue, or 219% of the seller's tangible book value.
Larger sellers tend to be better run, which justifies higher premiums, Terry Turner, Pinnacle's president and chief executive, said in a recent interview. "I wouldn't pay someone a higher premium just because they have $1 billion of assets," he said.
"But I would pay a better premium because they have market share, match up with my strategic initiatives and produce earnings accretion at a rate that is suitable for me," Turner added.
All is not lost for smaller institutions keen on getting a little bit more from potential buyers. Management teams at potential sellers should focus on improving profitability, Powell said. Doing so should include watching expenses and avoiding oversized capital expenditures, such as investments in new product lines and technology. Aspiring sellers should also monitor their risk profile.
Strong customer relationships and niche lines of business, like insurance brokerage or asset management, could also help drive a better premium, said Chip MacDonald, a lawyer at Jones Day. Potential sellers also need to make sure they are in good regulatory standing, especially in areas like anti-money-laundering programs and the Community Reinvestment Act.
"Those issues are deal killers," MacDonald said.