When the Daring Route Makes Sense in Bank M&A

Bank stock is a weak, unstable currency right now, but that hardly makes it worthless.

Three small, stock-funded deals announced last week were a reminder of that.

The merger agreements, in Texas and California, underscored how volatile stock prices are not necessarily deal-killers when the buyer's stock is worth a lot of money, or when both parties are trading for cheap.

All-stock deals in a down market also make sense between banks owned by investors who want to cash out (and pay taxes on their capital gains) eventually, not immediately, investment banker Steven Hovde says.

That last point describes the shareholders of two banks in a $38 million deal he helped arrange: California United Bank in Encino's agreement to purchase Premier Commercial Bancorp in Anaheim.

They settled on an all-stock deal because the demand for their equity is similar, says Hovde, the president and chief executive of the Hovde Group, of Inverness, Ill., which advised California United. They are each trading at a discount to their book values, and have relatively illiquid stock traded over the counter. Combined they should have more profits, investors and thus, worth.

"It is a case of one plus one equals more than two," Hovde says. "They get greater scale."

Both have clean loan books, he says, and California United's especially cheap deposits should help Premier make more lucrative small business loans.

There were similar factors at play in Plano, Texas-based ViewPoint Financial Group Inc.'s $71 million deal for Highlands Bancshares Inc. in Jacksboro, Texas. Highlands is much smaller, and private. Its shareholders like the deal because its chief executive, Kevin Hanigan, will run the merged bank. They will get shares in a publicly traded bank. Also, ViewPoint is paying a relatively decent premium of 1.2 times Highlands' tangible book value, which is fairly high considering that ViewPoint is trading at about 1.1 times its tangible book, says Brad Milsaps, an analyst with Sandler O'Neill & Partners LP.

"It makes a lot of sense" for Highlands investors because they "become liquid in a public market and can ride that up to a higher price," Milsaps says.

In the third deal, Prosperity Bancshares Inc. of Houston agreed to give about $20.4 million of shares to the owners of East Texas Financial Services Inc., a much smaller bank in Tyler.

Prosperity's stock is unusually valuable right now. Its shares are trading at three times the nearly $10 billion-asset company's tangible book at a time when most banks are lucky to be trading at just over book value. That means it does not have to issue a lot of shares to offer sellers a relatively good price.

Prosperity's deal for East Texas — its second deal in three months — will result in scant dilution to shareholders, Milsaps predicts.

Though strategic pressure to merge is building up on banks, he says, deal activity will remain slow until the markets level out. That has not happened yet in his view.

"Every day we're at the mercy of what's going on in Europe," Milsaps says. "I don't think anyone is ready to say that things are overly stable yet."