Wilmington, Banc One: The Logic Behind 2 High-Priced Deals

Rising bank stock prices, up 62% since last October's low, have produced a rash of large bank acquisitions financed with stock.

Since late March, plans for four $100 million-plus deals have been announced. The potential acquirers include Wilmington Trust,, driving to build a Delaware empire by acquiring Sussex Trust Co.; and Banc One Corp., which is seeking the First Illinois Corp. franchise in Chicago's western suburbs.

Prices have been high: $61 million, or 220% of book value, for Wilmington's acquisition of Sussex Trust; and $373 million, or 275% of book value, for Banc One's acquisition of First Illinois.

Sound Reasons

No one disputes the strategic logic.

In the Wilmington-Sussex case, for example, both parties agree that combination was inevitable.

Sussex Trust's chief executive officer, Robert Thompson, said he regards the deal as an "absolutely excellent marriage."

David Gibson, an associate vice president at Wilmington Trust, said that the two institutions have "talked on and off for 10 years."

Wilmington Trust currently focuses on northern Delaware; in the southern part of the state, "historically, we're not strong in retail deposits or the commercial side," Mr. Gibson said.

Sussex, on the other hand, has built a strong franchise in southern Delaware.

A One-Third Market Share

"Post-merger, Wilmington will control a one-third market share," Mr. Gibson said. The combined $4.3 billion institution would be the only large independent bank in Delaware.

As for the Banc One/First Illinois combination, John McCoy, Banc One's CEO said: "First Illinois has strong positions in markets with characteristics we have traditionally favored, including being a strong retail and middle-market lending organization headquartered in a university town."

Bruce McPhee, First Illinois' 47-year-old CEO, shares Mr. McCoy's expectations for the deal. "Banc One will support our efforts with its resources, systems, and technology while maintaining the local autonomy of our banks," he said.

"This, in our mind, is the perfect blend."

The fly in the ointment is that both deals are expensive.

In order to attain a 15% return on investment in a reasonable period of time, Wilmington would have to pay no more than $45 million for Sussex. At the $61 million price, it would take Wilmington 12 years to earn a 10% return and 27 years to earn a 13% return.

(Underlying these projections is the assumption that Sussex Trust could reach a maximum sustainable long-term return on average assets of 1.70%. This assumption credits the Sussex acquisition with all projected savings in operational expenses and takes the view that, in the long run, Wilmington would enjoy great success in marketing its arsenal of fee-based services in the southern Delaware region.)

A Departure for Banc One

As for Banc One, it is clear that a buyer in Illinois must pay a price well above the current averages.

But this time, Banc One is paying too much to have reasonable expectations of generating a return of 14% or higher on its acquisition investment.

Our projections show that it would take Banc One 21 years to achieve a 12% return on its acquisition investment and 35 years to achieve a 13% return.

This pricing is uncharacteristic of Banc One transactions.

Paying such high prices can be justified only by considering several factors.

One is that with the rise of the acquiring banks' stock prices, the deals would be less painful to those banks' shareholders. In the mergers and acquisitions game, stock is not valued as highly as cash.

Another consideration is market dominance. After the over-capacity of the banking industry has been eliminated, market dominance could result in bigger profit margins.

Wilmington's acquisition would position it as the preeminent depository franchise in Delaware, controlling one-third of all normal deposits.

The combined $4.3 billion institution would stand as the indisputable leader of Delaware banking. Pro-forma capital would measure over 7.5% of assets. Earnings, after expense reductions, would be about 1.8% of assets.

(Only Wilmington shareholders, who face a 3.8% earnings dilution, would suffer - and then only mildly. The emergence of Wilmington as the premier Delaware bank, along with an expected increase in profitability, should mitigate the initial effects of shareholder dilution.)

Banc One's move would put it in a similarly strong position in Illinois. By positioning itself in the Chicago area Banc One, would be better able to expand its franchise as new opportunities presented themselves, especially with in-market acquisitions in the Chicago area that could greatly improve the economics of operations.

Lower Capital Costs

Wilmington and Banc One may also be betting that long-term capital costs will decline in the U.S. economy overall and the banking sector in particular.

If the perception of risk in the banking industry declines as bank consolidation proceeds and weak markets begin to recover, a lower return-on-investment standard may prove appropriate. [Graphs Omitted]

Mr. Dan Piro is executive editor of Bank Mergers and Acquisitions, a newsletter published by SNL Securities, a Charlottesville, Va., publishing firm that specializes in the banking and thrift industries. Mr. Kevin Stiroh is an SNL analyst.

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