Second of a two-part BankThink series debating whether bank mergers are worthwhile. Previously: former investment banker Harvard Winters argued that there are lots of risks and little financial reward in bank mergers.
Bank mergers are an economic necessity because there are currently more banks than the nation can support, leaving many of them struggling to earn a decent return.
Considering bank failures in 2010 cost the Deposit Insurance Fund $24.18 billion, consolidation is a good alternative to another wave of closures!
Banks that are producing inadequate returns are squandering shareholder capital that could be invested more productively elsewhere, and they are increasingly at risk of government seizure. Moreover, because they typically offer poorer products and services than stronger players, these banks are not even doing right by their own customers.
High-performing banks, on the other hand, are by definition generating strong returns for shareholders, supplying the capital our nation's businesses and communities need to prosper, and offering top-notch products and services for consumers. Given increasingly stiff competition for loans and talent, it makes perfect strategic sense for these banks to buy underperforming institutions they know that they can turn around, rather than compound the problem by building more branches.
Consider the case of the underperforming Heartland Community Bank in Franklin, Ind., acquired by Horizon Bancorp (HBNC) in Michigan City, Ind., in 2012 a deal that was good for all parties. (I was one of them, having owned about 8% of Heartland's shares.)
Horizon paid off the $246 million-asset Heartland's Troubled Asset Relief Program obligations the day the deal was completed. That benefited taxpayers, and it spared shareholders the risk of a dilutive capital raise to repay Tarp followed by anemic returns. It may have even prevented a failure that could have cost the federal insurance fund millions of dollars.
Heartland's customers also benefited, because Horizon was able to offer them larger loans, stronger cash management programs, a greater range of trust and wealth management offerings, and even better rates on certificates of deposits.
Heartland's stock rose 30% the day the merger was announced. Horizon's shares held steady that day and since then have doubled in value. Considering the progress the combined companies have made, shareholders can expect to see even greater gains.
Specifically, in 2011, Horizon reported the largest profit in its 138-year history, including an average return on equity of 11% and return on assets of 0.9%. By mid-2013, almost a year after consummating the deal, Horizon could boast of a stellar 14.7% ROE and 1.3% ROA. And there's still plenty of room for it to grow in Heartland's home base in and around Indianapolis.
This is why the market has rewarded smart buyers, like Wells Fargo (WFC) and U.S. Bancorp (USB) two of the country's most profitable banks. Since 1990, Wells Fargo has purchased a whopping 127 banks and . U.S. Bancorp has purchased 18 banks. Each of these acquirers now trades above its precrisis high, while earning more than 1.5% on assets and more than 13% on shareholder equity. Given the inherent operational efficiencies of combining enterprises, it's almost a given these days that an acquirer's earnings per share and market value will go up upon announcement of a bank M&A deal.
This is also why poor performance is becoming less and less acceptable to investors. I have to agree with activist shareholder groups such as Stilwell Partners and PL Capital on this score there's really no excuse for continuing to tolerate underperforming banks, when there are plenty of opportunities for them to obtain more than they are even worth in a sale.
Philip Timyan, who ran the former Riggs Partners investment fund, writes a blog on community banking and sits on the board of two Chicago-area banks.