Mergers & acquisitions: US banks return to M&A trail
Commercial lending key to earnings growth; valuations more favourable for buyers/sellers.
Pressure on banks to increase revenues is leading to increased M&A activity in the US. According to Dealogic, there were 281 US bank M&A deals year-to-date September 3 – the second-highest number of deals year-to-date since the beginning of 2006.
Christopher McGratty, bank analyst at Keefe, Bruyette Woods, says that amid still slow economic growth, M&A is one of the few ways for banks to boost performance. “While the US economy seems to be back on a stable footing, GDP growth is slow and loan demand is spotty. In order to boost earnings, banks are looking to scale up.”
It is the small to mid-tier banks that are most active. The increased regulatory scrutiny on large banks and determination to put limits around too-big-to-fail institutions means that even with excess capital on the balance sheet and pressure to increase earnings, large players will not be leading players in bank mergers and acquisitions.
In particular, small and regional banks are looking for ways to increase their exposure to loans.
Fitch analysts reported in July that US bank M&A activity was set to pick up. One reason, the report’s authors say, is that “intense loan origination competition is currently plaguing the industry. An increase in acquisition activity will remove some industry capacity, which Fitch views positively as too many banks are chasing too few lending opportunities.” Justin Fuller, analyst at Fitch Ratings, says that commercial banking activities such as cash management are also appealing to retail banks because clients for these tend to be stickier.
Christopher Marinac, managing principal and director of research at FIG Partners, says that community banks are being forced to merge to scale up their loans business and manage concentrations.
Banks are permitted to lend to one borrower only up to 15% of their tier 1 capital or, in some cases, up to 25%. “So if you are a community bank with $250 million in assets and $25 million in capital – so quite strong and sound – the most you can lend to a commercial customer is $3.75 million or, in the right circumstance, up to $6.2 million. Many businesses have credit needs well above $6 million, so community banks are often at a disadvantage if they are seeking to be real commercial players. So marrying to become $500 million, $600 million or, better yet, over $1 billion creates a capacity to pursue more and larger commercial credits,” says Marinac.
Sameer Gokhale, managing director and analyst at Janney Montgomery Scott, says that although auto loans and credit card sectors are relatively mature and dominated by a few large players, the US commercial lending market is still fragmented enough to be ripe for consolidation. He puts forward CIT and Newstar Financial as potential acquisition targets.
Specialist loans businesses are receiving an increasing amount of attention from regional banks looking for earnings growth.
In July, California retail bank PacWest Bancorp announced that in a deal valued at about $2.3 billion it would be buying local commercial bank CapitalSource to create the eighth-largest commercial bank based in California. Matt Wagner, chief executive of PacWest, said at the announcement of the deal that buying a community bank would not have made sense. “Most of the community banks you are looking at today – you’ve got anywhere from a 40% to 70% loan-to-deposit ratio. You’ve got a big-buying portfolio that I don’t need. I am going to end up with a bunch of excess deposits.”
“In some ways it is a perfect tie-up,” says McGratty. “Specialty finance companies do not have stable funding and typically rely on wholesale markets, so need access to deposits, while the bank is looking for the earnings boost that comes through increased lending.”
But for the largest top-10 financial institutions, analysts say that the regulators are unlikely to support a large acquisition of a loans originator and that small deals would not be of interest to the mega-cap banks.
Gokhale says that present valuations are also going to lead to acquisitions. “Valuations are now at levels where buyers are willing to use their shares as currency and potential sellers are more willing to sell, given higher takeover premiums.”
“In the PacWest-CapitalSource deal, the target was bought at 1.5 times book value and 1.7 times tangible book value. Gokhale says: “PacWest’s shares were trading at close to two times book value, so it could use its stock as a strong currency to pursue the acquisition. The takeover price for CapitalSource was also significantly above where CapitalSource shares were trading before the deal was announced. We are likely to see similar deals in which sellers fund acquisitions with a combination of cash and stock.”
Bank investors, however, remain cautious, looking for deals where transaction risk is low and cost-saving opportunities are substantial. “They don’t want a bank in the Midwest buying a bank in Florida, for example. That didn’t work so well in the last cycle,” says McGratty.