Where Are the Deal Makers?

On the surface, the odds of CEO John Corbett’s CenterState Bank Corp. recording a third straight year of multiple bank acquisitions in 2017 appeared slim.

The Winter Haven, Florida-based company was approaching a size threshold that many banks hesitate to pass. Its target markets in central and south Florida hold a dwindling number of attractive merger candidates. And while the company’s share price rose by as much as 15 percent in 2017, a beneficiary of the post-election “Trump bump,” many smaller banks’ valuations had jumped even more.

Yet no one seemed surprised when Corbett, on a characteristically steamy August Monday in central Florida, announced not just one, but two deals.

The acquisitions of $1.9 billion asset HCBF Holding Co. in Fort Pierce, and Sunshine Bancorp, a $955 million asset converted thrift in Plant City, make CenterState the largest banking company based in Florida-a long-stated goal of Corbett’s-and also push it over the dreaded $10 billion asset level where added regulatory costs and hassles kick in.

“It’s a lot to do two deals of that size at once, especially with going over $10 billion,” Corbett concedes. “But if we didn’t do it now, then someone else would jump in, and there really aren’t many other viable partners left.”

In today’s environment, CenterState’s sense of urgency is the exception to the rule. Bank valuations have risen sharply in the past year, and advisors say the amount of deal-related chatter is high. Yet for a variety of reasons, the long-awaited surge in M&A activity has failed to materialize.

Banks like CenterState, which has completed 17 deals since 2007, set the pace in an M&A market still colored by the fallout from last decade’s financial crisis. In total, 71 banks now lie in the ideal size from $10 billion to $50 billion in assets where they’re big enough to do deals but small enough to avoid the most arduous of regulations.

The list includes the likes of Chicago’s Wintrust Financial Corp., Conway, Arkansas-based Home Bancshares, Prosperity Bancshares of Houston and Iberiabank Corp. of Lafayette, Louisiana-all once-small community institutions that have used opportunistic acquisitions to build their franchises into regional players in an unsettled post-crisis world.

Since the beginning of 2007, the eight most active buyers in that group have announced a combined 134 whole-bank, branch or Federal Deposit Insurance Corp.-assisted deals, according to figures supplied by S&P Global Market Intelligence.
Lately, however, the mood of the $10 billion to $50 billion asset set has become decidedly more cautious. While some of those banks remained active in 2017, market conditions, uncertainty over what will emerge from Washington and seller expectations have encouraged many of those erstwhile acquirers to take a breather.

“The pricing on acquisitions has moved away from us,” says Ed Wehmer, CEO of $27 billion asset Wintrust, which has done 10 whole-bank acquisitions, nine FDIC-assisted deals and six branch purchases since 2009, but none in more than a year.

“We’re looking at deals, but seller expectations are high, and gestation periods are long,” Wehmer adds. “It’s hard to get anything done because sellers aren’t under pressure to sell, and we’re able to grow more profitably organically than by buying at current prices.”

This isn’t exactly the way things were supposed to play out. Two years ago, the storyline was that valuations were holding back the bank M&A market. Once currencies began to climb, the narrative went, there would be an explosion of activity.
Well, the valuations have risen sharply of late-the KBW Nasdaq Bank Index was up in 2017 by as much as 70 percent over February 2016 levels-and pricing is better for sellers.

The median multiple for deals announced through November 15, 2017, was 162.6 percent of the target’s tangible book value, up from 130.6 percent of tangible book value in 2016, according to figures compiled for Bank Director magazine by Sandler O’Neill + Partners, a New York-based investment bank.

One seller, $2.5 billion asset Pacific Continental Corp. in Eugene, Oregon, fetched 3.17 times tangible book value in its January 2017 sale to Columbia Banking System, a $9.8 billion asset company based in Tacoma, Washington. In total, 14 of the 25 largest deals in 2017 went for more than 2 times tangible book.

Even so, the promised surge in deal activity has not materialized-at least not yet. After a relatively busy first quarter of 2017 that witnessed three $1 billion-plus deals, the market has slowed considerably.

Through November 15, 220 deals had been announced, putting 2017 on roughly the same pace as 2016’s full-year total of 240 deals, and slightly behind the 2015 pace, when 278 deals were announced, according to Sandler O’Neill.

Is there a catalyst in sight for 2018-something that can restore a sense of urgency to the market?

Maybe, but it’s complicated.

Bankers and advisors say the amount of deal-related chatter in the industry is greater than it has been in a decade, which indicates that the table could possibly be set for a surge of deals. For now, however, the market is choppy, colored by regional variations, long courtships and general stagnation.

Nearly two-thirds of 2017’s deals occurred in the Midwest, home to thousands of community banks, and the Southeast, where the economy is in full rebound. Just 15 percent took place in the Mid-Atlantic and New England, combined. Pricing multiples were highest in the West and Southwest, and lowest in the Northeast.

In Florida, where the number of locally headquartered banks has dropped to 120 from 315 a decade ago, “there’s a scarcity premium for quality banks of any meaningful size,” says Bill Hickey, a principal and co-head of investment banking at Sandler O’Neill. “If you want to buy, you need to jump quickly and pay more.”

Contrast that to the Midwest, where stories abound of small, rural banks that can’t find a buyer. “What’s different today, compared to the pre-crisis days, is that just because you want to sell your company doesn’t mean someone will want to buy it,” Hickey says.

There are no absolutes in this market, and no guarantees. And there’s certainly no rush. Discussions are taking years instead of months, and a surprisingly large number of deals are being scuttled at the last minute, often due to culture or control issues.

“They see at the end of the process what the organization will look like afterwards and conclude that it’s not worth it for the price they’re getting,” says John Freechack, a partner and head of the financial institutions group at Barack Ferrazzano Kirschbaum & Nagelberg, a Chicago law firm.

Boards are keeping their options open-simultaneously considering sales, purchases and alternatives beyond M&A. Some are pilfering lending teams from rivals or opening loan offices. Mergers-of-equals, which have a bad reputation, also are being talked about more frequently.

“A lot of boards we deal with today have a feeling that they need to do something, but they don’t know what it should be,” Freechack says.

Being creative and open to all possibilities can pay off.

Shortly after MidWestOne Financial Group, a $3 billion asset company based in Iowa City, Iowa, acquired a bank in Minnesota, it signed a group of six commercial lenders in Denver.

“Frankly, for every discussion with boards that we’ve had about M&A, we’ve also talked about [whether] there’s a team they can pick up,” says Freechack, who represents MidWestOne.

In Florida, the board of HCBF, parent of Harbor Community Bank, closed on its own purchase of a community bank in Tampa last July, just two weeks before agreeing to be acquired by CenterState.

The $416 million cash-and-stock sale of HCBF, valued at 2.09 times tangible book value, came “a little sooner than we thought it would,” says HCBF Chairman Mike Brown Sr., who had talked with a number of other suitors.

But the company’s private-equity investors, who capitalized the company seven years earlier, were itching for an exit, and its core vendor contract was up for renewal. “We were approaching a crossroads, and this felt like the right people with the right price,” Brown says.

The most visible obstacle to more deals getting done is the stark difference between the pricing expectations of buyers and sellers. The ingredients behind that stalemate-inducing price differential include a hefty dose of uncertainty about tax reform and regulatory relief, and what it might mean for the industry.

President Trump and the Republican-controlled Congress have promised tax reform and regulatory relief, among other corporate goodies. At the same time, the Federal Reserve is raising interest rates.

Such changes could make institutions more profitable and give acquirers more buying power-juicing multiples for sellers.
Already, shareholders have bid up the prices of smaller banks that look like they could be candidates to be acquired by the $10 billion to $50 billion asset banks.

The problem for the market is that the larger regional banks and megabanks-the logical buyers for those smaller regionals-have been complete no-shows when it comes to bank M&A.

No potential acquirers means no takeover premium, which means those banks in the $10 billion to $50 billion asset range often don’t have strong-enough currencies to meet the expectations of would-be sellers.

“The key holdup is relative valuations,” says Sandler’s Hickey. “Once you get north of $10 billion in assets, the valuations on a price-to-earnings and price-to-tangible-book-value basis are actually lower than those in the $5 billion to $10 billion asset size. “It’s difficult to make the math work.”

The new class of regionals is run by seasoned, disciplined bankers who capitalized on the financial crisis to build their organizations. They are committed to deals being accretive, and pride themselves on not overreaching or taking excessive risks.

“Our stock is trading around 16.5 times earnings, and some of the banks we might want to acquire are trading at 20 times earnings,” explains David Zalman, chairman and CEO of $22 billion asset Prosperity, a historically active acquirer that hasn’t bought another bank in two years.

“The stock prices of a lot of small banks are already pegged to be sold-they’re extremely high right now, so it’s harder to make a deal,” he adds. “A deal needs to be accretive for us to consider it.”

Scott Carmelitano, a partner and bank deals leader at New York-based PwC, a consulting firm, notes that the recent surge in stock prices has come without a corresponding jump in underlying earnings. “Acquisitions at these values are potentially risky,” he says.

“The question in many peoples’ minds now is whether the Trump bump actually ended up slowing down M&A instead of boosting it,” Carmelitano adds.

Compromise could go a long way toward resolving the stalemate, Zalman says. He tries to persuade potential sellers to accept lower premiums now to be part of a bigger, more profitable bank in the future.

But many sellers have dug in their heels on pricing, convinced that they will eventually get what they’re looking for. “There are a lot of banks that are willing to sell, or want to sell, but it’s because of what they think they can get” in a deal, Brown says.

“The primary motivation is to get to a number,” Brown adds. “Boards will say, ‘We want X, and we’re going to wait until we get X.’ That’s their strategy.”

If they can’t get that price now, they’re content to ride out a strong economy, and see how Washington’s reforms and the rate environment play out.

Steven Hovde, chairman and CEO of Hovde Group, a Chicago-based investment bank, says he knows of many community banks that are interested in selling, but are waiting to see if tax reform can pass and, perhaps, give their valuations an extra jolt.

It’s a calculated risk, which may or may not pay off.

The tax proposal most talked about, for example, would drop the corporate tax rate to 20 percent from 34 percent. “If you reduce that rate to 20 percent, there would be a very significant pick-up in earnings per share and stock valuations, and probably an increase in acquisition premiums,” Hovde says.

“So, do you wait to see what happens before deciding to sell, because you think you’d be worth more?” he asks. “If you do and Congress gets nothing done, bank stocks could retreat” from their post-election gains, and premiums could fall.
A verdict on tax reform, for better or worse, will likely come sometime in the near future, bringing clarity that could help some boards pull the trigger on deals. (Tax reform was working its way through Congress as this issue went to press.)
Regulatory relief could be even more impactful on the M&A market. The new Republican-led regime has already halted additional rule-making required by the Dodd-Frank Act, and changes in the leadership of key regulatory agencies-most notably at the Consumer Financial Protection Bureau-portend more easing down the road.

Lowering compliance burdens could reduce costs, freeing up more money for deals.

Raising the $50 billion asset threshold at which a bank is deemed a systemically important financial institution (SIFI) to $100 billion or even $250 billion, as has been proposed by some Republicans in Congress, could encourage some of those larger banks to jump back into the M&A market.

SIFI banks face stiffer capital and liquidity requirements, tougher stress tests and much closer scrutiny. They also find it tougher to complete deals.

Since the threshold was established in 2012, only one bank, CIT Group, has dared to cross it, via its 2015 acquisition of IMB Holdco, parent of Los Angeles-based OneWest Bank. CIT has since divested several specialty finance businesses and is below $50 billion in assets.

A return of big banks to M&A would provide a lift to the entire market, Hickey says. The mere prospect that some of those smaller regional banks could be acquired would likely create more interest in their stocks, giving them stronger currencies to acquire the price-hungry institutions in the tier below.

“Pricing cascades through the system,” Hickey says. “Everyone is asking me, ‘When will the big guys above $50 billion get back into the marketplace? We need them for a healthy market.’”

Whether action in Washington will be enough to kick-start the M&A market remains to be seen. Behind the scenes, rising costs related to technology, cybersecurity and compliance are putting pressure on banks to find scale efficiencies, while many smaller institutions are struggling to grow.

If things do pick up, the regionals in the $10 billion to $50 billion asset range will likely be in the center of it.

Randy Chesler, CEO of $9.3 billion asset Glacier Bancorp in Kalispell, Montana, announced two deals in 2017, and foresees more activity if Congress takes care of business. “You have a flat yield curve, a tax policy that’s in flux, potential regulatory changes,” he says.

“There are hundreds of banks in the West that could be good partners for us,” Chesler says. “If those things get resolved, it will affect some of the timing for some of them, and they’ll be ready to sell.”

The longer-term prospects for bank M&A, however, appear cloudy. The number of banks and savings institutions at the end of the third quarter stood at 5,737, according to the FDIC, down 33 percent from the 8,560 institutions a decade earlier.

While the number of banks has fallen more or less steadily for decades, the decline has been made more precipitous by post-crisis rules that require new banks to raise $20 million of capital and place stiff limitations on how that capital is deployed, and how fast a bank can grow.

The industry averaged 158 de novo openings per year between 2000 and 2007-a total of 1,264 new institutions added to the pool of potential sellers. In the seven years since 2011, eight new banks have been launched.

“Long term, the problem is that there’s no de novo activity: we don’t have any seedlings coming up to repopulate the forest,” Corbett says. That has him considering opening more offices in Florida or acquiring in neighboring states, such as Georgia.

“What I’ve told my board is that the next five years will be different from the last five years, in terms of how we grow and create value for shareholders,” Corbett says.

“If you want to use M&A as a strategy, you can’t afford to wait too long, or there’ll be nothing left to acquire,” he adds.