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Are Banks on the Brink of a Merger Boom?
There have been spurts of merger and acquisition activity periodically throughout the history of the bank industry in the United States, and the number of players in the industry has declined sharply over the years. Some think the sector is now ripe for another wave of consolidation. Although a lot of banks have professed interest in making acquisitions, there have been few actual transactions recently.
Bank merger activity got a real boost in the 1980s when the barriers to bank combinations across state lines began to break down. States first passed laws permitting banks within specific regions to join forces. A flurry of mergers followed, with big players like NationsBank, a forerunner of Bank of America (BAC - Free Bank of America Stock Report), and Chemical Banking Corp., one of the many predecessors of JPMorgan Chase & Co. (JPM - Free JPMorgan Chase Stock Report), bulking up considerably. Restrictions were gradually loosened, and an interstate banking law was eventually passed in 1995. Since then, the number of FDIC-insured commercial banks and savings institutions has declined by more than 35%.
A number of factors have been cited as possible triggers of a new wave of bank mergers, including the growing pressure on bank revenues---due to weak economic activity, low interest rates, and tighter restrictions on bank activities. In addition, the smaller banks may not be able to offset the costs of complying with new regulation as easily as the larger banks, prompting some to accept takeover offers. Too, banks with severe credit-quality problems may welcome being rescued via an acquisition by a healthier entity. Finally, bankers are a much-maligned group these days, and the earnings stress and hassle of complying with an expanding universe of new rules may prompt top management of some institutions to throw in the towel and enter into merger discussions.
What would motivate a bank to acquire another? Diversification of the institution’s business mix or geographic area is an important acquisition incentive. Big Canadian banks, like Bank of Montreal (BMO.TO), which recently purchased Wisconsin-based Marshall & Ilsley, and Toronto-Dominion Bank (TD.TO), buyer of auto lender Chrysler Financial, fall into this group. Achieving economies of scale by combining backoffice operations may also incent some banks to join forces. In addition, Ohio-based Fifth Third Bancorp (FITB) recently indicated that one of its merger objectives might be to strengthen its share of its existing markets via fill-in acquisitions.
As noted, however, in spite of the much-forecasted pickup in bank merger activity, not much has happened on this front lately. The industry is in a stalemate. While the acquiring banks may be seeking bargain deals, the acquisition targets seem to be holding out for better prices.
Times have changed. Back in 1998, Florida-based Barnett Banks was purchased by BankAmerica for nearly four times book value at a time when the Sunshine State was viewed as a lucrative growth market. But Florida was hit hard by the housing crisis. And the days of high-multiple deals seem long gone. Indeed, Wilmington Trust was recently acquired by M&T Bank (MTB) for around 50% of Wilmington’s book value. Many in the industry expect deal prices in the near term to hover moderately above one times book value. Note also that some of the big banks that might be interested in making acquisitions lack the currency to do so, due to their weak stock prices.
Another possibility is that potential buyers of other banks may have also gotten more selective, avoiding banks with severe credit-quality or other problems. Bank of America certainly has taken a lot of punishment as the result of its acquisition of troubled mortgage lender Countrywide Financial, and the rest of the bank industry surely has taken note. Moreover, in the aftermath of the financial crisis, and given the controversy over too-big-to-fail banks, bank regulators probably are taking a closer look at bank deals.
New equity capital guidelines also threaten to raise the costs of making acquisitions. Banks will be required to hold a higher percentage of equity capital relative to their assets. Adding assets through acquisitions raises the amount of capital that they will need to hold. Finally, uncertainty regarding new regulations and economic prospects are probably also contributing to the slow pace of bank deals thus far in 2011.
So, are banks on the brink of a merger boom? Probably not soon. More like a trickle of deals, until the industry feels itself on more solid ground and some of the uncertainty regarding new regulations and economic prospects is dispelled. Banks recently have appeared more interested in acquiring businesses rather than whole banks, like PNC Financial’s (PNC) recent purchase of the U.S. retail banking operations of Royal Bank of Canada (RY.TO).
Which banks might be merger candidates? We don’t have any inside information, so the following is pure speculation. Banks that are still struggling may be targets, like BancorpSouth (BXS). The company’s presence in a number of southeastern markets may be of interest to a bank outside the region. Geogia-based SunTrust Banks (STI) has long been the object of merger conjecture. But the company is large, probably limiting acquirers to the few very largest banks (Perhaps JPMorgan Chase), and the stock’s relatively high multiple (for a bank) suggests that any deal would be expensive.
There are also a number of midsized banks, some in states with a large number of banks (like Ohio), that may eventually become merger candidates . Most of these banks, however, are in good financial shape and have expressed interest in acquiring smaller banks rather than being acquired. But the heightened pressures on revenues and increased regulation may eventually lead some of them to combine, possibly in so-called mergers of equals. Many of the companies in our Bank (Midwest) Industry fit this profile. Banks in the fragmented but potentially lucrative Chicago market, like PrivateBancorp (PVTB), may also be merger candidates.
Should merger considerations enter into investment decisions? In most cases, a company’s acquisition potential probably shouldn’t be the main reason for taking a position in a stock. As noted above, whether a bank is a merger candidate is pure speculation, and a handsome (or any) premium over the takeover target’s pre-merger announcement stock price isn’t assured, as in the case of Wilmington Trust. Moreover, given the considerable economic and regulatory uncertainty currently, investors interested in profiting from bank mergers may have a long time to wait.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.