Merger & Acquisition,
Community Bank Valuation &
Capital Markets Update
Presented by: Thomas R. Mecredy
Vining Sparks Community Bank Advisory Group
tmecredy@viningsparks.com
512-495-9890
Current M&A Environment
Key Factors Driving Community Bank M&A








Gap in trading multiples between the big and small banks
Failed bank deals have run the course
Improved asset quality – reduced credit marks
Challenging operating environment (loan growth, NIM
pressure)
Slow organic revenue growth (and outlook for growth)
Compliance costs are increasing
Increased capital requirements
Regulatory fatigue
2
Current M&A Environment






Seller asset quality is improving
Pricing has been steadily improving & more deals
have been announced at attractive premiums
Activity is increasing and “interest” in M&A is high
Buyers are maintaining financial discipline
Better performing banks are considering sale
Strategic mergers are a viable alternative to sale
3
Current M&A Environment





Some bank directors & managers are ready to enjoy the next few
years after 5 years of the “hunker down” mentality before
considering a sale
Sellers’ expectations are that pricing multiples are going up, so
waiting can be beneficial
Regulatory agencies have eased off of a number of challenged
banks allowing more flexibility in terms of timing decisions to sell
There are more potential buyers than last year, but fewer than you
might think
Given the lower relative M&A multiples, social issues continue to
be a primary focus
4
Industry Performance
Factors Impacting Performance
 Low rate environment
 Soft loan demand
 NIM pressure
 Mortgage banking revenue decline
 Improvements in asset quality
 Provision expense is less than NCOs
 Increased compliance costs
 Anticipated pressure on ROA
 Increased capital requirements
 Anticipated pressure on ROE
5
Industry Performance - 2013
Under$1 Billion
Over $1 Billion
ROAA (1)
0.73%
0.91%
ROAE (1)
6.70%
8.50%
Net Interest Margin
3.31%
3.47%
Efficiency Ratio
71.57%
65.10%
Net Charge-Offs
0.13%
0.21%
Nonperforming Assets/Total Assets
1.25%
1.33%
Loan Loss Provision Expense
0.08%
0.11%
Tier 1 Leverage Ratio
10.20%
9.75%
Loan Growth Rate
3.3%
6.3%
Deposit Growth Rate
1.1%
2.9%
Median for all commercial & savings banks
(1) S-Corporation companies adjusted to C-Corporation status
6
Source: SNL Financial
Acquisition Multiples Remain at Depressed
Levels, but Improving
Acquisition Multiples for Bank & Thrift Transactions
30.0
3.50
25.0
3.00
2.50
20.0
2.00
15.0
1.50
10.0
1.00
5.0
0.50
0.0
0.00
Median Price/Earnings
Median Price/Book (x)
Median Price/Tang. Book (x)
Median Price/Earnings (x)
Median Core Deposit Premium (%)
Source: SNL Financial
2003
2.02
2.05
23.5
13.7
Median Core Deposit Premium
2004
2.03
2.13
23.3
15.5
2005
2.06
2.18
22.8
17.0
Median Price/Book
2006
2.15
2.27
23.1
18.6
7
2007
2.04
2.18
22.8
15.6
2008
1.58
1.62
23.4
9.4
Median Price/Tang. Book
2009
1.14
1.15
18.3
1.7
2010
1.16
1.22
22.2
3.0
2011
1.02
1.05
25.2
0.3
2012
1.12
1.16
18.8
2.4
2013
1.18
1.25
19.1
3.3
Bank & Thrift Activity by Region
Summary by Region
Region
Mid-Atlantic
Midwest
Northeast
Southeast
Southwest
West
Source: SNL Financial
Median Transaction Multiples
Price
Price
Price Premium
to
to
to
on Core
Number Equity Tang. Equity Earnings Deposits
20
1.28x
1.30x
19.2x
4.2%
78
1.21x
1.25x
16.0x
3.4%
8
1.16x
1.16x
33.0x
2.0%
51
1.06x
1.13x
19.8x
1.6%
43
1.27x
1.28x
21.9x
4.1%
27
1.35x
1.40x
16.0x
4.8%
8
Bank & Thrift Deal Count by Pricing
Transactions Announced in 2013
50
45
40
40
36
35
35
30
25
20
15
15
9
10
7
5
0
< 100%
100-125%
125-150%
150-175%
Price / Tangible Book Value
Source: SNL Financial
9
175-200%
> 200%
Current M&A Environment
Consolidation is
expected to be more at
the smaller asset-size
companies for a
number of reasons
including:
 Regulatory costs
 Larger relative
number (over 6,000
private companies,
41% of which are
Sub S)
U.S. Banking Companies by Assets
>$1T
4
$100B-$1T
23
$10B-$100B
72
$1B-$10B
539
$500M-$1B
641
$100M-$500M
< $100M
10
3,185
2,056
Eight Year Trend in Number of Banks (‘05 to ‘13)
Change in Number of Banks
300
$500M to $5 Billion
160
200
100
0
-100
$150M to $500M
-64
-200
-300
-400
-500
-600
-700
-800
-900
Source: SNL Financial
$50M to $150M
-810
11
Consolidation Trends
600
500
400
300
200
100
0
New Charters
Mergers
12
Failures
What Drives Value
After reviewing the top 10% of deal values (based on the price to
tangible book value) each year over the previous 11 years and
noted the following key factors:

Size

Geography

Performance (ROAA)

Metro vs. rural markets

Asset quality

Deposit mix and deposits per branch
13
Current M&A Environment – Deal Structures




Most are now traditional stock purchase and merger
transactions
Some asset purchase transactions (leaving bad assets
with seller & entering into servicing agreements)
More branch deals
Consideration – more private stock (not publicly
traded); stock and cash deals are very common
14
Current M&A Environment – Buyer Perspective

Develop relationships with attractive target banks in advance
of introducing the transaction






Participate in industry organizations
Personal visits with ownership/CEO
Loan participations (sample underwriting)
Seek to understand the business culture and psychological
motivations of sellers, especially when dealing with family or
closely held companies
Go beyond the numbers
Address the needs of the seller
15
Current M&A Environment – Buyer Perspective







Create programs to support newly acquired customers to reduce
customer losses
Make sure your technology infrastructure is ready for acquisitions
including conversion programs
Consider potential for sellers to remain involved as supporters of
the new bank after the transaction closes
Handling of TRUPS/TARP
Handling of contingent liabilities
Handling of problem loans/escrow/servicing seller retained loans
Handling of potential bond portfolio losses from initial discussions
until closing
16
Current M&A Environment – Buyer Perspective
Smaller Transactions are Generally Harder
 Closer and more personal to the seller
 Every contract and one-time expense is material;
transaction costs can be unduly burdensome in a
smaller deal
 Impacting people (directors, community and
shareholders)
17
Current M&A Environment – Buyer Considerations






Does your company have the necessary acquisition currency,
capital capacity and/or access to capital to acquire a bank?
Does your company have the necessary risk management acumen
and best practice processes to integrate an acquisition target?
Are you in good standing with the regulators?
Does your company have the human and technological platform in
place?
Are you prepared to manage the risk of market extension or out-ofmarket transactions?
Does the board and management team have the level of
engagement, stamina and vision to focus on growth through M&A?
18
Characteristics of Successful Buyers




They have a history of executing accretive transactions that
are supported in the market, both post-announcement and in
terms of relative outperformance over time
They tend to under-promise and over-deliver
They are able to demonstrate to potential sellers in a stock
transaction that there is attractive current and long-term
value in their shares, which lends credibility to the proposed
exchange ratio
They can convince a seller that not only are they the best
buyer from a social perspective, but they provide the best
financial value as well
19
Consult Regulators Early




“New normal” for regulatory approvals
You need to know what the issues are as early as
possible and preferably before a specific transaction is
contemplated
Let regulators know about your appetite for deals; they
should welcome discussion of what they will expect
Let regulators know about a specific transaction before it
is “fully baked”

Early feedback allows efficient mid-course corrections and
avoids bad surprises and needless delays
20
Hidden Costs of M&A












Employment contracts
Stock options
Executive salary continuation agreements (SERP)
BOLI
Director retirement agreements (DRP)
Key employees (pay to stay, severance pay, change-of-control
payments)
280G tax issues
Data processing break-up fees
Problem loan sales
Professional fees
Merger run-off / employee pirating
Mark to market issues (FAS 141R)
21
Current M&A Environment-Due Diligence
The due diligence checklist is lengthy, but here are some of the
priorities:
 Review of credit documentation
 Review of investment portfolio for interest rate and credit risk
 Review of deposit and loan concentrations
 Assessment of fixed asset/lease obligations
 Review of regulatory correspondence and documentation on any
compliance related issues
 Review of all change-in-control agreements, especially data
processing
 Full balance sheet mark-to-market
 Detailed transaction cost analytics
22
EPS Dilution/Accretion Analysis

Compare stand-alone EPS to pro forma EPS post-acquisition

Conventional wisdom: If pro forma EPS equals or exceeds standalone EPS, then the deal has acceptable financial returns.

Reality: EPS accretion does not necessarily mean that a deal has
acceptable financial returns
Example: An all cash deal that is EPS neutral/modestly accretive

If you are spending/investing capital in a deal, it is important to
earn a return commensurate with the amount invested and risk of
the deal. Purchase accounting requirements complicate this
analysis.
23
Tangible Book Value Impact

Dilution to tangible book value per share must be
fully recovered in a “reasonable” period of time

For a strategically important deal the tangible book
value per share payback period should not exceed
five years
24
Historical Earnings & Tangible Book Value Impacts
Announced Earnings Accretion Over Time
15.00
9.7
10.00
8.1
7.9
7.4
4.2
5.00
1.3
2.3
0.3
1.5
0.7
0.00
2004
(0.7)
2005
2006
2007
(5.00)
2008
(3.8)
2009
(2.0)
2010
(6.0)
(8.8)
(11.7)
(15.00)
Median EPS Accretion (%)
Median TBV Dilution (%)
25
2012
2013
(4.3)
(6.9)
(10.00)
2011
(6.9)
(5.7)
Stages of M&A Cycle
Stage 1



Market decline
Assisted transactions

Stage 2


Creative structures
 Earn outs
 Bankruptcy (363/pre-pack
structures)
 Good bank/Bad bank
Lower valuations, distressed
targets with higher credit marks



Stage 3



Market recovery
Traditional M&A
Higher valuations, normalized
credit marks
26
We are entering Stage 3 in the M&A
cycle
Volume of FDIC deals continues to
dwindle
No-loss share deals are coming to the
forefront
Buyers are considering creative deal
structures with an emphasis on risk
management
Buyers are more confident in
estimating credit loss
Factors Driving Industry Consolidation









Board and management fatigue
Depressed stock price without a
clear catalyst for improvement
Greater regulatory burden
relative to large banks
Rising but unknown regulatory
capital targets
Meaningful dilution implied by
raising needed capital
Need to refinance TARP/CPP
Revenue growth challenges
Insufficient scale to compete and
perform in light of increasing
fixed costs
Succession and estate planning
issues
Hurdles:
− Economic uncertainty
− Low trading multiples of
buyer stock prices
− Acquisition accounting
− Weak capital markets
conditions
− Changing regulatory
environment
− Seller inertia
27
Seller Dynamics

Value if sold today taking into account:









Price to earnings multiples
Price to book and tangible book multiples
Price to deposits
Premium on core deposits
Discounted cash flow / earnings analysis
Merging with a peer bank (strategic merger)
Ability to pay analysis
Sell now / sell later analysis
Other factors impacting sale decision:
−
−
−
−
−
Liquidity needs
Slower growth / declining earnings
Management / staffing
Regulatory burden
Economic indicators
28
Preparing the Bank for Sale
Short-term strategies (<1 year)
 Cut staff levels through attrition / hiring freeze
 Curb use of strategic planning, operations and marketing
consultants
 Defer development of new product lines and marketing
programs
 Avoid purchase of additional DP equipment
 Do not enter into any long-term lease arrangements
 Postpone any significant capital expenditures
 Add a fraction (loan pricing) subtract a fraction (deposit rates)
 Improve quality of loan files and the loan portfolio
29
Preparing the Bank for Sale
Long-term strategies (2-3 years)

Reengineering process to improve efficiency

Add new fee income

Eliminate unprofitable products, services and customers

Growth in assets should match growth in equity (excess
capital only worth $ for $)

Improve quality of loan files and the loan portfolio
30
The Sales Process
Board / key shareholder objectives:
1.
Pricing

Influenced by core earnings level

Influenced by core earnings growth potential

Influenced by buyer’s currency

Influenced by strategic opportunity of the market
31
The Sales Process
Board / key shareholder objectives:
2.
3.
Form of consideration

Cash

Stock

Combination of cash and stock
Degree of liquidity necessary
32
The Sales Process
4.
Financial issues in addition to price

Options

Change of control contracts

Retention bonuses / non-compete agreements
33
The Sales Process
Level of marketing / use of an adviser:

Single party negotiations

Limited auction process

Full scale auction process
Key question: Can we get the same pricing and avoid
the auction or limited auction process?
34
Current M&A Environment –
Negotiated Transactions
Negotiated Processes are on the Rise (split %)
100%
80%
60%
45.0%
87.5%
40%
55.0%
20%
0%
31.6%
68.4%
12.5%
2011
2012
Negotiated
Source: SNL Financial
Auction Process
35
2013
Current M&A Environment – Pricing by Process
Process Valuation – Price / TBV Comparison (x)
2.50
2.00
1.88
1.84
1.60
1.50
1.30
1.23
1.29
1.00
0.50
0.00
2011
2012
Negotiated
Source: SNL Financial
Auction Process
36
2013
Why is the Seller Selling?
Good reasons:

Shareholders need liquidity

Board is getting older or tired

Successor management will be a problem

Makes sense to join a well run regional company to
better serve the customers and community
37
Why is the Seller Selling?
Reasons that will detract from value:

Asset quality deterioration

Increased competition will limit growth in market

Earnings are maxed – “This is as good as it gets”

Board is unhappy with management or each other

A large employer is laying off a significant portion of
its workforce
38
Current M&A Environment –
Seller Perspective Other than Price




Family business
Family legacy
Status in the community
Friendships developed over decades
39
Current M&A Environment –
Who will be the Sellers?

Frequently a member of the family that founded the bank








Family legacy over many generations
Often has spent most of their working career in this bank
Bank represents a significant portion of their retirement funds
and estate
Typically over 65 years old
Many times health is an issue
Proud of their accomplishments
Important members of the community
Current generation is not as committed as earlier generation
40
Typical Pricing Terms
Cash Transaction Example
Fixed Price plus Interim Earnings:
 Interim earnings are typically from the date (quarter end) of
original offer through closing
 Interim earnings excludes (or prohibits) nonrecurring gains
 Carve-out for transaction related costs (professional fees,
contract termination fees, CIC/severance payments, etc.)
Fixed Price with Minimum Equity Provision:
 Minimum equity typically established as of the most recent
quarter or month end prior to agreement
 Minimum equity can be a price adjustment or a closing
condition
 Carve-out for transaction related costs (professional fees,
contract termination fees, CIC/severance payments, etc.)
41
Typical Pricing Terms
Stock Transaction Example
Fixed Exchange Ratio: Buyer issues 2.5 shares for every 1.0 share held
by Seller shareholders



Seller protects ownership position
Seller takes price risk for movement in Buyer’s stock price
Collars are often used to protect from significant price change
Variable Exchange Ratio: Buyer will pay Seller shareholders $25.00 per
share in Buyer stock with exchange ratio determined by using an
average price of Buyer’s stock for the 10 trading days prior to closing



Seller protects deal value
Buyer takes exchange ratio/dilution risk for movement in stock price
Collars are often used to protect from significant price change
42
Negotiations





Eliminate as many walk-aways as possible
Establish reasonable termination date, so buyer
cannot drag feet
If taking a Buyer’s stock, who becomes very
important
Structuring a deal to realize benefit of upside
potential prior to closing can easily outweigh all
other pricing negotiations
Agree on performance until closing issues; earnings,
minimum equity, bond portfolio, etc.
43
Negotiations

Convey only positive reasons for selling

Limit eagerness

Use adviser in addition to key person(s) as
determined by the board

Agree on price and other important people issues
before due diligence

Negotiate all key points at one time

You don’t have to win every point
44
Strategic Mergers-Typical Characteristics






Typically an all stock exchange - sometimes involves a special
dividend/cash payment to equate value
Ownership split is driven by relative value contribution with
little to no premium paid to either party
Value creation comes from shared cost savings, synergies and
other value enhancement of the combined company
Negotiation “one-off deal” – not a competitive bid process
Equal or proportionate (to share ownership) representation
on the board and senior management team
“Best practices” philosophy often followed with other areas
45
Why do Strategic Mergers Make Sense?

Economics are favorable for both sets of shareholders
−


Short-term growth is achieved through efficiencies
Intellectual capital is improved
−

Best practices, best personnel drive the combined organization going
forward
Size matters
−

“Would I rather own my existing stock or the stock of the combined
company?”
The current banking environment requires broad resources to operate
effectively
Combined company is better positioned to take advantage of the
market
−
Better buyer, more attractive target
46
Strategic Mergers are Difficult to Accomplish
Financial issues:




The exchange of equity at a price that is potentially not the
highest possible price
All members of both boards have to be aligned with strategic
merits of combination
If there is an obvious third party that can pay a significant
premium, the likelihood of success is limited
Transaction is difficult to protect with customary deal
protections
47
Scarcity of Strategic Mergers
Total M&A Deals Since 2002
2,603
Strategic Mergers (1)
52
% of Total
2.0%
Mergers of Equals (2)
29
% of Total
1.1%
(1) As defined by SNL Financial.
(2) Strategic mergers in which the relative assets of the parties is no more
than 60%/40%.
48
Strategic Mergers-Valuation Analysis

Balance sheet contribution
−
−
−

Shareholders’ equity contribution
−
−

Tangible common equity
Adjusted tangible common equity (w/fair value adjustments)
Earnings contribution
−
−
−

Loans
Core deposits
Nonperforming assets
Net income
Normalized net income (for nonrecurring items)
Pre-tax, pre-provision income (core earnings)
Market capitalization (if applicable)
49
Strategic Mergers-Valuation Analysis



Cost savings – not as much as an acquisition (5-10% of
combined expenses)
Revenue enhancement – repurchase loan participations,
larger credit relationships, new lines of business
Per share equivalent analysis (adjusted for exchange ratio)
−




EPS, TBVPS, Dividends
TBVPS recovery period and EPS cross-over period
Expected market price enhancement – multiple expansion
Seller may demand some premium for giving up control – cost
savings must outweigh premium
Cash can be used to validate pricing/premium
50
Strategic Mergers
Advantages




Improves EPS accretion via cost
and / or revenue savings
Improves geographic scope,
product mix and / or
management – fills strategic void
Builds critical mass and expands
or preserves the franchise
Diversifies and adds granularity to
loan portfolio and funding base
Disadvantages
 May fail to create business line and product scope











Requires compromise on business and social issues, including:
Business model
CEO / CEO responsibilities
Chairman / Chairman responsibilities
Responsibilities of CFO and other senior management
Board composition / representation
Headquarters location
Name of holding company
Name of bank subsidiaries
Sharing of cost savings
Where to “cut the pie”
 No or low premiums can discourage shareholders, especially
if banks were acquirable
 One party ultimately loses voting control – for no / less
premium
51
Branch Transaction Summary
Number of Transactions
120
100
Franchise Premium
9.00%
8.00%
7.00%
6.00%
5.00%
4.00%
3.00%
2.00%
1.00%
0.00%
105
86
71
80
65
79
78
83
89
78
60
40
20
0
2005
2006
2007
2008
2009
2010
2011
2012
2013
$20.7
$20.0
$10.0
$5.5
$5.0
$3.0
$2.9
2006
2007
2008
2008
2009
2009
2010
2011
2012
2.8%
2010
2011
Northeast-5
7%
Midwest-29
40%
$0.0
2005
2007
Southwest9
14%
$8.7
$3.3
2006
West-10
13%
$12.7
$7.3
3.3% 3.4%
2.2%
2.4%
2012
2013
Branch Transactions by Region
2013
Deposits Transferred ($ in Billions)
$12.2
5.0%
2005
$25.0
$15.0
7.8%
7.3% 7.0%
2013
Source: SNL Financial
52
MidAtlantic-5
7%
Southeast15
21%
Reasons to Sell Branches

Free up capital that can be more profitably deployed
elsewhere

Enhance efficiency ratio by unloading small branches

Exit market where the company’s market share is weak

Change business line focus

Exit markets where demographic / growth characteristics are
not as favorable

Make your company more attractive as an acquisition target

Recognize that the branches may be worth more to someone
else that they are to you
53
Bank Equity Market Performance
2013 Review / 2014 Outlook









Strong equity market performance in 2013
Banks over $1 billion were up 83% in 2013 and 122% since 2011
Banks under $1 billion were up 37% in 2013 and 60% since 2011
Banks over $1 billion trade at 69% price/tangible book premium and 17%
price/earnings premium to smaller banks
Pricing differential supported by underlying financial performance
Valuations are now approaching “intrinsic value” – but not overvalued
More room for bank stocks to increase, but significant equity market gains
are behind us
Valuation gap for “strong” and “weak” banks will increase
Banks with strong performance and currencies will dominate M&A
54
Bank Equity Market Performance
Median Price / Tangible Book Value
Median Price / LTM EPS
300%
250%
20.0
239%
16.716.7
16.0
200%
15.0
180%
155%
150%
120%
131%
14.1
12.6
12.1
12.0
121%
92%
75%
13.6
13.2
108%
88%
100%
14.1
15.9
15.4
155%
146%
125%
13.8
15.5
14.8
13.9
74%
67%
10.0
76%
50%
0%
5.0
2006
2007
2008
2009
> $1 Bill
Source: SNL Financial
2010
2011
2012
2013
2006
< $1 Bill
2007
2008
2009
> $1 Bill
55
2010
2011
< $1 Bill
2012
2013
Capital Planning
Asset Size
< $500M
$500M - $1B
$1B - $2.5B
$2.5B - $10B
$10B - $50B
>$50B
Capital Offerings by Banks & Thrifts in 2013
Common
Preferred
Sub. Debt
# of
# of
# of
Offerings Amount
Offerings Amount Offerings Amount
32
$222M
36
$110M
1
$6M
23
$369M
18
$210M
5
$40M
38
$1,235M
15
$344M
6
$55M
21
$765M
9
$473M
1
$65M
9
$4,377M
11
$1,609M
2
$375M
0
0
22
$16,199M
32
$24,322M
Source: SNL Financial
56
Conclusion










Asset quality concerns are near pre-cycle levels
Growth/earnings growth is now driving pricing
Still a buyer’s market in most areas of the U.S.
Rising rates will again make deposits attractive
Negotiated transactions are becoming favored, which allows sellers to
pick a buyer with the most upside/best currency
Strategic mergers will continue, but will remain difficult
Diminished importance of branch network
EPS accretion and synergies are most important
Challenges of scale for small banks and challenges of regulation for the
largest banks will create a “sweet spot” from a valuation standpoint
Focus on tangible book value dilution and immediate EPS accretion and
earn-back period when pricing a deal
57