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Bank M&A Looking Strong So far

originally published on RealMoney.com

I have been paying even more attention than usual to the news this week. Not only is Baltimore a place I called home for many years, my daughter lives downtown, near the ballpark. As things calmed a bit last night, I caught up on some reading I had neglected — although CNN and the streaming news feed form local Baltimore channels were on in the background.

I was delighted to see that I had the newest white paper on bank Mergers and Acquisitions from my friends at FJ Capital in my inbox. Andrew Jose and the rest of the team at the firm are fantastic bank stock investors, and have been generous about sharing information and ideas over the past few years.

The report covered M&A activity in the first quarter of 2015. Deal-making has picked up once again, with 66 deals done in the fourth quarter of 2015. Larger deals are getting done, as total volume in the quarter was $8 billion compared to just $2.7 billion a year ago and $6.7 billion in the final three months of 2014. As predicted, deal multiples are starting to climb as well, with the average price-to-book value ratio of announced deals at 1.41 compared to 1.28 last year. The numbers are skewed a bit by the Royal Bank of Canada (RY) buying City National (CYN) in the biggest deal since 2011 at a premium price of 262% of book value.

The Midwest is seeing the most M&A action with 24 deals followed by the Southeast region of the US with 14 deals. The pace in the Northeast has slowed, with just two deals in the quarter. The Mid-Atlantic region had seven deals and the Southwest had 10. The West region saw just nine deals, but because of the City national deal, it was the dollar volume leader by a wide margin.

There continues to be a discrepancy between the prices paid for higher-performing banks over competitors who might be struggling a bit. The high-performing banks were defined as those with a return on average assets over 1% and returns on equity and over 10%. Buyers were willing to pay quite a bit more for the 11 high performers purchased in the quarter, and on average paid 196.8% of book value.

The more pedestrian banks were purchased for 135.7% of book value. This suggests that if I am willing to pay 85% for low-performing banks, I might consider paying up to 130% of those very rare high performers. I need to spend a little time pondering and testing that conclusion, but at first glance that appears to have merit.

FJ Capital also broke out some common characteristics of sellers in the quarter. Most target banks were small, with 50% of them having less than $500 million in assets and 75% of sellers having less than $1 billion in total assets. It is these smaller banks that are having the most problem with compliance costs and the huge need for technology spending that are making it difficult to generate consistent profits.

Most of the banks going on the block are having problems generating earnings, and have returns on average assets on an average of 0.49% and returns on average equity of just 4.28%. The costs I mentioned are a big reason for the earnings and profit drags, and these small low performers are in a position where they almost have to sell.

I was not surprised to see that the banks being bought tended to have higher equity-to-assets ratios. According to the paper, 80% of the banks purchased in the past three years had equity-to-assets ratios greater than 8, and 40% were in the 10 to 15 range that has been my hunting ground.

Credit quality for target banks is improving, as on average non-performing assets as a percentage of total assets for sellers was 2.1% over the past three years. Only 20% have been those high-quality little banks that have less than 1% NPAs, but that is changing. The average NPAs of selling banks in the first three months of 2015 was 0.94%.

According to Andrew and his team at FJ Capital, banks with high core deposit ratios are attracting buyers’ attention as well. They say in the report that “more than 80% of sellers in the past three years have core deposit ratios higher than 75%. When the Fed likely begins to increase interest rates in the near future, banks with strong core deposit bases could be more valuable to buyers.”

They conclude that they expect the pace of deals to pick up, as I do. Multiples are going to continue to rise during the year, as buyer currency and seller credit quality continue to improve as well. The Trade of the Decade is alive and well, and 2015 is shaping up as a great year for community bank investors.

Roger, Charlie and the Smart Kids. Compelling Evidence Part III

Small bank stocks are the place to be right now. There are powerful social, economic and demographic trends that are going to create an ongoing merger wave. There is an enormous amount of money to be made by patient disciplined investors. We know that Roger Ibbotson of Yale discovered that illiquid value stocks outperform everything else in the market by a wide margin. Now we have Charlie Munger telling us that “I just thank God that they didn’t give me the assignment of managing $200 billion and beating the indexes. I would not have welcomed that challenge. The people who still have value in investing are people who are willing to work very diligently and intelligently in less efficient markets.” That’s the definition of small bank stocks.

Here just the latest sampling of investors, bankers and analysts and their thoughts of what is going on in the small banks. Read it over, realize the opportunity and join us at Banking on Profits by clicking here

In college, a group of friends and I created an investment club. I received a small amount of stock in a small regional bank from my grandfather, who always had an interest in investing. While I watched people trying to get rich quickly losing money quickly, this small regional bank compounded in value at a nice clip. It taught me the importance of a well-positioned business, prudently managed and purchased at the right price. – Kimball Booker First Eagle Investment Management

M. Ray Cole Jr., president and CEO of Hattiesburg, Miss.-based First Bancshares Inc., acknowledged at the conference that multiples have risen some in the Southeast, but not necessarily in his company’s market in Mississippi and along the Alabama coast. While he said offers for high-performing banks have increased, he is not sure that multiples have moved much higher for other sellers. He believes that a number of smaller banks could consider selling as they recognize that economic growth remains slow and continue to face pressure from their boards and regulators. Cole said he is receiving more inbound calls from potential sellers and believes that technology will allow the company to take out up to 50% of a target’s cost base even if there is no direct overlap between the two franchises. – Nathan Stovall SNL Financial

Although the much-trumpeted surge in bank mergers and acquisitions generally expected over the last few years has not yet occurred, we think investors still need to prepare for a material pickup as industry dynamics still favor increased consolidation but for slightly different drivers than those in the first years after the financial crisis.Each bank is different, but ultimately community and smaller regional banks depend on solid economic growth in their markets or taking share from competitors to drive net interest income expansion in order to increase profitability. Although some markets are more vibrant than others, our discussions with a number of bank managements indicate banks are largely taking share as opposed to enjoying solid organic growth, which should support increased bank mergers and acquisitions (M&A). – Guggenheim Securities

M&A activity in the non-SIFI group of banks is expected to continue rising among small community banks, as these institutions struggle to deal with the increasing cost of regulations, keep up with technology and deal with extreme levels of competition from larger banks and nonbanks. Many community banks have found it difficult to effectively walk the line between cutting enough costs to help boost their bottom lines and keeping the cuts from impacting the overall quality of customer service. As such, some community banks have shifted their focus to specializations where they can carve out a niche or where minimal competition provides an edge. Those specializations can be geographic, product or demographic specific. As such, merging with like-sized, like-minded banks with similar business models and customer bases remains a seemingly easy way for small banks to leverage fixed costs.- – Mortgage News Daily

The Nashville region, and state for that matter, has seen an uptick in bank consolidation in the past two years after a dry spell following the financial crisis. Since the beginning of 2014, there have been 15 deals inked involving Tennessee banks, a pace that has made Tennessee one of the most active state’s for bank M&A.- Nashville Business Journal

Unless you do something specific to safeguard the community banks, at the same time letting the market operate… it’s going to affect small business lending and the local community,” said Kabir Hassan, PhD.

He says this could result in bank mergers and higher interest rates on small business loans and mortgages. US Senator David Vittter, who chairs the Senate Small Business and Entrepreneurship Committee, says he is taking Dr. Hassan’s results to Washington as proof community banks are worth saving.- WAFBTV Baton Rouge, Lousiana
In an era of bank mergers and acquisitions, American Community Bank of Indiana remains one of the only locally-owned financial institutions and continues to grow in its niche market, shareholders heard Wednesday at the annual meeting.Michael J. Mellon, president and CEO, gave shareholders financial updates and discussed why the bank’s charter and name were changed earlier this year from American Savings, FSB, at the shareholders meeting held at the Munster location, 8230 Hohman Ave.American Community Bank also has locations in Dyer, Hammond and Schererville.“This is the second best year in the bank’s history and the best year in more than five years,” Mellon said, pointing to a 6 percent increase in total assets that rose $10.4 million to $184.9 million on Dec. 31, 2014, from $174.5 million on Dec. 31, 2013. – Northwest Indiana Times

Austin Associates marked its fifth transaction of 2015 with the announcement on April 9 that Andover Bancorp, Inc., Andover, Ohio, will acquire Community National Bank of Northwestern Pennsylvania, Albion, in an all cash transaction valued at $19 million. Andover lists assets of $353 million and operates The Andover Bank with eight offices in northeast Ohio. Community National has $77 million in assets with five branches in northeastern Pennsylvania. Austin served as financial advisor to Andover Bancorp. – Austin Associates

State Bank Financial Corp. Chairman and CEO Joe Evans also said that any acquisition has to be a good fit and serve a strategic purpose and that any buyer needs to exhibit patience. However, he said that at some point, if any acquirer cannot find a target that makes sense, they might need to consider selling themselves. If a larger bank is looking for a larger presence in Georgia, “I think we are a very attractive franchise,” Evans said at the event.- SNL Financial

Bridge Bank agreed to be sold to Western Alliance Bancorporation for $425 million in cash and stock.
The deal’s timing reflects striking while the iron is hot. It’s hard to imagine a better time to sell a Bay Area bank than right now, especially for a bank that competes against Silicon Valley Bank in serving the fast-growing technology sector.”This is a sign of things to come. The question is simply who will come together,” said Michael Natzic, a senior vice president at Crowell, Weedon & Co., which makes a market in about 75 community banks.- San Francisco Business Times

Just last month, FIG Partners gathered clients in San Francisco, where the firm’s Director of Research Chris Marinac said he anticipates bank mergers to heat up this year as more bank boards decide it’s time to join forces with rivals. He said several CEOs at small banks think it’s going to be some time before profit margins expand on lending. On Monday, Bridge Bank’s Myers said the compressed lending margins amid today’s low-interest-rate environment have lasted far longer than he and other bankers had expected. – San Francisco Business Times

Chris Marinac, director of research at boutique broker/dealer FIG Partners, which specializes in financials, said that smaller, regional banks are largely undervalued. “Dividends have increased, and more are coming,” he said. “That’s a big plus.” –CNBC

New data compiled by SNL Financial shows Wisconsin has led the nation in bank location closures over the past year, with the state’s southeastern corner hardest hit.It’s no big surprise that the numbers are high. Locally and nationally, banks have followed a steady trend toward consolidation, which is only likely to continue. It’s driven by technology (customers doing more banking online or via mobile device), and by regulation. In both cases, costs can be high, meaning mergers or consolidations make sense- Milwaukee Business Journal