Confab: Bank Holding Company Association

Bankers are talking a lot about mergers and acquisitions but the M&A boom predicted by some still hasn't come about, said Tom Mecredy, an executive with the Memphis, Tenn.-based Vining Sparks Community Bank Advisory Group. "As the cost of doing business has increased, banks see that they need to grow the franchise, organically or through M&A, in order to improve earnings," Mecredy said to bank owners and holding company officers attending the Bank Holding Company Association's spring seminar on May 6. "Certainly we are seeing steady activity. But discussion among bankers hasn't created any large increase in M&A activity.".The meeting was conducted at the Minneapolis Airport Marriott Hotel in Bloomington, Minn..While the number of transactions per year is flat, prices have improved and will continue to improve, Mecredy said. "Right now, even banks that are looking to sell at some point are delaying until they can fetch the price they'd like," he said..The banking industry still faces headwinds for net interest margin, fee income and loan growth, Mecredy said. Most banks already have taken their hits on asset quality issues and have healthy capital levels. Returns, however, are not what they used to be. "We liked to see over 1 percent ROA and 15 percent ROE before the recession," he said. "I think high performance will be 1 percent after tax ROA and 10 percent ROE, given the higher levels of capital required, the cost of doing business and the rate environment.".As earnings growth continues to be difficult, bank valuations will continue to be driven by core earnings, Mecredy said. "As to what justifies a reasonable price for a bank, buyers look at how fast they can earn back the premium they paid for the bank," he said..Acquisition multiples remain depressed across the country, Mecredy said. "Back in 2005, we were seeing multiples in the area of 2.5 times book," he said. "In 2013, the median multiple of book was 1.18. That was an increase from 1.12 times book in 2012.".More consolidation will come for banks with fewer than $500 million in assets, Mecredy said. The industry saw the number of banks between $50 million and $150 million drop by 810 during the period from 2005 to 2013. The number of banks between $150 million and $500 has dropped by 64 over the same period, he reported. At the same time, the number of banks between $500 million and $5 billion has increased by 160. "We are not seeing any de novo activity," Mecredy said. "That tells me consolidation will continue as we have seen.".Mecredy offered tips for avoiding common M&A pitfalls. "If you are going to buy a bank, make sure you tie up the key people. You need to secure the value of what you're buying," he said. "It is common for us to see two-year non-compete agreements with lenders and board members.".Data processing contracts also can be a stumbling block, Medredy said. "If you are buying a $100 million bank that just renewed a five-year contract with its data processor, the breakup fee is likely to be around $2 million," he said. "For most buyers that's not worth it.".Strategic mergers, otherwise known as mergers of equals, have many attractive features from a financial standpoint, Mecredy said. "The value of the deal stems from sharing costs, synergies and other value enhancements of the combined company," he said. "There is no bidding processes. Ownership often is split based on the value contribution of the participating banks with little to no premium paid by either party.".Strategic mergers, however, can be difficult to achieve, Mecredy said. "According to SNL, strategic merges account for just 2 percent of the 2,603 deals completed since 2002," he said..One reason for the low number of strategic mergers is that success is limited when there is an obvious third party that can pay a significant premium, Mecredy said. Another hurdle is that members of both boards have to align on the strategic merits of the merger..Much more often, strategic mergers fall apart because of social issues, Mecredy said. "Each bank has a CEO, a chairman, a board and executive team," he said. The proposed changes in responsibility for these people can throw a wrench in the gears, he said. .In 2014, Mecredy expects banks performing well will dominate in the M&A scene. As asset growth and earnings growth continue to drive pricing, he also expects the valuation gap between strong banks and weak banks will increase. The M&A market has been a buyer's market in most areas of the country; it will remain so in 2014, he said.