"Factors Affecting Bank Acquisition Valuations," which was published in the first quarter 2008 issue of SRC Insights, discussed key factors affecting the bank acquisition valuation trend during the five-year period of January 1, 2002, to December 31, 2006 (2002-2006 analysis). Specifically, it was noted that acquiring banks were paying a significant price-to-book premium for target banks and that by the end of 2006, valuations were at record levels. Over the last two years, economic and financial conditions have deteriorated significantly, and the challenges of the weak housing market, subprime mortgage crisis, a slowing economy, reduced liquidity, and capital issues have led to a decline in the number of bank acquisitions and lower price-to-book premiums paid for target banks. For this article, data from 734 U.S. commercial banks acquired from January 2002 to June 2008 were reviewed to update the 2002-2006 analysis.
The 2002-2006 analysis found that price-to-book premiums paid for acquired institutions were impacted by several factors, including geographic location, core deposit ratios, intrastate acquisitions versus interstate acquisitions, total asset size of the target bank, and the composite CAMELS or RFI/C rating of the acquired institution.1 The average price-to-book premium peaked at 2.56 in 2006 and declined to 2.43 in 2007. The average during the first six months of 2008 dipped to 1.96 (Figure 1).
The factors from the 2002-2006 analysis were reevaluated using the expanded data period, and the conclusions were consistent. Generally, a higher price-to-book premium was paid for out-of-state target financial institutions in desirable geographic locations with high core deposit ratios and strong composite CAMELS and RFI/C ratings. The total asset size of target financial institutions also had an impact on the acquisition price, as the price-to-book ratio appears to increase with the total asset size of the acquired institution.
During the January 2002-June 2008 period, the average nationwide price-to-book premium paid was 2.45, and the banks acquired within the Federal Reserve's Atlanta District had a 2.75 average price-to-book premium, which was the highest in the U.S., followed by Dallas and San Francisco, respectively (Figure 2).
Locally, institutions acquired in the Third District received a 2.46 average premium during the six and one-half-month time frame, which was consistent with the 2.47 average from the 2002-2006 analysis and could be an indication that the Third District was less affected by current nationwide trends. The largest acquisition in the Third District during the period January 1, 2007-June 30, 2008, was Toronto Dominion Bank Financial Group's purchase of Commerce Bancorp for $9.1 billion in 2008, and the price-to-book premium was 2.91.
Over the last year and a half, the FRB Minneapolis District's ranking changed from twelfth highest to fifth, as the six deals occurring in its District during 2007 and 2008 had a 3.19 average price-to-book premium, which was a significant increase from its 1.98 average for 2002-2006. During the January 1, 2007-June 30, 2008, time period, the highest priced deal in the U.S. occurred in the FRB Minneapolis District, with Merchants Financial Group Inc. acquiring Jerema Inc. for 4.62 times its book value. The FRB Richmond and FRB Minneapolis Districts were the only Districts whose 2008 acquisitions averaged a higher price-to-book premium than their 2002-2006 average.
The number of acquisitions during the first half of 2008 slowed significantly to 24, compared to 84 deals during the same period in 2007. The average price-to-book premium was 1.96 in the first half of 2008, which was a significant drop from the 2.46 average from 2002 to 2007. The slowing economy, weak housing market, declining stock market, and uncertainty in financial stocks have depressed bank valuations.
In theory, financial institutions that have solid overall performance should expect to receive a higher price-to-book premium, as solid overall performance commonly results in composite CAMELS or RFI/C ratings of strong or satisfactory. Thus, examination and inspection ratings should positively impact the price-to-book premiums paid. This fact was evident in the 2002-2006 analysis and again proved to be the case with the recent data.
The average price-to-book premiums paid during the January 1, 2002-June 30, 2008, time period for 1- and 2-rated banks were 2.59 and 2.45, respectively, and for 3- and 4-rated banks were 2.05 and 1.54, respectively (Figure 3). In comparison, in the first half of 2008, the average price-to-book premiums paid for targets dropped significantly for 2- and 3-rated banks; however, 1-rated banks did not decline as much. The 1- and 2-rated targets' values declined to 2.39 and 1.87, respectively, while 3- rated banks had a 1.23 average.2
Deterioration in economic and financial conditions has led to a decline in the number of bank acquisitions and lower price-to-book premiums paid for target banks. Multiple factors influence the price-to-book premium paid for financial institution acquisitions. Acquiring institutions still appear willing to pay a higher price-to-book premium for out-of-state targets in desirable geographic locations with high core deposit ratios and strong composite CAMELS and RFI/C ratings.
As Harry Truman once said, "A pessimist is one who makes difficulties of his opportunities, and an optimist is one who makes opportunities of his difficulties." Although these times are challenging, there may be great opportunities for acquiring institutions.
The views expressed in this article are those of the author and are not necessarily those of this Reserve Bank or the Federal Reserve System.