SRC Insights: Third Quarter 2010

Pace of Bank Mergers and Acquisitions Increases as Valuations Gradually Improve

by William Lenney, Regulatory Applications Specialist Analyst

This is the fourth installment in a recurring series on national and Third District trends in bank mergers and acquisitions. The first three articles were as follows:

"Factors Affecting Bank Acquisition Valuations," 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 2002-December 31, 2006. 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.
"Bank Mergers and Acquisitions Slow with Economy," published in the first quarter 2009 issue, extended the original study to June 30, 2008. The deteriorating economic and financial conditions during 2007 and the first half of 2008 and the challenges of the weak housing market, subprime mortgage crisis, a slowing economy, reduced liquidity, and capital issues all led to a decline in the number of bank acquisitions and lower price-to-book premiums paid for target banks.
"Bank Mergers and Acquisitions Continue at a Slow Pace," published in the third quarter 2009 issue updated the study for the period July 2008-June 30, 2009. Bank mergers and acquisitions continued at a slow pace, and price-to-book valuations continued to decline.

For this article, the study was updated for the period July 2009-June 30, 2010, and data on 920 U.S. commercial banks acquired from January 2002, to June 30, 2010, were reviewed and analyzed. The same analytic factors used in the three previous analyses were also applied to this most recent time period. In general, the analysis found that the pace of bank mergers and acquisitions has increased, while price-to-book valuations stabilized in the second half of 2009 and showed improvement during the first six months of 2010 (see figure below). There were 149 acquisitions from July 1, 2009, to June 30, 2010, compared to only 29 acquisitions from July 1, 2008, to June 30, 2009.¹ Factors that may have an effect on the price-to-book valuation include target location, asset size, bank rating, and geography.

Interstate vs. Intrastate

The price-to-book valuations appear to vary regarding whether the acquisition is interstate or intrastate. Interstate bank targets received a higher price-to-book premium during the most recent period. For the July 2009-June 30, 2010 period, interstate targets received a 1.14 average price-to-book premium compared to intrastate targets that received a 1.02 average price-to-book premium. This was consistent with the January 2002-June 30, 2008 period, when interstate bank targets received a 2.53 average price-to-book value, while intrastate targets only received 2.31. In contrast, in the July 2008-June 30, 2009 period, interstate banks only received a 1.17 average price-to-book premium, while intrastate banks received a 1.39 average price-to-book value. The data indicate that during economic contractions, it is likely that acquirers are more willing to stay near home, but during economic recoveries there is the propensity to pay a premium to expand into new markets and other geographic locations.

Total Asset Size of Targets

During the 2002-June 30, 2008 period, the total asset size of target financial institutions had an impact on the acquisition price, as the price-to-book ratio appeared to increase with the total asset size of the acquired institution. However, from July 1, 2008, to June 30, 2009, large target institutions received a lower price-to-book premium than smaller target institutions. Banks with assets exceeding $1 billion received a 0.88 average price-to-book ratio, while banks with less than $1 billion in assets received an average of 1.02 price-to-book premium. This trend continued in the July 2009-June 30, 2010 period, as banks with assets exceeding $1 billion received a 0.76 average price-to-book ratio, while banks with less than $1 billion received an average 1.04 price-to-book premium. This valuation cycle is consistent with the deleveraging theme that has been occurring during the past two years.

CAMELS and RFI/C Rating

Strong composite CAMELS and RFI/C ratings and core deposit levels continue to demonstrate a solid relationship to higher price-to-book values. 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, it is not surprising that examination and inspection ratings correlate and correspond to price-to-book premiums paid. This fact was evident in the 2002-June 30, 2009 analysis and again proved to be the case with the recent data.

The average price-to-book premiums paid during the January 2002-June 30, 2009 time period for 1- and 2-rated banks were 2.57 and 2.42, respectively, while 3- and 4-rated banks received 1.96 and 1.87, respectively (see figure below). During the last 12 months, 1-rated banks received 1.50, while 2-rated banks received 1.28. The average price-to-book premiums for 3-and 4-rated targets were 1.03 and 0.84, respectively, while 5-rated targets received an average 0.75 times book value. Although the premiums paid were consistently lower during the past 12 months versus the historical average, higher-rated banks continued to consistently receive a higher price-to-book premium than lower-rated banks.

Core Deposits

In the prior studies, target banks with a high percentage of core deposits received a higher price-to-book premium. This continues to be the case, as banks with core deposits over 20 percent received a 2.30 average price-to-book premium, while banks with core deposits of five percent or less only received a 1.14 average price-to-book value. This continued trend shows the importance of the stability of deposits.

Valuations by District

Geography still plays an obvious role in price-to-book values as well, but the ratios in each region have changed noticeably. The targets in the Dallas, Boston, and St. Louis Districts received the highest average price-to-book ratios—1.44, 1.25, and 1.18, respectively—from July 1, 2009 to June 30, 2010 (see figure below). The most significant valuation deterioration occurred in the San Francisco and Atlanta Districts during the same period compared to the July 2008-June 30, 2009 period. The average price-to-book premium paid for targets in the San Francisco District declined from 2.15 to 0.99, while valuations in the Atlanta District fell from 1.75 to 0.84. Although targets in the Dallas District received the highest average price-to-book premiums, they also experienced a significant decline.

Some Districts showed improvement. Average price-to-book premiums increased in the Chicago, Cleveland, New York, Richmond, and St. Louis Districts during the July 2009-June 30, 2010 period. Chicago had the most significant increase, as the average price-to-book premiums in the District improved from 0.80 in the July 2008-June 30, 2009 period to 1.03 in the July 2009-June 30, 2010 period.

The highest price-to-book premium paid in the nation from July 1, 2009, to June 30, 2010, was Green Dot Corporation's purchase of Bonneville Bancorp in the San Francisco District for 2.43 times book value. Bonneville Bancorp also had the highest core deposit ratio of all targets. The lowest price-to-book premium over the last 12 months was 215 Holding Company's purchase of White Rock Bank from BancMidwest Corporation for 0.17 times book value for $1.3 million.

Institutions acquired in the Third District received a 0.86 average price-to-book premium in the July 2009- June 30, 2010 period, which was a significant drop from the 1.37 average during the July 2008-June 30, 2009 period. The highest price-to-book premium paid in the Third District during the July 2009-June 30, 2010 period was the Bank of Princeton's $5.5 million acquisition of MoreBank, which was priced at 1.19 times book value.

Conclusion

During the past year, the pace of acquisitions has increased, while price-to-book premiums paid for targets have gradually improved. Acquiring institutions are more willing to pay a higher price-to-book premium for out-of-state targets, as institutions look for opportunities to expand their operations geographically. Smaller targets command a higher premium compared to larger targets, as it appears that acquirers want to grow in smaller conservative increments. Institutions that had strong overall performances and ratings are still considered more valuable. Similarly, banks with high core deposits continue to receive a higher average price-to-book premium.

Warren Buffet, known for his investment wisdom, once said, "I don't look to jump seven-foot bars; I look around for one-foot bars that I can step over." In the bank acquisition business, it appears that this same wisdom applies. While institutions are increasing their desire to expand, they are also looking on a smaller scale now as compared to the mid-2000s.

¹ In addition to the 149 acquisitions occurring between July 1, 2009, and June 30, 2010, there were 155 government-assisted acquisitions that were not included in this study. Price-to-book data are not available for these transactions.

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.