Dwayne S. Safer 2017-08-16 13:41:31
Each and every year following the financial crisis there are predictions of a broad-based consolidation wave, particularly among community banks. At face value, the underlying rationale regarding the drivers of consolidation appear sound. The catalysts cited for a resurgence in mergers include the assertion of over-capacity in the industry, the need for scale, an inability to achieve adequate returns for shareholders in part due to the regulatory burden and improved bank stock currencies, to name a few. In particular, there was heightened optimism that 2017 would be a watershed year for bank M&A activity given the conducive landscape. The markets have demonstrated continued strength with unusually low volatility (VIX at all time lows), bank stock valuation multiples have surged, credit costs remain benign, the rate environment is moving higher and regulatory reform is on the horizon. Despite the logic and data reflecting that M&A deals as a percent of total banks are at higher than historical levels, the M&A market has continued to defy predictions (see below chart). Thus far in 2017 the number of whole bank M&A deals is tracking down year over year with 118 deals announced through June 30 (236 annualized), compared to 250 in all of 2016, according to S&P Global Market Intelligence data. In an era where the large money center and regional banks have been closing branches at a torrid pace and pushing customers to digital offerings, community banks have continued to strive for personalized hands-on service and convenience. Despite the restrictive regulatory environment post Congress enacting Dodd-Frank, most community banks have remained resilient and endeavor to provide the vital financial services critical to the success of their communities. Now that the potential for relief from excessive regulatory complexity may be near, evidenced by recent U.S. Treasury recommendations for regulatory reform and the passing of the Financial CHOICE Act by the House, there is reason for community banks to be optimistic. Assuming a blue sky scenario where there is a new regulatory paradigm coupled with accelerated economic growth from infrastructure spending stimulus and tax cuts, wouldbe buyers and sellers have to wrestle with how this impacts valuation and pricing expectations. Larger buyers are reticent to pay for the upside until more clarity emerges while potential sellers have seen their stock prices outperform (stock prices of Banks with assets between $500MM - $1B are up +35% since the election, outpacing their larger brethren) which has made the decision to sell more challenging given the enhanced value that’s been achieved on a standalone basis. Furthermore, the regulatory pendulum is about to swing back in favor of community banks as politicians have acknowledged that smaller banks have borne the brunt of the compliance burden which has favored larger institutions that are better able to absorb the costs. As articulated in the recent report released by the U.S. Department of the Treasury on June 12th, “Most critically, regulatory burdens must be appropriately tailored based on the size and complexity of a financial organization’s business model and take into account risk and impact.” Given the risks associated with M&A, many community banks find it to be an inopportune time to pursue a sale at this point of the cycle given the value proposition that it will be able to deliver going forward on a standalone basis. Buyers have not shown a willingness to pay for the full upside until further clarity emerges whether it be on the regulatory, fiscal or economic front. As such, community banking institutions should remain focused on realizing their full potential by being community leaders and stimulating economic growth and development– in doing so, their valuation will also display its leadership potential. DWAYNE S. SAFER IS ASSISTANT PROFESSOR OF FINANCE FOR THE DEPARTMENT OF BUSINESS AT MESSIAH COLLEGE. HE CAN BE REACHED AT DSAFER@MESSIAH.EDU.
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