As we enter 2012, it appears merger activity is at an inflection point. Building upon the momentum of activity in December, there were 16 deals announced in January of 2012 compared to only 3 in January of 2011. Various industry tensions involving pricing, new regulations and asset quality are getting resolved and deals are coming together. The resolutions of these tensions vary by region, moving in favor of sellers in areas of economic strength and in favor of buyers in areas of economic weakness.

Pricing for profitable banks in strong regional economies has ranged between 1.50x and 2.00x tangible book (adjusted to an 8% level). In exceptional circumstances, we have seen prices go as high as 2.25x. Exhibit 1 is a recap of merger activity and trends in 2011 with a look toward what may develop in 2012.

Recap of 2011 Merger Activity and Trends

At the beginning of 2011, expectations abounded that it would be the breakout year for the next wave of industry consolidation. The second quarter surge in M&A transaction volume seemed confirmation of the year-end 2010 trend. But it proved the exception rather than the rule as volume ebbed in the final two quarters. Whole-bank transaction volume for 2011 totaled 157, down from 173 for 2010. Transaction volume in the second half of 2011 was no doubt affected by the continuing regulatory uncertainty and the tenuous nature of the U.S. economic recovery, exacerbated by the budget deficit debate and the deepening financial crisis in Europe.

An analysis of the types of buyers in 2011 reveals a marked shift from 2010. Transactions involving investor groups as buyers fell to 36 or 23% of total transactions in 2011, half the 73 (42%) posted for 2010. Banks reclaimed their naturally predominant position (versus investor groups) in bank M&A, acquiring 111 banks or 71% of the total sold during 2011 compared to just 83 or 48% in 2010.

Median pricing as measured by the price to tangible book trended downward in 2011. The 0.92x median tangible book multiple for the fourth quarter of 2011 was the lowest quarterly level recorded for at least the last eleven years. This trend in pricing seems counterintuitive since industry asset quality has found a bottom and profitability is trending up.

A review of fourth quarter transactions reveals nineteen transactions (51% of the quarterly total) involving a publicly-traded regional community bank buyer with assets over $1 billion, which explains the relatively large median size of the buyer. Thirteen of the selling banks were also publicly traded. Common stock accounted for some or all of the consideration in sixteen of the transactions compared to a total of twenty-four for the other three quarters combined. As noted in Exhibit 2, the median seller was experiencing some stress from asset quality issues.

Representative of recent transactions is $3.9 billion-asset SCBT Financial’s acquisition of Peoples Bancorp ($546 million), both South Carolina-based banks. The all-stock transaction also entailed the payoff of Peoples’ outstanding TARP in full at closing. For SCBT, the transaction deepened its upstate South Carolina footprint along the I-85 corridor and offered potential savings from charter consolidations and other synergies. The all-stock structure minimized goodwill, maintaining SCBT’s strong capital ratios. Peoples’s shareholders maintain their investment in the industry, but in the more liquid stock of a larger, stronger company.

Peoples Bancorp was well-capitalized and under no enforcement formal action. Its asset quality and earnings had improved over the last four quarters, indicating that the bank had ring-fenced its problem assets and was working through them. Yet its management realized that the shareholders would likely realize greater value at lower risk by merging with a larger partner with similar banking philosophy.

This scenario, with variations, was played out many times during 2011 (not just the fourth quarter), sometimes with the seller taking stock in a privately-held bank. This suggests that buyers are comfortable with their own financial position and are willing to take on some risk. Even though sellers may be confident of survival, they are recognizing that survival may not equate with success in the future banking environment. The path to success for many has been to merge with a partner at today’s prices and realize full shareholder value in the future.

The recovery in the banking industry progressed at a moderate pace during 2011 as profitability and asset quality improved at the nation’s largest banks. Industry profitability for the three quarters of 2011 as measured by the aggregate ROAA improved to 0.92% from 0.64% for the comparable 2010 period. Much of the improvement stemmed from lower provision expenses. Net charge-offs and non-current loans also fell from their 2010 levels, reducing the prospect of higher provisioning in future quarters.

Exhibit 3 shows the components of pre-tax, pre-provision net income (bars) and the resulting pre-tax, pre-provision net income (line) as a percent of average assets by size category for the median bank over the twelve-month period ending September 30, 2011. Note the direct correlation between size and profitability in this chart, a theme that pervades today’s banking environment and will fuel M&A activity.

Exhibit 4 shows the percent of total banks by last-twelve-months (LTM) ROAA since 2002 broken into four segments. Over the four quarters through the third quarter of 2011 (date of most recent industry data), the number of loss-making banks showed the greatest decline in number, falling from 2,166 or 28% of total banks for the comparable twelve-month 2010 period to 1,395 or just 19% in the 2011 period. Of the profitable banks, those earning 0.50% to 1.00% increased the most to 36% of the total or 2,654 in the 2011 period from 23% in the 2010 period. Overall, fifty-eight percent of total banks were profitable on an LTM basis at the end of the third quarter of 2011 compared to 47% for the LTM period ending the third quarter of 2010.

While the largest banks are far along in resolving problem assets, real improvement in asset quality is proving elusive at the community bank level. The total number of banks with NPAs+90s/ Total Assets greater than 2% fell by 270, just 7% to 3,605 over the twelve-month period ending September 30. While some banks are emerging from the tar pits, others have just become ensnared as evident in Exhibit 5.

The number of institutions with the most severe challenges (measured here as over 6% NPAs/ Total Assets) has steadily declined for the last five quarters. However, the reduction of 109 during that time was only slightly less than the number of failures – 119. Not all of the 109 were failures: some banks moved out of the category through successful resolution of some of their problem assets. But the message here is that while the level of problem assets has peaked, it appears the decline will have a long, fat tail.


As mentioned previously, there were sixteen transac­tions announced in January of 2012 versus three in January, 2011. As we see it, the fourth quarter of 2011 M&A activity signaled the beginning phase of the next consolidation wave spurred not by a desire for growth for its own sake, but for sustainibility in the face of an uncertain future. This applies to buyers as well as sellers.

It seems that the ingredients for more robust M&A ac­tivity are in place. Fourth quarter earnings announce­ments among the nation’s publicly-traded banks have been positive with a continuation of the trend in better profitability, lower provision­ing, and lower levels of problem assets. Loan volume, though anemic, seems to be stabilizing, with many publicly traded banks reporting higher loan levels and expectations for modest growth in 2012. While regulatory guidance regarding capi­tal remains unclear, there seems to be greater receptivity on the part of regu­lators to well-structured transactions.

There is pent-up demand on both sides of the negotiating table. Buyers are look­ing for loans and inexpensive deposits to boost net interest income and gain enough efficiency to offset lower non-interest income and higher non-interest expenses (driven largely by as-yet undeter­mined regulations). Many sellers have postponed en­tering the market in the last two years due to perceived low prices and uncertainty regarding their own finan­cial condition. The same issues driving buyers into the market, particularly margin compression and the need for size, are also driving sellers into the market.

Today, with the marked improvement of many larger community banks and the reemergence of these banks as the predominant acquirers, sellers have more poten­tial suitors which should lead to better clarity on pricing. Additionally, the recent flurry of merger activity points to better opportunities to find the right merger partner.

Contact us today for a complimentary discussion of the values and opportunities in your market.

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