September 18, 2014

Banks thirsty for loan income step up M&A activity

Banks are on a mission to increase their loan income, and their desire to meet this objective has helped fuel mergers and acquisitions.

Banks enjoy strong M&A
Dealmaking in this sector has been robust for the past few years, as many financial institutions made an effort to compensate for lackluster loan origination. Many of these organizations are driven to consolidate amid the current market challenges, which include stringent regulations and falling revenue from activities like trading.

Consolidation has been particularly intense between community banks, as these smaller organizations struggle to stay afloat amid stricter regulations. The number of these local lending institutions has plunged 54.9 percent in the last 30 years, totaling 6,279 in the second quarter of 2014, down from 14,496 in 1984, Finance and Commerce reported.

Sterne Agee: Annualized bank deals growing
"Activity in general has picked up as 191(287 annualized) bank deals have been announced in YTD14," Sterne Agee analysts wrote in a recent report, according to ValueWalk. "This compares to 246 in 2013, 244 in 2012 and 175 in 2011."

This upward trend has been happening after the number of transactions fell to a low between 2008 and 2010, the media outlet reported. While the number of bank deals has been climbing steadily higher in recent years, the premiums that buyers pay for the core deposits held by other institutions have been growing as well.

"We see that takeout valuations have steadily improved since 2011 as the P/TBV has increased to 1.37 times in 2014 vs. 1.05 times in 2011 and the core deposit premium has increased to 4.1 percent in 2014 vs. 0.3 percent in 2011," the Sterne Agee analysts wrote.

Healthy banks pursuing M&A
While it is easy to understand banks suffering from lackluster loan income resorting to M&A, industry participants reporting robust growth in this key metric have also been getting involved with this dealmaking, according to American Banker.

Potential challenges of dealmaking
Regardless of how well a bank is doing in this area, buying other financial institutions to bolster loan income certainly comes with risks, including regulatory complications, failed transactions or paying too much for purchases, the media outlet reported.

Larger banks have additional considerations that could discourage them from taking part in M&A. For example, entities with large enough scale could be deemed systemically important by regulators. If financial institutions obtained this designation, they would need to comply with stringent capital requirements that could put downward pressure on their balance sheets. There are other additional regulatory requirements as banks reach certain asset levels well before reaching the systemically important stage.

Rapidly-growing banks that want to purchase organizations enjoying the same robust pace of expansion could run into some speedbumps, as equity research analysts may be skeptical of the projected improvement in earnings, according to American Banker.

A perfect example of this is Bethesda, Maryland-based Eagle Bancorp's recent agreement to purchase Virginia Heritage Bank, the media outlet reported. During the second quarter, the former company's loans expanded 7 percent from the prior three months, while the latter enjoyed 5 percent linked-quarter loan growth.

Eagle predicted this deal would be almost 5 percent accretive to 2015 earnings, however many analysts did not increase their financial forecasts for the company by this amount, according to the news source.

Appeal of loan portfolios
If financial institutions want to bolster their loan income but are wary of the pitfalls that come along with M&A activity, they might consider purchasing loan portfolios. By doing so, they can obtain the income these pools offer without having to pay the related overhead or increased purchase price that comes along with the high equity multiples prevalent in the banking sector.

In other words, buying loan portfolios will allow you to increase your loan income without having to purchase an entire bank.

If you are interested in learning more about the opportunities associated with debt sales, you might consider speaking with Garnet Capital Advisors, which has substantial experience in this space.