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Chasing the unicorn

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Chasing the unicorn

Nancy Bush is a veteran bank analyst. The following does not constitute investment advice, and the views and opinions expressed in this piece are those of the author and do not necessarily represent the views of S&P Global Market Intelligence.

Well, I suppose it was inevitable that this would happen. The "merger of equals" between BB&T Corp. and SunTrust Banks Inc. that was announced Feb. 7 has kicked off a wave — make that a tsunami — of speculation on what similar deals might follow. There has been the predictable political blowback as Rep. Maxine Waters and Sen. Elizabeth Warren have decried the deal as indicative of the Trump administration's relaxed attitude toward financial services regulation. Waters has called for "serious scrutiny" of the merger on the part of the Federal Reserve (otherwise I'm sure she'd only look at it for 10 seconds and be done with it). And the attitude on the part of Wall Street has been one of general resignation — bank mergers with their resultant cost savings are the natural byproduct of a flat yield curve and the move to mobile and digital banking, and more large deals at low premiums will inevitably occur.

Well, maybe. I do believe that the BB&T/SunTrust merger will prove to be something of a laboratory, and that there will be an interested group of large-bank CEOs watching developments there closely. There is a remote — let me repeat, remote — possibility that the Fed will impose additional strictures before approval, requiring guarantees and limitations upon employee reductions and branch closings, and that as a result BB&T may not be able to get the full amount of cost saves ($1.6 billion net of investments, pretax). Or the banks may be required to divest more deposits than presently anticipated ($1.35 billion) in an effort to make sure that small banks get more benefit from the deal. The Fed — always a political institution, and a self-protective one — will be keenly sensitive to any tremors of regime change in 2020 and will most likely position itself accordingly, and this major merger may be an indication of how future large deals will be received in Washington.

As readers know, I wrote a blog on this subject in February — titled "Creating the no-name bank" — and my "meh" opinion on the BB&T/SunTrust deal has sadly not changed in the intervening months. Nor has my view that MOEs are the "unicorns" of the banking industry — rare, infrequent and most often illusory — and I do not expect a rash of similar deals to follow in its wake. But I am willing to concede that the possibility of low-premium deals in the community banking segment is much greater — and that these combinations are more likely to produce outcomes that are indeed additive — than are these mega-MOEs that produce a lot of smoke and sadly little heat in the final analysis.

The possibility of more positive outcomes in the smaller banking universe is not hard to imagine. Such combinations — while still not "mergers of equals," since those in reality do not exist — are unlikely to involve the technological and operational risk that will be seen in the BB&T/SunTrust deal and are also likely to produce outcomes that are less harmful to their local markets. I have always believed that community bankers are closer to their clients and are thus more adept at judging the actual and psychological impacts of merger activity upon their customer base, both retail and commercial. Would the closing of a branch or a reduction in customer-facing staff make a difference? Easier to know if you are closer to the ground and not looking at the question from 30,000 feet, or making decisions with a cadre of consultants guiding the process.

But the community banks have one major impediment to doing low-premium deals that the larger banks do not, and that is the nature of the shareholder bases of many community banks, especially here in the Southeast. I know few investors who owned the stocks of SunTrust and BB&T with the expectation that either of these companies would be taken out at a premium in a deal. While that may not have been the case for SunTrust in the old days — rumors about Jamie Dimon's quest for a large Southeastern franchise were a daily occurrence in 2005-2006 — that has not been the case for at least the last decade, and any investor who believed that BB&T was for sale to any bank anywhere and at any time would have to be deemed delusional or worse.

Not true for the community banks, and with good reason. One need only look at the merger path of Pinnacle Financial Partners Inc. to see why owning Southeastern community stocks like BNC Bancorp — which sold to Pinnacle at roughly 20x projected earnings in January 2017 — has been a lucrative endeavor. There has long been a group of extremely savvy bank stock investors who did not bother with the over-analyzed large bank sector but specialized in knowing the stories (in minute detail) of the community banks, including the likelihood that these banks would one day choose to sell (with the age of the chairman/CEO a big factor in that equation.)

As I have closely observed on several occasions, these investors tend to get irked when those watched-and-owned banks choose to do low-premium deals, especially when their holdings are deemed the "lesser of two equals" and are essentially selling themselves without much reward for shareholders. The logic behind these deals must be compelling and go beyond issues of simple geography or scale — there must be an element of greatly enhanced profitability that may result in the new bank becoming either a more important player in the community banking industry and/or a more attractive acquisition candidate on its own. Many of these investors do not take what they see as unjustified MOEs lying down, and their objections (as well as their votes) can become an important obstruction to the completion of a deal.

A statement that Central Valley Community Bancorp CEO Jim Ford made at a recent D.A. Davidson conference seemed to encapsulate the dilemma: "Let's say we're on the selling side of that MOE. Why should we take a much lower premium than we could get if we just sold the company? And I think that's the debate that we're having internally,” Ford said during a discussion of MOEs.

He went on to concede that the issue was being discussed at his company nevertheless: "The question was raised at our last strategic planning meeting because this is the in-vogue thing all investment bankers are talking about.”

Ah, yes — everybody's talking. Let me propose that we talk about something else. I had the good fortune recently (while working on another assignment) to come across a community bank with about $2 billion in assets located in Bluefield, Va., called First Community Bankshares Inc. that has chosen to go a whole different way than its community banking peers. After an exhaustive period of due diligence and deal-doing in the wake of the Financial Crisis, this bank found itself unsatisfied with the results, burdened by a cumbersome and costly balance sheet and detached from its real business of being a community bank. In 2013, it stopped doing deals, largely cut off communication with Wall Street, went on a balance sheet cleanup, and decided to pass all excess capital along to its shareholders, including through special dividends if necessary.

The result? A bank that is earning a 1.75% ROA, a 12% ROAE and has a NIM in the mid-4% range, with a stock that sells at 15x forward earnings and at 223% of tangible book. And it just raised its dividend, which is up 39% over the past year. Now THAT is a banking unicorn — and one that even I can chase.