Heritage Commerce Corp. is looking to blanket the entire Bay Area, and analysts believe that long-term strategic goal justified the 19% premium paid to acquire Presidio Bank.
Heritage Commerce's stock was down 1.47% at around 3 p.m. ET May 17, while Presidio's stock price jumped more than 13% and the rest of the banking group was largely flat. That selloff in Heritage Commerce shares paled in comparison to the sharp declines seen over the last year when banks paid up for deals. The deal's price amounted to 205.7% of Presidio's tangible book, resulting in 8.0% dilution and a projected earnback period of 4.3 years, according to a merger presentation.
"Heritage Commerce is underperforming today modestly, but certainly not nearly to the level we've seen in other transactions with similar characteristics," D.A. Davidson analyst Gary Tenner said in an interview. "The market is looking at it and saying, 'We understand the dynamics behind the deal, and we value the strategic part of this, and we know a $4 billion commercial-focused community bank in that footprint certainly has scarcity value.'"
This is the eighth U.S. bank deal announced this year with a value over $200 million, compared to nine in the same period of 2018 and 15 in the same period for 2017.
During a May 17 deal call, Heritage Commerce CEO Walter Kaczmarek said the bank has been focused on growing its physical presence across the Bay Area and wanted to fill the gap it had in San Francisco and Marin counties. Presidio has a branch in each of the two affluent counties.
"The scarcity value from an opportunity standpoint in the Bay Area is pretty significant and Presidio, in our opinion, was absolutely the premier community bank in the $1 billion [asset] size range," Kaczmarek said.
Later on the call, an executive said the bank would continue to pursue an expansion to cover the entire Bay Area, with the only remaining gaps being San Leandro, Oakland and Richmond — a contiguous trio of communities lining the East Bay. The executive said Heritage Commerce does business in those areas but does not yet have a physical presence and "would continue to look for teams, potentially, to fill out that area."
FIG Partners analyst Timothy Coffey said the expansion into the East Bay would more likely be done organically than via another acquisition given the few banks that operate in the area that would be for sale. Analysts said the long-term strategy to have a presence throughout the Bay Area was a sound one, and the Presidio acquisition is of sufficient size to represent a meaningful expansion of the bank's footprint northward, into San Francisco and the North Bay.
"They have a higher level of regional dominance than they had before this deal because they encircle the market. That provides benefits not just from lending but also in recruiting, and it enhances their deposit gathering as well," Keefe Bruyette & Woods analyst Jacquelynne Bohlen said in an interview.
Analysts said the deal provides Heritage Commerce with a larger balance sheet that can be used to drive core operations in the market. Over the longer term, it also makes Heritage Commerce a more attractive target for a potential sale. Further, the consolidation of a Bay Area community bank only increases the scarcity value in future deal-making, likely providing some knock-on benefits to other community banks in the region.
On the financial metrics, executives forecast cost savings of 50%, or $12.1 million, in 2020. Of that figure, $1.3 million would come from retiring Heritage Commerce employees who would be replaced by existing Presidio employees. Management said on the deal call that the cost-saving figures were on the conservative side, and analysts said in interviews that they believed savings could come in higher still.
Even with the projected cost saves, analysts said the deal mostly made sense from a strategic point of view.
"It's more of a strategic fit than a financially good deal," Coffey said in an interview. "The cost saves are nice, but the book value dilution is on the high end of what investors are willing to accept. But the long-term benefits are immense."