Seeing political inaction, some banks are forging ahead with pricey deals to cross a regulatory threshold rather than waiting for clarity from Capitol Hill.
Immediately following President Donald Trump's victory, bank stocks appreciated on the belief that Republicans could cut corporate taxes and roll back financial regulation. Seven months into Trump's presidency, Republicans have failed to make progress on their first priority — healthcare reform — and the rest of their agenda now appears in doubt. Financial stocks have stalled, and banks are firing up the M&A machine. Over the last month, the industry has averaged roughly a deal a day with 34 bank-and-thrift M&A deals since July 21.
"There may be a bit of what I would call capitulation," said H. Rodgin Cohen, senior chairman for Sullivan & Cromwell and known as "the dean of bank M&A." Cohen said some banks had been waiting on regulatory reform, tax cuts and stronger interest rates. "I think people were saying to themselves, 'Once these three are in place, I'll be worth a lot more.' Well, tax relief remains very uncertain. The regulatory relief will be coming, but it looks like it will be more incremental, perhaps, than people thought. And the interest rate curve is not moving that much."
Several deals have involved banks jumping over a key regulatory threshold once thought to be on Congress' chopping block. Banks incur an array of regulation after crossing $10 billion in assets. Some of the most costly regulations include Dodd-Frank Act stress testing; Consumer Financial Protection Bureau oversight; and Durbin amendment compliance, which caps banks' interchange income.
An analysis by S&P Global Market Intelligence shows that banks tend to pay a higher price to cross the threshold. The analysis identified 30 deals in which banks crossed the threshold since 2011, based on the buyer's and target's assets at the time of the deal announcement. In some cases, banks crossed the threshold before closing the deal. In 2017, the median pricing on those deals was 241% of tangible book value, compared to a median price of 191% of tangible book for deals involving a buyer that was already over the $10 billion mark.
Home BancShares Inc. Chairman Johnny Allison said he has seen competitors do overpriced deals that were not a great fit: "I think it's both. They did a deal they shouldn't have, and they paid too much."
Potentially driving higher pricing, some banks have looked to "leap" over the $10 billion threshold and gain scale to defray the regulatory burden. "You would not want to be a $10.5 billion bank. If you're going to cross $10 billion, you're going to want to keep going," Cohen said, although he added that the database of deals crossing the threshold was too small to divine a definite pricing trend.
Recent deals to cross $10 billion suggest that bankers do not expect meaningful regulatory reform in the near future. Stress testing carries a significant start-up cost as well as an annual cost, Cohen said. Therefore, if bankers thought Congress would raise the $10 billion threshold, it would make sense to wait rather than incur the costs of building stress test models. Most recently, CenterState Banks Inc. announced a pair of deals to go over, and First Financial Bancorp. paid a hefty price to make the leap.
"Over the last five years, over 80% of public companies who have crossed $10 billion have relied on M&A to cross the threshold. We expect that trend to continue in the near term," Vinnie Badinehal, head of financial institution investment banking for RBC Capital Markets, said in an email.
Congressional inaction persists despite bipartisan support to raise the $10 billion threshold. In May, leading Democratic and Republican senators co-sponsored a bill to push the threshold for stress testing to $50 billion. The bill was referred to the Senate Banking Committee, has not had any actions since May and has a 4% chance of being enacted, according to Skopos Labs, a machine-learning firm.
The conundrum of the $10 billion asset threshold will need to be dealt with carefully as pricing appears elevated for banks with $2 billion to $5 billion in assets. Cohen called that bracket of bank size a "sweet spot" for M&A activity considering many of the superregional banks that would target larger banks "are in the penalty box" with regulators and unable to pursue deals. Year-to-date, there have been 14 banks sold in that "sweet spot."
Home BancShares' Allison cautioned that bankers need to ensure they pursue deals that are accretive to shareholders and that they guard against dealmaking purely for the sake of size. Home BancShares crossed $10 billion with two small deals before gaining significant scale with its purchase of Stonegate Bank, which Allison said the bank did without regard for regulatory burden. But, he said, the $10 billion threshold has altered other banks' strategies, and he said some banks have stumbled by trying to leap over $10 billion.
"You combine a poor-performing bank with another poor-performing bank and what do you get?" Allison said. "You get a pile of, you know — you've got a pile."
Click here for an article summarizing all deal activity through Aug. 15.
H. Rodgin Cohen, senior chairman for Sullivan & Cromwell, will be presenting "Key Regulatory Decisions Faced by Banks," an update on the political and regulatory environment for U.S. and global banks at Big Decisions in Banking, Oct. 11-13 in New York. For more information, click here.