Henry Michaels and Jerry Wiant have seen it all in bank M&A.
The two investment bankers have worked together for about 13 years at Lehman Brothers, Citigroup and now RBC Capital Markets — or long enough for Michaels during an interview to make a crack about Wiant's unfortunate wardrobe choices way back when, and for Wiant to recall the full head of hair that Michaels used to have.
Kidding aside, they offered serious projections of pricier deals, increased volume and a pickup in European divestitures. They also said stock still has advantages over cash for sellers, and that buyers' executives should lobby their big investors about the merits of a deal.
Michaels and Wiant joined Royal Bank of Canada's investment banking arm in 2009 and last year were named co-heads of its financial institutions practice. It advises banks with $10 billion to $15 billion assets on mergers, capital-raising and other matters. Michaels and Wiant have brought on more than a dozen of the practice's 30 employees.
The following is an edited transcript of the interview with Michaels and Wiant.
Deals have picked up a bit this year, in terms of volume and pricing. How do you feel about where things are going?
HENRY MICHAELS: It's a slow march upward, certainly larger deals could be impacted by what's going on in Europe. But a lot of the buyers are small to midsize regional banks who aren't as directly affected by what's happening in the global capital markets and by what's happening in Europe. If a deal is a good deal, provided their stock doesn't fall out of bed, I think they're going to go through with it.
JERRY WIANT: There is more caution at the larger end of the scale, so we're not very optimistic for large bank M&A and I wouldn't expect to see any of the bigger guys being active as acquirers. I think the trend with the bigger guys will be more rationalizing of the franchises that they have. You've seen B of A has sold off a number of businesses - really shrinking to what they view as their core businesses. Again, we see the highest level of activity in that midcap space.
What are the trends in deal pricing?
MICHAELS: We're expecting to see prices inch up over time. What is significant now is the differences in pricing between regions. If you look at the Northeast, if you've got a relatively clean midsize institution, [pricing is at] somewhere between 1 ½ and 2 times book. And in markets like New York and Boston it's probably closer to 2 than 1 ½. Texas has been the other market where you're seeing robust premiums. What's interesting is it's starting to spread across the country. And we expect that to continue as the various regional economies recover.
Will price-to-tangible-book multiples exceed 2.5 times again?
MICHAELS: The optics of a deal at that kind of price is not optimal unless it had an extremely high fee component to the business. If it were a wealth management-oriented bank, could someone pay that or would someone pay that? Yes. For a traditional bank it would be hard to justify.
WIANT: So for investors to pay north of two times tangible book value if they're trading at — call it 1 ½ — they're going to suffer tangible book value dilution. And investors are very focused on the tangible book value dilution. Investors are willing to accept a little bit but they want to see a payback so that the deal is gonna earn back that tangible book value within really three to five years. And the sooner the better.
It seems like people are trying to figure out what is acceptable in earn-backs.
MICHAELS: One of the things we're seeing is institutions that are exploring a sale now are finding it easier to pull the trigger on sales despite the fact that premiums are much lower than they were pre-crisis if they're taking the common stock of another bank.
A good bit of common stock?
MICHAELS: A good bit of common stock, exactly. So they feel they've got leverage to a recovery in bank valuations at some point down the road. If you're selling for cash, it is much harder to get investors there.
Really? I took it that investors favored getting some cash.
MICHAELS: Well, some people want cash, when we've seen deals motivated by the fear of the change in the tax laws. But for a lot of community banks, if they're tying up with another bank who they respect and whose currency they like and they have the opportunity to participate on the upside, that makes the decision a lot easier.
What else did you want to say about tangible book dilution?
MICHAELS: There seems to be an excessive — albeit understandable — focus on it, and that is a real impediment to deals. Earlier in the year it appeared like we were going back to a focus more on earnings, but with the increased market volatility it is now back to book value.
Do managers need to go out and talk to their important investors first to get around that obsession with book dilution?
WIANT: There were a couple of transactions we worked on where there was an initial 2% to 3% dilution in tangible book value per share and maybe a correspondent decline in the initial stock price. Once management goes out and talked about the deal, the stock actually went up and benefitted the seller in one particular case to the addition of $2 per share in value that they were getting because the buyer's stock had appreciated between announcement and close. Keep in mind in the typical bank deal you have four to five months between announcement and close.
This discussion reminds me of events surrounding the F.N.B. (FNB) agreement to buy Parkvale Financial last year.
WIANT: That's a great example. So the stock did sell off I think 2% and 3% on the announcement of the deal. But if you look at the performance of FNB stock between announcement and close, it actually benefited the Parkvale shareholders to the tune of almost $2 per share in additional consideration, because you have a fixed exchange ratio.
Does that resonate with others thinking about a deal?
WIANT: Potential sellers.