Terminated First Guaranty-Lone Star Bank deal a casualty of industry tumult

First Guaranty Bancshares Inc. and Lone Star Bank terminated their merger in the wake of the recent industry tumult that led to pressure on US bank stock prices and dramatically changed the market backdrop for the sector.

The terminated transaction is the fifth US bank deal nixed so far this year as a string of transactions have been derailed by various market conditions, including the regulatory environment, stock prices and uncertainty that has only increased since three regional bank failures between March and May.

For First Guaranty, the termination means the loss of extra capital, lower-cost deposits and a Houston presence. But equity analysts were not discouraged by those losses, since the environment is incredibly uncertain right now, and growth is currently not a focus for banks and investors alike.

"The environment has gotten increasingly uncertain since the deal was announced. I mean it was announced in January. It's crazy to think what has changed since then," Graham Dick, an analyst with Piper Sandler, said in an interview. "I can understand why for both sides, it might not make as much sense as it did in January."

First Guaranty and Lone Star Bank did not reply to request for comment. In a press release, the companies said "market conditions have changed since January 6, 2023."

One major change since January is US bank stock prices. Analysts said that was likely a large contributing factor for this termination, especially given how much pressure bank stocks came under after the recent bank failures.

"That really brought down share prices across the board. That's been a challenge for executing M&A deals that were announced before that," Feddie Strickland, an analyst with Janney Montgomery Scott, said in an interview. "That just made it tough for any bank to complete M&A using their own currency."

First Guaranty's stock price closed at $24.08 on Jan. 6, the last closing price before the deal was announced, down 50.17% to $12.00 on July 10, the last closing price before the termination announcement.

The termination likely "stems from the hit to [First Guaranty]'s stock in what was an all-stock deal," D.A. Davidson analyst Kevin Fitzsimmons wrote in a July 11 note. The merger agreement was structured such that First Guaranty would issue shares equal to 150% of Lone Star Bank's tangible book value as of the month-end prior to the closing date.

The termination announcement also came one day prior to Lone Star Bank's scheduled shareholder vote meeting, which was originally set to be held on June 13 but was delayed. The bank said it delayed the meeting in order to solicit additional proxies in favor of the merger and to give Lone Star Bank shareholders sufficient time to consider First Guaranty's recent settlement with the Securities and Exchange Commission, according to a press release.

It is possible that Lone Star Bank was unsure it would secure enough shareholder votes, which could have also contributed to the decision to terminate, Strickland said.

Given First Guaranty's stock price decline and the postponement of the shareholder vote, the termination "shouldn't be a complete surprise to investors," Fitzsimmons wrote.

Not a huge loss

The termination will strip away some attractive additions Lone Star Bank would have brought to First Guaranty, including increased capital, a lower cost of funds and expansion into Houston. While the loss of those benefits is not ideal, analysts were not discouraged by the termination and are still bullish on First Guaranty's stand-alone future.

"Having that excess capital and being able to grow and have runway in Houston is pretty attractive," Dick said. "Missing out or losing out on those two things is unfortunate. But at the end of the day, the environment has changed a lot since they announced the deal in January. Growth isn't as key for the banking industry as a whole right now."

While the termination "weakens the pro forma growth trajectory," it is unlikely that there will be much pressure on First Guaranty's stock price since growth is less of a focus for banks right now, Dick said.

First Guaranty's stock price closed down just 0.67% on July 11, the day after the termination announcement, compared to a 1.68% gain in the KBW Nasdaq Bank Index that day.

Still, the deal was expected to bolster First Guaranty's capital position.

The bank reported a common equity Tier 1 (CET1) ratio of 10.03% at March 31, which is "screening below peers," Fitzsimmons wrote. Comparatively, Lone Star Bank had a CET1 ratio of 16.83% as of the same date.

However, analysts said the loss of the additional capital from the deal is not a big deal.

"[It] wasn't going to create a demonstrable change in their capital ratios. It would have been kind of more of a little boost," Dick said.

The deal was also expected to lower First Guaranty's cost of funds since Lone Star Bank had lower-costing deposits, the analysts said. Moreover, Lone Star Bank's "more favorable" cost of funds and net interest margin were expected to boost First Guaranty's earnings per share, Fitzsimmons wrote.

Lone Star Bank's cost of funds was 1.75% at March 31 compared to First Guaranty's 2.57%, according to S&P Global Market Intelligence data.

However, analysts again were not discouraged by the loss as First Guaranty is currently working on de novo expansions in West Virginia and Kentucky, so "they've got some levers that they're working on pulling so they can potentially make up for it," Strickland said.

Geographic expansion, both through M&A and de novo efforts, has been a focus for First Guaranty. The Lone Star Bank deal was set to move First Guaranty into the Houston area.

Not moving into a high-growth market like Houston is a loss because it offered a "healthy loan growth market" and "improved geographic growth profile," Fitzsimmons wrote.

But the door is not completely closed because First Guaranty could pursue organic expansion efforts in Houston, Strickland said, or look for another M&A partner there in the future.

Future M&A

Dick, Strickland and Fitzsimmons all agreed that M&A will continue to be part of First Guaranty's strategy, but not in the near term given the ongoing uncertainty and the company's capital levels and stock price.

"When the stock's multiple and capital levels move higher, we wouldn't be surprised to see [First Guaranty] return to M&A opportunities," Fitzsimmons wrote, adding that he "can't rule out the bank seeking a larger partner at some point."

Another possibility is that First Guaranty and Lone Star Bank come back together after things are more normal.

"You never know, there's a possibility that they could talk to each other again after some of the uncertainty goes away," Strickland said.