Research — 29 Nov, 2023
Unlocking keys to balance sheet restructurings, bank M&A
By Nathan Sovall
The negative impact from higher interest rates has led a number of banks to consider balance sheet restructurings and a few institutions have pursued those transactions by unlocking capital through sales of business lines or merging with another company, according to Bill Burgess, co-head of financial services investment banking at Piper Sandler.
Burgess said in the latest Street Talk podcast that most discussions in the bank sector currently revolve around capital and a potential restructuring of balance sheets as increases in interest rates have pushed loans and, in particular, bonds deeply underwater. In fact, when marking publicly traded banks' balance sheets to market, Burgess said the median reduction in tangible common equity was 42% in the second quarter. That reduction was even larger at the end of the third quarter given further increases in rates.
"In some examples, banks can have no capital on a mark-to-market basis," Burgess said.
The veteran investment banker said that such severe marks, which buyers are required to take when acquiring another institution, make many deals untenable. He said those marks remain the biggest hurdle to a rebound in bank M&A, which remains historically depressed. Lower valuations and a regulatory environment that is not conducive to banks with more than $100 billion in assets participating in deals represent additional headwinds to bank M&A activity.
"Everything is capital today in the M&A world," he said. "Otherwise, it's all about trying to find a way to restructure your balance sheet if you believe that these current market rates are going to persist.”
Some banks have managed to do the latter by unlocking capital through a variety of transactions, including sales of their insurance brokerage units. Eastern Bankshares Inc. did that to help facilitate the purchase of Cambridge Bancorp, and Cadence Bank sold its insurance brokerage unit to fill the capital hit associated with a balance sheet restructuring.
Burgess said banks could unlock capital through other means, including the sale of branches or Visa class B shares or by exiting geographies they do not consider core to their franchise. Selling insurance brokerage units has been in vogue, he said, given that targets are fetching close to 35.0x earnings, while bank stocks trade at a fraction of a value.
Some other banks have pursued outright sales to change their situation. Burgess said CapStar Financial Holdings Inc. will be able to effectively restructure its balance sheet in connection with its planned sale to Old National Bancorp. He noted that CapStar’s net interest margin was under pressure, and it likely would have needed to issue common stock to facilitate any balance sheet restructuring. Instead, Old National provided the capital and a small market premium when agreeing to acquire the franchise.
"If you are a $1 billion asset bank and you have an attractive franchise in terms of footprint, but less so in terms of the mark of your overall balance sheet, can you find an acquirer that will basically mark your portfolio and fill in the capital hole required and maybe provide you with a premium," Burgess said. "That's right now the discussion that is taking place in most major MSAs, which means if you are a bank right now with excess capital, you are, in essence, the one-eyed man in the land of the blind. You have the ability to pursue transactions that many others cannot because of the negative impacts of purchase accounting."
He said that some additional banks could pursue transactions with the help of outside capital either from existing investors or private equity firms. While banks are trading at historically low valuations, the fundamentals are arguably not as daunting as seen in other downturns, he said. Burgess said that unlike the great financial crisis, when banks had large capital holes due to credit issues, the capital shortfalls now largely stem from underwater bonds that banks will eventually recover.
"If I'm a private equity firm, I love this. This is wonderful. I don't have to kind of bet the ranch that commercial real estate is going to have a better loss given default than I had modeled or reliant upon a third-party loan firm to assess what could go wrong. So I do think that there's a lot of interest for private equity to partner with institutions," Burgess said.
This article was published by S&P Global Market Intelligence and not by S&P Global Ratings, which is a separately managed division of S&P Global."Street Talk" is a podcast hosted by S&P Global Market Intelligence that takes a deep dive into issues facing financial institutions and the investment community.