Investors often sell off on large bank deals, but market reaction has been positive for several megadeals announced in the past two weeks.
Among the 18 megadeals — deals with a value of at least $500 million at announcement — year to date, stock prices for the buyers and the six banks involved in mergers of equals, or MOEs, closed down a median of 0.63% on the day of announcement. But the Street was initially positive on Valley National Bancorp, U.S. Bancorp and Home Bancshares Inc.'s respective deals, all announced in the last couple of weeks. The deals carried little to no tangible book value dilution, a key metric for investors.
"The market, when it looks at bank M&A transactions, it really focuses on a lot of those metrics," James Stevens, a partner at Troutman Pepper Hamilton Sanders LLP, said in an interview. "You can say all you want about strategy and new markets and new products, but right now, in bank M&A, tangible book value dilution and earnback is the biggest determinant of how the buyer and the seller's respective stock performs."
Drilling down on dilution
Valley National's acquisition of Bank Leumi Le-Israel Corp. is expected to be about 1% dilutive to tangible book value and carries an earnback period of about one year. Similarly, U.S. Bancorp's deal with MUFG Union Bank NA is also expected to be about 1% dilutive to tangible book value per share with an earnback period of less than a year under the accretion method. Analysts and investors have said the Street looks for earnback periods of three years or less. Earnback measures the amount of time it would take the acquirer to recapture the tangible book value dilution through stronger earnings.
Valley National posted the largest day-one stock price gain among the 18 megadeals announced this year. The company's stock price closed up 6.9% on Sept. 23, compared to gain of 3.5% in the KBW Nasdaq Bank Index. U.S. Bancorp's stock price closed up 2.6% on the day of its deal announcement, compared to a 0.1% decline in the KBW Nasdaq Bank Index.
The Street also gave a nod of approval for Home Bancshares' acquisition of Happy Bancshares Inc. The company's stock price
Home Bancshares Chairman, President and CEO Johnny Allison attributed the positive stock price move to Home Bancshares' reputation as a "very, very disciplined acquirer."
"We don't do deals for the sake of doing deals. We do deals because we think it's better for our shareholders," he said in an interview. "People are doing deals out here today that are dilutive, dilutive, dilutive and it's three and a half years before they even get back to even."
Home Bancshares' deal for Happy Bancshares is expected to be immediately accretive to earnings per share, book value per share and tangible book value per share.
Home Bancshares' day-one stock movement marked the first time, excluding the six banks involved in MOEs, a megadeal buyer's stock price closed up on the day of announcement since April when New York Community Bancorp Inc. announced a deal with Flagstar Bancorp Inc. and its stock price rose 4.5%. New York Community Bancorp's deal is expected to be 3.5% accretive to tangible book value per share at close.
"Those kinds of deals are going to get rewarded," Stevens said of Home Bancshares' deal. "I'm not surprised that Home's stock was rewarded for striking that deal. The reality, though, is that most deals are not like that."
Minimal dilution is not a foolproof path to day-one stock gains. Though First Interstate BancSystem Inc.'s acquisition of Great Western Bancorp Inc. is expected to be 0.1% accretive to tangible book value per share, the company's stock price underperformed following its deal announcement on Sept. 16. The company's stock price closed down 7.4% on the day of announcement, the largest drop among all the banks involved in megadeals this year.
On the conference call to discuss the transaction, management teams from First Interstate and Great Western fielded a slew of questions about the seller's credit quality and ongoing de-risking effort. Great Western President and CEO Mark Borrecco was surprised by the amount of questions and concern about the bank's loan portfolio, he wrote in an email.
"Investors should feel confident we have conservatively ring-fenced any legacy issues," he wrote.
Though the Street has been mostly wary of large deals this year, deal advisers expect the trend of transformational bank M&A to continue as banks focus on the pro forma franchise and long-term benefits.
"Smart banks don't get too focused on that short-term stock impact because at the end of the day, you've got to do strategic transactions. This is the long game," Stevens said. "You've got to play the long game, even if it has some short-term impacts."