Basel III, the latest update to the international banking accord, will make it clearer which banks have sufficient capital and liquidity. That, in turn, could drive renewed mergers and acquisitions in the U.S. banking industry.
THE CHAOS IN THE BANKING industry in the past two years brought mergers and acquisitions to a near-standstill. But new regulations that will bring greater clarity to banks' balance sheets, combined with a tough environment for earnings growth, suggest deal activity is likely to increase sharply in coming months.
With the recent announcement of Basel III rules on capital requirements and liquidity, which are intended to shore up the international banking system against further shocks, banks now will know how much capital, and of what sort, they need to retain in the future. Institutions with excess capital will know how much they have available to spend on buying other banks, while banks with insufficient capital might find it prudent, in many cases, to sell themselves to healthier competitors.
"The Basel III rules are game changers in the bank-industry model," says Karen Shaw Petrou, a managing partner at Federal Financial Analytics, a financial-industry consultant primarily to large institutions. "The capital rules will increase [banks'] cost of capital and decrease returns on equity, and that will drive M&A.…They'll all re-evaluate their positions and decide if they want to buy or sell."
Mergers also could help the banking industry offset declining earnings or substandard profit growth. The increase in capital requirements is expected to restrain earnings gains, as compliant banks won't be able to employ as much leverage now as they did in the past.
Large banks that historically earned a 25% return on tangible common equity now can expect a 15% return, Christopher McGratty, a regional bank analyst at Keefe, Bruyette & Woods, says. The news is even worse for smaller banks, which could see returns shrink to 13% from a historic 19%.
Tepid loan growth and low interest rates won't help earnings either, and the Dodd-Frank financial-reform bill recently signed by Congress only adds to the banking industry's pain. Among other things, it limits their exposure to the private-equity business and reduces revenue from credit cards while increasing compliance costs. Bank mergers, on the other hand, afford an opportunity for the combined institution to boost earnings by cutting costs, at least for a year or two.
Bank-industry analysts expect well-capitalized, mid-tier banks such as U.S. Bancorp(ticker: USB), PNC Financial Services (PNC) and BB&T (BBT) to become buyers in the post-Basel III market. Large Canadian banks such as TD Bank Financial Group(TD), which weathered the financial crisis better than their U.S. counterparts, also could start shopping, as could Morgan Stanley (MS). Among smaller institutions,Huntington Bancshares (HBAN) and Iberiabank (IBKC) are thought to be on the prowl.
Sellers, on the other hand, could include banks such as SunTrust (STI), Fifth Third Bancorp (FITB) and KeyCorp (KEY), which still haven't repaid all the TARP (Troubled Asset Relief Program) funds they received from the federal government amid the crisis.Boston Private Financial Holdings (BPFH), Synovus Financial (SNV) andSterling Bancshares (SBIB) are even smaller players that analysts speculate could become targets. Ironically, banks that can raise capital quickly could evolve just as quickly into buyers, not sellers.
THE U.S. BANKING INDUSTRY already has shrunk through consolidation to about 8,000 banks from roughly 14,000 in 1980, and that trend will continue, says Toos Daruvala, head of the Americas Banking and Securities practice at McKinsey. Of the fifth- to 20th-largest banks by asset size today, only 10 or 12 will be independent in three years, he predicts.
So far this year there have been 119 bank and thrift deals announced, with a total value of $2.8 billion, according to Capital IQ. The year-end tally is likely to hit a four-year high in volume, if not in dollars, although it won't come close to the 232 mergers announced in 2000, or the $132 billion in dollar volume announced in 2004.
Recent deals have been much smaller, and most have occurred within the context of the cleanup from the Great Recession. Some resulted from the FDIC selling small banks that were deemed insolvent, while others involved banks selling non-core assets, such asCitigroup's (C) recent move to sell its 80% stake in Student Loan Corp. (STU).
One of the first opportunistic mergers of the year was announced in August when First Niagara Financial (FNFG) agreed to acquire NewAlliance Bancshares (NAL) for $1.5 billion. This is the biggest industry takeover since late 2008, although it pales when set alongside the largest deal done in the past decade: JPMorgan Chase's (JPM) buyout of Banc One in 2004, for $57.5 billion.
A Decade and More of Deals
The volume of bank acquisitions peaked in 2000, while their dollar value hit a high in 2004. So far this year, both the number of transactions and their value surpassed last year's totals.
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EARLIER THIS MONTH the Basel Committee on Banking Supervision, a group of regulators and central bankers from around the world, determined banks should hold Tier 1 common equity equal to 7% of their total risk-weighted assets. The banks have until 2019 to reach that target. The Basel committee still must decide how the industry should value, or risk-weigh, those assets.
In the U.S., regulators need to designate which banks must follow the Basel standard. It is expected to apply to banks with assets of more than $50 billion, which would encompass the nation's 20 largest banks. In addition, the government must decide how much capital the banks need to hold as part of the counter-cyclical buffer the Basel committee mandated that the banks have in good times. Regulators are expected to require an additional 1% or 2% of assets, which they most likely will announce between year end and mid-2011, says Kevin St. Pierre, an analyst at Sanford C. Bernstein.
In the first round of bank acquisitions, targets are expected to fetch modest premiums. "There are far more sellers today than there are willing and able buyers," says KBW's McGratty. "The economics will favor the buyers early on."
In the prior merger boom, from 2000 to 2007, the median buyout occurred at 24 times trailing earnings. McGratty expects multiples this time around to more closely resemble the 15.4 times earnings that prevailed in the early 1990s. Similarly, he expects buyers to pay about 1.5 times tangible book, as they did in the early 1990s, and not 2.2 times, as they did just before the financial crisis.
The biggest U.S. banks can't participate in the coming round of bank mergers because they are approaching or exceed regulators' 10% limit on the share of deposits a bank can hold nationwide when making an acquisition. Bank of America (BAC) controls 13% of deposits; Wells Fargo (WFC), 11%; and JPMorgan Chase, 9%. Mid-tier banks such as U.S. Bancorp, PNC and BB&T aren't close to that limit, however.
If markets remain fairly calm, Bernstein analyst Brad Hintz thinks Morgan Stanley also might try to acquire a bank. New regulations put limitations on proprietary trading and derivatives. They also curb private-equity investments. Thus, capital that would have been allocated to trading activities at the company instead could be used for lending.
Companies such as Morgan Stanley "have to be looking pretty aggressively at what they are going to do," says Hintz. While Morgan Stanley could buy a large bank, it is more likely to test the waters by buying a smaller, regional institution first.
AMONG POTENTIAL SELLERS, many banks still need to raise equity to repay TARP funds. SunTrust, for instance, owes the feds $4.85 billion. Fifth Third and KeyCorp have smaller bills, and all trade at discounts to book value. Potential acquirers like targets that trade at discounts to book because a buyer immediately can accrete the negative goodwill resulting from the deal, which causes a pop in earnings, says Dick Bove, an analyst with Rochdale Securities. Bove likes Zions Bancorp (ZION) and Regions Financial (RF), among others, in part because of their takeover potential.
The list of sale candidates is fluid, as sellers could become buyers if they raise enough equity or earn enough money to pay down TARP debt. But that probably won't happen until 2012. Until then, Wall Street can expect a major round of mergers.
Time to Start Shopping
Acquirers favor banks that trade at discounts to book value, because they can recognize negative goodwill when a deal closes, producing an instant increase in earnings. Stronger banks have money to spend.
| Recent | 12-Mo. | Mkt | Assets | Tier 1 | Price/ | EPS | ||
| Company/Ticker | Price | Chg | Val (bil) | (bil) | Ratio* | Book | '10E | '11E |
| POTENTIAL BUYERS | ||||||||
| BB&T/BBT | $23.63 | -16.6% | $16.0 | $155 | 8.9% | 97% | $1.14 | $2.02 |
| Comerica/ CMA | 35.31 | 19.9 | 6.2 | 56 | 9.8 | 113 | 0.85 | 2.14 |
| CVB Financial/CVBF | 7.35 | -9.6 | 0.8 | 7 | 13.3 | 115 | 0.64 | 0.71 |
| Huntington Bancshares/HBAN | 5.63 | 28.8 | 4.0 | 52 | 7.0 | 113 | 0.15 | 0.44 |
| Iberiabank/IBKC | 49.00 | 5.1 | 1.3 | 10 | 18.1 | 102 | 2.04 | 3.04 |
| Morgan Stanley/MS | 24.74 | -22.8 | 35.0 | 809 | 9.4 | 84 | 2.92 | 3.29 |
| PNC Finl Services Group/PNC | 51.43 | 11.9 | 27.0 | 262 | 8.3 | 103 | 5.13 | 5.87 |
| TD Bank Financial Group/TD** | 71.35 | 11.6 | 62.0 | 604 | N/A | 170 | 5.69 | 6.43 |
| U.S. Bancorp/USB | 21.82 | -1.1 | 42.0 | 283 | 7.4 | 166 | 1.64 | 2.18 |
| POTENTIAL SELLERS | ||||||||
| Boston Private Finl Holdings/BPFH | $6.18 | -7.6% | $0.5 | $6 | 8.7% | 102% | 0.09 | 0.42 |
| Fifth Third Bancorp/FITB | 11.72 | 19.0 | 9.3 | 112 | 7.2 | 96 | 0.37 | 0.98 |
| KeyCorp/KEY | 7.65 | 14.2 | 6.7 | 94 | 8.1 | 89 | 0.00 | 0.38 |
| Marshall & Ilsley/MI | 6.78 | -20.9 | 3.6 | 54 | 7.0 | 72 | -1.03 | 0.03 |
| Regions Financial/RF | 6.76 | 2.9 | 8.5 | 135 | 7.7 | 62 | -0.65 | 0.33 |
| Sterling Bancshares/SBIB | 5.19 | -31.6 | 0.5 | 5 | 12.2 | 84 | -0.07 | 0.14 |
| SunTrust Banks/STI | 24.86 | 6.1 | 12.0 | 171 | 7.9 | 72 | -0.77 | 0.82 |
| Synovus Financial/SNV | 2.44 | -36.8 | 1.9 | 32 | 9.5 | 71 | -1.18 | -0.15 |
| Zions Bancorp/ZION | 20.10 | 7.8 | 3.5 | 52 | 7.9 | 78 | -2.17 | 0.46 |
| *Tier 1 common equity divided by risk-weighted assets. **October fiscal year. E=Estimate. N/A=Not available. | ||||||||
| Sources: SNL Financial; Thomson Reuters | ||||||||
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