With careful strategies, merger opportunities exist for banks

As the financial institutions industry continues to consolidate through mergers and acquisitions, the focus is shifting away from the advantages to shareholders of being acquired.

Now the industry appears to be entering a period where institutions can create significant shareholder value by growing and acquiring.

Rampant acquisition activity started in the mid-1980s and peaked in 1994 and 1998. As banks were acquired, newly chartered banks stepped in to fill the community void at a brisk 3-to-4 ratio, i.e., for every four banks merged out of existence, three new banks started up.

The result is that today there are 9,821 financial institutions chartered in the United States. While the total number of financial institutions has decreased, it is a far cry from the predictions of 3,000 banks at the turn of the century.

The dynamics of the change provide insight and make a case for new opportunities to those that wish to grow and prosper through a simple, low-key acquisition program.

The opportunity

Acquisitions in recent years have consolidated the consolidators, i.e., the traditional buyers of yesteryear are gone, merged. Over the years, generations of buyers have gone through the cycle ... buy banks, grow, buy banks and sell.

Currently there are 9,300 banks with assets under $1 billion, compared to 13,900 in 1991. However, during the same time period, the number of banks with assets greater than $10 billion has actually increased from 58 to 99. The banks that grew by acquiring other banks and thrifts have reached a point where they become likely candidates for consolidation themselves.

So we are beginning to see a buyer's market and a lack of buyers. This void should and can be filled by certain aggressive and growth-minded financial institutions. Growth aimed at creating shareholder value is a laudable goal.

What's involved

Probably the most significant part of the equation is a publicly traded stock. Initially price, multiples and volume of trading are not the most important issues. High multiples and high volume are a significant advantage and, in time, both will come. But first, the important piece is to have a currency that others believe in and that provides liquidity.

Obviously, no real value can be created by transactions that result in significant or permanent dilution. So, in the initial years, prices paid will probably, by necessity, be lower, reflecting the lower multiples of a buyer's stock. But, to the extent sellers can be convinced that over the long run the paper they receive in a transaction is and will be worth more than the shares they are trading for it, they will be rewarded.

Thus, management and the board of the acquiring institution must be diligent and disciplined in both the selection and pricing of each transaction. After the transactions, the new company must be diligent in realizing the economies and opportunities of the merger.

The rewards

Markets will reward earnings. Markets also will reward enhanced liquidity, more locations, growth and size. The multiples accorded banks with higher and consistent earnings exceed, by a margin, the multiples realized by poor performers.

In addition, larger banks are accorded larger multiples, with those banks below $100 million priced at 0.96 of tangible book value compared to 1.67 of tangible book value for those between $1 billion and $2 billion. Banks with five to 50 locations are priced higher than banks with fewer than three locations. While not earth-shattering, it's good to see that the markets are rational.

Where to begin

To take advantage of this opportunity to create shareholder value, begin with a strategy and a map. For example, an acquisition within a 15- to 25-mile radius makes more sense than one 300 miles away. The acquisition of an agricultural bank is a smart move in an agricultural community, particularly if the expertise acquired shores up deficiencies in your staff.

An acquisition should fit within the context of your strategic plan. It should take advantage of your strengths and/or strengthen your areas of weakness. When combined with a calling program by your chair or president, opportunities to present proposals will arise.

The long-term success of your acquisition program will be determined by the message in your proposals. Consequently, the message should convince your target that the paper their shareholders will receive is superior, over the long run, to the paper they currently hold.