The coronavirus pandemic certainly put a damper on bank mergers and acquisitions (M&A) in 2020. But as the economic outlook began to brighten in the remaining few months of the year, M&A activity began to pick up, specifically in the regional bank space.
In October, First Citizens BancShares (FCNCA 1.22%) acquired CIT Group (CIT). In November, PNC Financial Services Group (PNC 3.76%) acquired the U.S. Operations of the Spanish lender BBVA (BBVA -0.11%). And most recently, Huntington Bancshares (HBAN 4.26%) acquired TCF Financial (TCF).
All of these deals had a few things in common that are important to consider as we look toward bank deals in 2021.
1. Big potential gains in earnings
In all three of these deals, the acquiring banks expect to see strong earnings-per-share (EPS) accretion once the deals are complete. First Citizens expects to gain an astonishing 50% in EPS in 2022, PNC expects to realize 21% accretion, and Huntington is expecting 18%. EPS accretion means that once the deals are complete, each acquiring bank will be able to realize that much more in earnings on a pro forma basis than it would have on its own in 2022.
This is important because when acquiring a bank, the buyer almost always dilutes its tangible book value -- typically more so in an all-stock deal, when the buyer is issuing shares to complete the transaction. Investors want to see that the buyer can earn back that dilution in a reasonable time frame. For instance, Huntington expects to see 7% dilution to its tangible book value upon closing the deal with TCF. However, because of significant EPS accretion, Huntington expects to earn back that dilution in 2.7 years. Investors and analysts are typically OK with tangible book value dilution if it can be earned back within three years, although shares of Huntington have been down since the announcement of the deal.
The three buyers did not model in many of the potential revenue synergies into the potential EPS accretion. These don't always materialize, but they have the potential to boost EPS accretion in 2022 even more.
2. Lots of cost savings
Two of three of these deals expect huge cost savings, which is one of the main drivers behind the big EPS accretion. First Citizens only expects 10% in cost savings, which is pretty typical in a bank deal, but PNC and Huntington expect cost savings of 35% and 37%, respectively. A lot of the expense cuts come from branch consolidation, staff cuts, and elimination of outside services, but technology is also playing a role.
First Citizens expects to realize a quarter of its total costs savings by getting rid of legacy systems and services. PNC said in its presentation that its tech investments are expected to allow the bank to quickly and effectively reduce expenses from BBVA. The buyers are also expecting to invest in technology as part of the merger plan, which will cost money up front, but likely result in savings down the line. Huntington expects to invest $150 million in technology at the combined bank over the next 3.5 years.
3. Geographic diversity
A common strategy in a lot of bank acquisitions is to purchase a competitor in market and realize cost savings with lots of branch consolidation, while taking over the selling bank's customers and relationships. While this is certainly still a relevant strategy, these three deals represent a lot of geographic diversity and breaking into new markets.
In the Huntington-TCF deal, there is still a lot of branch overlap, with 48% of TCF branches within a three-mile radius of a Huntington branch. But there is much less overlap in the PNC-BBVA and First Citizens-CIT deals, as PNC and First Citizens plan to expand into new markets and build more of a national presence. PNC will gain a presence in 29 of 30 of the top metropolitan statistical areas in the country, while First Citizens will have a significant presence in New York; Pasadena, California; Omaha, Nebraska; Phoenix, Arizona; Jacksonville, Florida; New Jersey; and Columbia, South Carolina, among other locations. Acquisitions have always been a strategy for entering a new market, but the future of digital banking and the expected reduction in bank branches across the country certainly makes geographic expansion more possible than ever before.
4. Crazy discounts were rare
During the Great Recession from 2007 to 2009, because so many banks were on the verge of legitimately failing, buyers were able to acquire banks at huge discounts. PNC purchased National City Corp. for $7 billion less than tangible book value, while JPMorgan Chase purchased Washington Mutual, a $300 billion asset bank, for just $1.9 billion. Today, however, banks are much better capitalized and so far have shown much better underwriting standards on loans. There have't been many bank failures so far during the pandemic, so don't expect to see too many discounted deals like in the Great Recession.
CIT Group, the cheapest of the three acquired banks, traded at just about 40% of tangible book value prior to the acquisition, and ended up selling for an implied value of about 43% of tangible book value. That's a crazy discount, which is likely why First Citizens was able to realize so much tangible book value accretion from the deal. But PNC bought the U.S. operations of BBVA, which had struggled in the past, for an implied value of 134% of tangible book value, and Huntington bought TCF for 150% of tangible book value. According to S&P Global, the median premium to tangible book value paid in a large bank deal is about 141% since 2007.
A lot of the dynamics and projections in these three deals are very attractive and really do make the acquiring banks much stronger, especially if they can execute on revenue synergies. That means there should be ample opportunity for stock price appreciation in not only bank sellers, but also bank buyers from a long-term perspective.
Not only will these acquisitions increase the buyer's scale, but they will also increase their investment and capabilities in technology. This could finally give investors and analysts the confidence that regional banks are up to speed with technology and ready to compete with the largest banks in the country and emerging fintech players.
Predicting the buyers and sellers is never easy, but a good place to start is by looking at the banks with high price-to-tangible-book-value ratios that might be interested in making an acquisition, and those with low price-to-tangible-book-values that might be interested in selling.