In the third merger-of-equals (MOE) this year, Old National Bancorp (ONB 2.60%) is teaming up with First Midwest Bancorp (FMBI) to create a $45 billion asset bank in the Midwest. Although technically just a merger, an MOE is when two banks of somewhat similar sizes merge with the plan to really keep both banks somewhat intact, including the management team, board of directors, and various business lines in each bank.
The overall goal is to use scale to spread a smaller amount of expenses over a greater revenue base that will ultimately drive returns, while also giving the bank greater ability to invest in technology. Let's take a look at whether this deal can enhance shareholder value.
Terms of the deal
Old National Bancorp, which has nearly $24 billion in assets, is the technical buyer and will purchase First Midwest and its $21 billion in assets in an all-stock deal valued at $2.5 billion, or roughly $21.60 per First Midwest share. That values First Midwest at roughly 165% of tangible book value (equity minus goodwill and intangible assets). Old National Bancorp will be the surviving entity and the board of directors will consist of eight members from each bank, while the executive leadership team will consist of four leaders from each bank.
The move will allow Old National Bancorp to fill in a key hole in its branch footprint by entering the Chicago market. Old National currently has a presence in Indiana, Michigan, Wisconsin, and Minnesota, while First Midwest is primarily in the Chicago and Greater Chicago markets.
The deal is expected to be accretive to Old National's earnings per share (EPS) in 2022 by 22%, meaning earnings of the combined entity are expected to be 22% higher in 2022 than Old National's projected 2022 earnings on a stand-alone basis. The deal is expected to be 35% accretive to First Midwest's earnings. The combined company also expects to strip out 11% of total expenses.
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The deal will bring together two attractive and low-cost deposit franchises, both with a cost of deposits under 10 basis points (0.10%), and create a loan book composed of 72% of commercial loans. Fee income will make up 24% of total revenue on a pro forma basis, with wealth management and mortgage banking as the main sources of fee income.
Dilution vs. returns
While there are certainly merits of the deal and it's hard to argue against banks getting bigger at a time when adding scale is paramount, the purchase of First Midwest is going to dilute Old National's tangible book value per share by more than 8% upon closing and take more than three years to earn back. That's pretty dilutive, especially in an all-stock deal. While three years is not the worst earn-back time, many deals this year, including other MOEs, have been much less dilutive with a quicker earn-back period.
Additionally, once the deal closes, management expects the combined bank to generate a 15% return on average tangible common equity (ROATCE) in 2022. That's certainly very strong, but both banks already seem to be able to generate those kind of returns on their own. Old National did an 18.8% ROATCE in the first quarter of this year, which is clearly higher than normal, but the bank also did a 13.27% ROATCE and a nearly 15% ROATCE in 2020 and 2019, respectively.First Midwest also generated a 14.5% and 13.87% ROATCE in 2019 and 2018, respectively.
I imagine that next year's projections assume a lower-rate environment than 2018 and 2019, so 15% is very solid, but when banks are doing an acquisition, they are really thinking about how an acquisition can get them somewhere faster than they could have reached on their own. Considering the dilution and the earnings power of each bank on their own, I am not entirely sure sitting here today that the deal is worth it, although the combined entity may be able to achieve an even higher ROATCE once they start to look at revenue synergies. The same goes for the deposit base. It's great that the combined bank will have more balance sheet capacity, but both banks already had equally impressive deposit franchises on their own.
A few other doubts I have are on the fee income front. Having nearly 25% of total revenue come from fee income is solid for a bank with $45 billion in assets, but more than one-fifth of that fee income is from mortgage banking, which obviously comes and goes during different housing cycles, so it's not as stable. Management said they think there are opportunities to grow capital markets, treasury management, and mortgage fee income businesses, but all of that remains to be seen.
Lastly, while going into Chicago makes sense for Old National, I do wonder how getting rid of the established First Midwest brand will impact the business. I am sure people have heard of Old National, given its surrounding geography, but it's certainly not the same as having a bigger, more established national bank come into a market and take over a bank. The Chicago banking market is competitive, so the new entity will not want to lose any ground.
Remains to be seen
The deal is very dilutive to shareholders, so I would want to see proof that the combined entity can gain traction in the Chicago market and also generate revenue synergies. I also want to make sure the bank can consistently generate that promised 15% ROATCE and maybe grow it a little bit as well. While there are certainly plenty of things to like in this deal, I am not ready to go all in just yet.
