The large super-regional lender U.S. Bancorp (USB +0.38%) recently completed its acquisition of Mitsubishi UFJ Financial Group's U.S. banking subsidiary Union Bank more than a year after it initially announced the acquisition in September 2021.
Completion of the deal took longer than the bank expected and certainly hurt U.S. Bancorp's stock price in the near term. But with the deal now complete, U.S. Bancorp should benefit from this large acquisition, and it also looks like they made the deal at the right time. Here's why.
The environment for M&A is worse right now
Many large banks took advantage of the low-interest-rate and easy-money environment at a time when banks were struggling to find growth and generate good core returns to make big blockbuster deals that could meaningfully add scale.
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U.S. Bancorp's acquisition of Union Bank added $82 billion of assets and also grew the bank's deposit market share to the fifth leading position in California while adding 1 million consumer bank accounts, 190,000 business clients, and a nice stream of low-cost deposits.
But it was also done just as bank regulators were sharpening their fangs on large bank mergers and acquisitions (M&A). The Federal Reserve, in particular, has been taking much more time to review bank M&A, which is why so many of these acquisitions have been held up and have had to extend their merger agreements. Things may only get stricter under the current administration.
Additionally, bank M&A significantly slowed in 2022 because of soaring interest rates. Banks loaded up on bonds in 2021 and early 2022, taking on too much duration. As interest rates rose, those bond values took a big hit, which temporarily lowers a bank's tangible book value or net worth. This is a big factor bank buyers and sellers take into consideration when evaluating M&A. It has made an agreement on a valuation difficult and led many banks to decide to wait until bond values recover before deciding on whether to sell.
Deposit costs
One of the most important attributes of a bank is its deposits, specifically how much they cost the bank and how sticky they are in a rising-rate environment like the one we are in now.
When U.S. Bancorp announced its acquisition of Union Bank back in September of 2021, interest rates were at zero, the banking system was awash in deposits, and expectations for interest rate hikes were far below what they ended up being. As such, I assume that U.S. Bancorp got a much better deal than it would have, had it tried to purchase Union Bank now.
Roughly 40% of Union's total deposits were non-interest-bearing, meaning the bank pays no interest on them. U.S. Bancorp paid the equivalent of 130% of Union's tangible book value and a 2% deposit premium.
NYSE: USB
Key Data Points
Now, I suspect when the merger agreement was extended, U.S. Bancorp likely had to pay a higher deposit premium. But looking at the deal post-close, the purchase price is lower, the dilution earn-back time is fairly similar, the cost synergies are the same, and the earnings boost to the combined entity is more than initially modeled.
Union's low-cost deposit base is already paying dividends as well. On its recent earnings call, U.S. Bancorp management guided for the bank's net interest margin (NIM) to grow five or 10 basis points (1 bps = 0.01%) in the first quarter of the year, which is better than what most of its peers are expecting. NIM is the difference between the interest banks pay on interest-bearing liabilities such as deposits and what they make on interest-earning assets such as loans.
Removing the overhang
Investors were previously concerned about the Union Bank deal because it ended up lowering the bank's regulatory capital position more than expected. But now that it's closed, while regulatory capital did decline, U.S. Bancorp expects to build this position back throughout the year.
Furthermore, the bank now has added scale in California, a market that conforms with its small-business and payments strategy.
Investors will never really know how a bank acquisition turned out until at least two or three years later, when they can see if the acquirer captured all of the expected cost and revenue synergies. But I do think U.S. Bancorp made this purchase at the right time and will see the benefits.
