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What’s a good price?

Don’t get hung up on multiples—worth is what counts

What’s a good price?

What’s a good price for a community bank these days?

Well, that’s like asking, “What’s a good price for a car these days?”

New or used? Premium or basic transportation? Great reputation? Or a serial recall with wheels?

Yet people will ask the question. And often what they ask demonstrates how poorly M&A pricing is understood.

Ingredients that go into pricing

We’ll fix that. My last few blogs have discussed the “sides” of community bank mergers and acquisitions. To stick with the theme, this is the first in a series of blogs discussing community bank merger and acquisition pricing.

On a national level, pricing for community bank mergers and acquisitions has been on the rise. To truly understand the implications of this rise in pricing, however, it is necessary to understand how the pricing data is derived, collected, and disseminated. Multiples such as price-to-book, price-to-earnings, price-to-assets, and price-to-core deposits are all disseminated to interested folks around the country.

But all the metrics in the world are useless if those individuals do not know the underlying framework.

Once two community banks go through the courting process, enter into an Expression of Interest, conduct due diligence, and sign a Definitive Agreement, the purchasing party typically structures some type of transaction announcement. At the time of that announcement, the parties typically disclose the dollar amount of the transaction—that is, the purchase price.

I say the dollar amount is “typically” disclosed because that is not always the case with private community bank holding companies. Public bank holding companies are required to disclose the purchase price, and the price would eventually be disclosed by a private bank holding company in connection with an application to the regulators to approve the transaction. The latter form of disclosure, though, is not as readily accessible for pricing analysis purposes.

Once the dollar amount of the transaction is disclosed, then the analysts at SNL Securities in Charlottesville, Va., (the fount of all merger and acquisition pricing knowledge these days) translates that purchase price into all the various metrics just named.

Remember, all of those pricing metrics are simply after-the-fact reporting mechanisms. They are not the basis on which a deal is negotiated and cut; they are simply mechanisms for relaying the purchase price associated with the transaction in a relatively comparable form.

People love simplified views

Over my career in the banking industry, I found out that community bankers primarily fall into two categories:

• Multiple of book value junkies or

• Multiple of earnings junkies.

Bankers in either category tend to have a threshold figure in their head. If a deal’s value is above that threshold, then it is a “good” deal. If the deal falls below that threshold, then the deal is “bad.” 

It is important to note that this data, on its own, is, frankly, pretty useless without an underlying analysis of the selling community bank.

For example, if a community banker asks me whether the sale of a community bank at 1.4 times book value was a good deal or a bad deal, my answer would be “I don’t know.”

Seriously.

The reason I do not know is I have not looked at performance and health of the underlying bank. A transaction valued at 1.4 times book of a bank that has a 16% capital ratio is probably a pretty darn strong transaction. That same value of 1.4 times book is probably not such a great deal if the underlying community bank is only capitalized at 7%.

The same issue presents itself when looking at earnings multiples.

Is a transaction with a 25 times earnings multiple a “good” deal or a “bad” deal?  I don’t know until I look at the underlying community bank target’s numbers.

If the underlying community bank had strong earnings, then maybe 25 times earnings is a strong value. However, if the community bank had little to no earnings, then 25 times earnings is likely a poor indicator of a community bank’s true value.

Many community bankers often do not understand that pricing multiples of 45 to 50 times earnings mean nothing … other than that the underlying community bank probably was a very poor earner.

Today’s pricing parameters

Having said all of that, the average pricing multiples are, as I mentioned at the beginning of the blog, on the rise.

On a national level, 2014’s approximately 188 bank and thrift merger and acquisition transactions have averaged a price-to-book ratio of approximately 132.92%; a price-to-earnings multiple of approximately 27.7 times earnings; a price-to-assets ratio of approximately 12.70%; and a price-to-core deposits ratio of approximately 4.24%. All of these outpace the comparable 2013 numbers. (Regional data is also available, but it is beyond the scope of this particular blog.)

The important thing to remember is a bank acquisition is not negotiated and priced based on what the average multiple of book value or earnings might be.

Ultimately, a transaction is priced on the earnings stream received from the seller by the buyer post-transaction compared to what the buyer has to give up in exchange for that earnings stream. Once that negotiation occurs and a price is determined, then—and only then—are the pricing multiples produced for public consumption. It is not the other way around.

When multiples really matter …

As a matter of fact, I have come to the conclusion that the only pre-transaction value to the “multiples” discussed above is when the acquiring community bank plans to be a “serial acquiror.” 

Under such circumstances, even if the acquiror can pay more for a specific target, it may not want to because it may cause the acquiror to look undisciplined to the market.

In other words, an unsophisticated target may look at a purchaser’s acquisition history and say “You paid that bank 1.6 times book value. I want at least that much.” 

That unsophisticated target is not considering that its underlying equity structure and bank is completely different than the prior target. Therefore, it is important for a buyer to stay within the community bank acquisition multiple history range.

My next blog will focus on how community bank acquisitions are actually priced. See you next time.

Every week this website features new articles from SNL Financial, including stories about M&A. Read all our SNL Financial articles. 

Jeff Gerrish

Jeff Gerrish is chairman of the board of Gerrish McCreary Smith Consultants, LLC, and a member of the Memphis-based law firm of Gerrish McCreary Smith, PC, Attorneys. He frequently contributes to ABA Banking Journal and ABA Bank Directors Briefing, and frequently speaks at ABA events and telephone briefings.
Gerrish formerly served as regional counsel for the FDIC’s Memphis regional office and with the FDIC in Washington, D.C., where he had nationwide responsibility for litigation against directors of failed banks. Since the firm’s formation in 1988, Gerrish McCreary Smith has assisted over 1,500 community banks in all 50 states across the nation with matters such as strategic planning, mergers and acquisitions, common stock private placements, holding company formation and reorganization, and a wide variety of regulatory matters. Jeff Gerrish can be contacted at jgerrish@gerrish.com.

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