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Mergers & Acquisitions,

Capital Markets
& Bank Valuation Update
ICBA Community Bank Day
May 20, 2014
Presented by: Thomas R. Mecredy

Current M&A Environment


Key Factors Driving Community Bank M&A

Gap in trading multiples between the big and


small banks
Failed bank deals have run the course
Improved asset quality reduced credit marks
Challenging operating environment (loan growth,
NIM pressure)
Slow organic revenue growth (and outlook for
growth)
Compliance costs are increasing
Increased capital requirements
Regulatory fatigue2

Current M&A Environment

Pricing has been steadily improving &


more deals have been announced at
attractive premiums
Activity is increasing and interest in M&A
is high
Buyers are maintaining financial discipline
Better performing banks are considering
sale
Strategic mergers are a viable alternative
to sale
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Industry Performance - 2013


Under$1
Billion

Over $1
Billion

ROAA (1)

0.73%

0.91%

ROAE (1)

6.70%

8.50%

Net Interest Margin

3.31%

3.47%

Efficiency Ratio

71.57%

65.10%

Net Charge-Offs

0.13%

0.21%

Nonperforming Assets/Total
Assets

1.25%

1.33%

Loan Loss Provision Expense

0.08%

0.11%

10.20%

9.75%

Loan Growth Rate

3.3%

6.3%

Deposit
Rate
Median forGrowth
all commercial
& savings banks

1.1%

2.9%

Tier 1 Leverage Ratio

(1) S-Corporation companies adjusted to C-Corporation status


Source: SNL Financial
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Acquisition Multiples Remain at


Depressed Levels, but Improving
Acquisition Multiples for Bank & Thrift Transactions
30.0

3.50

25.0

3.00
2.50

20.0

2.00

15.0

1.50

10.0

1.00

5.0

0.50

0.0

0.00

Median Price/Earnings

Median Price/Book (x)


Median Price/Tang. Book (x)
Median Price/Earnings (x)
Median Core Deposit Premium (%)

2003
2.02
2.05
23.5
13.7

Median Core Deposit Premium

2004
2.03
2.13
23.3
15.5

2005
2.06
2.18
22.8
17.0

Source: SNL Financial


5

2006
2.15
2.27
23.1
18.6

Median Price/Book

2007
2.04
2.18
22.8
15.6

2008
1.58
1.62
23.4
9.4

Median Price/T ang. Book

2009
1.14
1.15
18.3
1.7

2010
1.16
1.22
22.2
3.0

2011
1.02
1.05
25.2
0.3

2012
1.12
1.16
18.8
2.4

2013
1.18
1.25
19.1
3.3

Bank & Thrift Deal Count by Pricing


Transactions Announced in 2013
50
45
40
35
30
25
20
15
10
5
0

40
36

35

15

< 100%

100-125%

125-150%

150-175%

Price / Tangible Book Value


Source: SNL Financial
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175-200%

> 200%

Current M&A Environment


Consolidation is
expected to be more
at the smaller assetsize companies for a
number of reasons
including:
Regulatory costs
Larger relative
number (over
6,000 private
companies, 41%
of which are Sub
S)

U.S. Banking Companies by Assets


>$1T 4
$100B-$1T 23
$10B-$100B 72
$1B-$10B

539

$500M-$1B

641

$100M-$500M
< $100M
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3,185
2,056

Eight Year Trend in Number of Banks (05


to 13)
Change in Number of Banks
300
200

160

100
0
-64

-100
-200
-300
-400
-500
-600
-700
-800
-810
-900

Source: SNL Financial


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What Drives Value


After reviewing the top 10% of deal values (based
on the price to tangible book value) each year over
the previous 11 years and noted the following key
factors:
Size
Geography
Performance (ROAA)
Metro vs. rural markets
Asset quality
Deposit mix and deposits per branch
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Current M&A Environment Buyer


Considerations

Does your company have the necessary acquisition


currency, capital capacity and/or access to capital to
acquire a bank?
Does your company have the necessary risk
management acumen and best practice processes to
integrate an acquisition target?
Are you in good standing with the regulators?
Does your company have the human and
technological platform in place?
Are you prepared to manage the risk of market
extension or out-of-market transactions?
Does the board and management team have the level
of engagement, stamina and vision to focus on growth
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through M&A?

Consult Regulators Early

New normal for regulatory approvals


You need to know what the issues are as early
as possible and preferably before a specific
transaction is contemplated
Let regulators know about your appetite for
deals; they should welcome discussion of
what they will expect
Let regulators know about a specific
transaction before it is fully baked

Early feedback allows efficient mid-course


corrections and avoids bad surprises and
needless delays11

Hidden Costs of M&A

Employment contracts
Stock options
Executive salary continuation agreements (SERP)
BOLI
Director retirement agreements (DRP)
Key employees (pay to stay, severance pay, change-ofcontrol payments)
280G tax issues
Data processing break-up fees
Problem loan sales
Professional fees
Merger run-off / employee pirating
Mark to market issues (FAS 141R)
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EPS Dilution/Accretion Analysis

Compare stand-alone EPS to pro forma EPS post-acquisition


Conventional wisdom: If pro forma EPS equals or exceeds
stand-alone EPS, then the deal has acceptable financial
returns.
Reality: EPS accretion does not necessarily mean that a
deal has acceptable financial returns

Example: An all cash deal that is EPS neutral/modestly


accretive
If you are spending/investing capital in a deal, it is
important to earn a return commensurate with the amount
invested and risk of the deal. Purchase accounting
requirements complicate this analysis.
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Historical Earnings & Tangible Book Value


Impacts
Announced Earnings Accretion Over Time
15.00
10.00

8.1

7.9

7.4

4.2

5.00
1.3
0.00

9.7

(0.7)

2004

2.3
0.3
2005

2006

1.5
2007

0.7
2008
(3.8)

(5.00)

2009
(2.0)

2010

2011

(4.3)
(6.0)

(6.9)
(8.8)

(10.00)
(11.7)
(15.00)

Median EPS Accretion (%)


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2012

Median TBV Dilution (%)

(6.9)

2013

(5.7)

Seller Dynamics

Value if sold today taking into account:

Price to earnings multiples


Price to book and tangible book multiples
Price to deposits
Premium on core deposits
Discounted cash flow / earnings analysis
Merging with a peer bank (strategic merger)

Ability to pay analysis


Sell now / sell later analysis
Other factors impacting sale decision:

Liquidity needs
Slower growth / declining earnings
Management / staffing
Regulatory burden
Economic indicators
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The Sales Process


Level of marketing / use of an adviser:
Single party negotiations
Limited auction process
Full scale auction process
Key question: Can we get the same pricing
and avoid the auction or limited auction
process?
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Current M&A Environment


Who will be the Sellers?

Frequently a member of the family that founded


the bank

Family legacy over many generations

Often has spent most of their working career in


this bank
Bank represents a significant portion of their
retirement funds and estate
Typically over 65 years old
Many times health is an issue
Proud of their accomplishments
Important members of the community
Current generation17 is not as committed as earlier
generation

Typical Pricing Terms


Cash Transaction Example
Fixed Price plus Interim Earnings:
Interim earnings are typically from the date (quarter end) of
original offer through closing
Interim earnings excludes (or prohibits) nonrecurring gains
Carve-out for transaction related costs (professional fees,
contract termination fees, CIC/severance payments, etc.)
Fixed Price with Minimum Equity Provision:
Minimum equity typically established as of the most recent
quarter or month end prior to agreement
Minimum equity can be a price adjustment or a closing
condition
Carve-out for transaction related costs (professional fees,
contract termination fees, CIC/severance payments, etc.)
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Strategic Mergers-Typical
Characteristics

Typically an all stock exchange - sometimes


involves a special dividend/cash payment to
equate value
Ownership split is driven by relative value
contribution with little to no premium paid to
either party
Value creation comes from shared cost savings,
synergies and other value enhancement of the
combined company
Negotiation one-off deal not a competitive bid
process
Equal or proportionate (to share ownership)
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representation on the board and senior

Strategic Mergers are Difficult to


Accomplish
Financial issues:

The exchange of equity at a price that is


potentially not the highest possible price
All members of both boards have to be aligned
with strategic merits of combination
If there is an obvious third party that can pay a
significant premium, the likelihood of success is
limited
Transaction is difficult to protect with customary
deal protections
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Scarcity of Strategic Mergers


Total M&A Deals
Since 2002

2,603

Strategic Mergers (1)

52

% of Total

2.0%

Mergers of Equals (2)

29

% of Total

1.1%

(1) As defined by SNL Financial.


(2) Strategic mergers in which the relative assets of the parties is no more
than 60%/40%.

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Strategic Mergers
Advantages

Disadvantages
May fail to create business line and product scope
Requires compromise on business and social
issues, including:
Business model
CEO / CEO responsibilities
Chairman / Chairman responsibilities
Responsibilities of CFO and other senior
management
Board composition / representation
Headquarters location
Name of holding company
Name of bank subsidiaries
Sharing of cost savings
Where to cut the pie
No or low premiums can discourage shareholders,
especially if banks were acquirable
One party ultimately loses voting control for
no / less premium

Improves EPS accretion via


cost and / or revenue
savings
Improves geographic
scope, product mix and / or
management fills
strategic void
Builds critical mass and
expands or preserves the
franchise
Diversifies and adds
granularity to loan portfolio
and funding base

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Branch Transaction Summary


120
100

Number of Transactions
105

86
71

80

78

83

89

78

65

60
40
20
0
2005

2006

2007

2008

79
2009

2010

2011

2012

2013

Deposits Transferred ($ in Billions)


$25.0

9.00%
8.00%
7.00%
6.00%
5.00%
4.00%
3.00%
2.00%
1.00%
0.00%

Franchise Premium
7.3%

7.0%

7.8%

5.0%
3.4%

2005

2006

2007

2008

3.3%
2009

2010

2.8%

2011

$20.7

$10.0
$5.0

$12.7

$12.2

$8.7

$7.3
$3.0

$2.9

2007

2008

Midwest-29; 40%

$0.0
2005

2006

West-10; 13% Northeast-5; 7%


Mid-Atlantic-5;
7%
Southwest-9;
13%
Southeast-15; 21%

$5.5
$3.3

2009

2010

2011

2012

Source: SNL Financial


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2013

2.4%

2012

2013

Branch Transactions by Region 2013

$20.0
$15.0

2.2%

Bank Equity Market Performance


2013 Review / 2014 Outlook

Strong equity market performance in 2013


Banks over $1 billion were up 83% in 2013 and 122% since
2011
Banks under $1 billion were up 37% in 2013 and 60% since
2011
Banks over $1 billion trade at 69% price/tangible book
premium and 17% price/earnings premium to smaller banks
Pricing differential supported by underlying financial
performance
Valuations are now approaching intrinsic value but not
overvalued
More room for bank stocks to increase, but significant
equity market gains are behind us
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Valuation gap for strong and weak banks will increase

Bank Equity Market Performance


Median Price / Tangible Book Value

Median Price / LTM EPS

300%

20.0

250% 239%
200%

16.716.7

15.0

180%
155%

150%
100%

13.8

14.8
13.9

15.5
14.1

120%

131%
108%

14.1

75%

74%

67%

13.6

13.2

12.6
12.1
12.0

121%
92%

88%

15.9

15.4

155%

146%
125%

16.0

76%

10.0

50%
0%

2006

2007

2008

2009

> $1 Bill

2010

2011

2012

< $1 Bill

2013

5.0

2006

2007

2008

2009

> $1 Bill

Source: SNL Financial

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2010

2011

< $1 Bill

2012

2013

Conclusion

Asset quality concerns are near pre-cycle levels


Growth/earnings growth is now driving pricing
Still a buyers market in most areas of the U.S.
Rising rates will again make deposits attractive
Negotiated transactions are becoming favored, which
allows sellers to pick a buyer with the most upside/best
currency
Strategic mergers will continue, but will remain difficult
Diminished importance of branch network
EPS accretion and synergies are most important
Challenges of scale for small banks and challenges of
regulation for the largest banks will create a sweet spot
from a valuation standpoint
Focus on tangible book
value dilution and immediate EPS
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accretion and earn-back period when pricing a deal

Thank You
Intended for institutional investors only. Although the information
included in this report has been obtained from sources we believe to
be reliable, we do not guarantee its accuracy. All opinions expressed
in this report constitute the judgments as of the dates indicated and
are subject to change without notice. This report is for informative
purposes only and is not intended as an offer or solicitation with
respect to the purchase or sale of any product. The accuracy of the
financial projections is dependent on the occurrence of future events
which cannot be assured; therefore, the actual results achieved
during the projection period may vary from the projections. Member
FINRA/SIPC.
Thomas R. Mecredy
Vining Sparks Community Bank Advisory Group

tmecredy@viningsparks.com
512-495-9890
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