There was a lot more than spring in the air at the end of last week—late in day on Friday, there was a public report that FCB (NYSE:FCB) was looking for a buyer. Rumors that this bank or that bank is for sale or looking for a buyer are nothing new, but I was a little disappointed and chagrined that FCB was so publicly rumored to be selling (although I wasn’t particularly surprised). I think it is a pretty acknowledged fact that there is a subset of banks that are frequently the subject of sale rumors, and, unfortunately, as far as I am concerned, FCB gets lumped into this group.
To make it clear, I think that most rumors that any particular bank is looking for a buyer are probably made up of equal parts of speculation, wishful thinking and gossip. I have touched on this before, but I think it is fair to say that there is a widespread expectation among all those that follow the banking industry (investors, research analysts, investment bankers, lawyers, reporters etc.) that at some point (and hopefully soon), the floodgates will open and massive waves of consolidation will reshape the banking industry landscape. Unfortunately, however, those floodgates haven’t opened yet and, in the meantime, there is a lot of speculating who might be open to selling, hoping that some of these deals come to pass and gossiping about any possible signs of incipient M&A activity.
Nevertheless, these type of rumors are always swirling around and often formalized into “likely seller” lists published by research analysts and the like that read more like a tout sheet at the track than financial analysis. Not surprisingly, a lot of the same banks show up pretty consistently on these lists, which I think reflects how frequently people speculate that they might be for sale and, in turn, makes them frequent subjects of rumors that a sale process is underway.
Leaving aside FCB for the moment, I would say that a lot of the banks that are the subject of these rumors—let’s call them the bridesmaids—have actually been for sale for a number of years. That is not to say that there have been active sale processes going on for all that time (although I would expect that there are pretty regular soft market checks)—rather, there has been a continual expectation that the bank will be sold in the near term. I think this expectation comes from two sources that feed on each other and, on balance, likely diminishes (rather than enhances) the likelihood of any sale at any type of premium to market prices.
The first, and most important, source of these expectations is the management and the board. Anyone with any reasonable amount of familiarity with bank stocks knows that there are a decent handful of banks out there that were built to sell—usually with more emphasis on the “sell” and less on the “build”—and are now looking for an exit. These banks may not come out and explicitly say that is the goal, but the “body language” of management is pretty clear. Also, they are frequently the subject of takeover speculation, whether on “likely sellers” lists or talked about in the market.
One consequence of these management and board expectations is lack of investment in the bank’s business. Some of this is intentional, as necessary or desirable expenses are pushed off in hopes that they will be borne by a buyer after a sale. Some is less directly intentional, such as when a bank chases businesses that might result in immediate earnings but no real franchise value or fails to critically assess businesses or markets it is in and should exit or others that it is not in and should enter. Some is probably completely unintentional, such as when a bridesmaid cannot hire talented individuals who see no upside to going to work for a bank that might be sold to a competitor at any moment.
Feeding off management and board expectations of a sale are investors, who I think are generally pretty astute at recognizing a bridesmaid when they see one. As I mentioned in an earlier post, I would argue that the more that investors think the sale of a particular bank is likely, the more that expected sale premium gets built into the bank’s stock price. The stock price then just seems to trade based on what the market expects that a buyer might be able to pay for the bridesmaid, taking into constraints around earnings and tangible book value dilution.
As a total aside, thankfully, tangible book value dilution in bank M&A is becoming less of a concern as investors and research analysts become more focused on earnings. I’ll probably address it in another post, but I think it is a metric that represents an incredibly defensive view of bank stocks. It also fails to take into account different levels of capital and, more importantly, why banks might have different levels of capital.
My opinion is that these two sets of expectations reinforce each other. At the most superficial level, my sense is that the management and board of a bridesmaid would be likely to sense that stockholders too are expecting a sale and don’t want to diminish that expectation for fear that any such diminished expectations would result in a corresponding diminution of the takeout premium baked into their stock price. At a more profound level, if you take the view that stock price and valuation multiples are a gauge for investors’ satisfaction with management performance, valuation multiples that are inflated because they assume a yet to be received takeover premium can easily be conflated with valuation multiples that reflect excellent management performance.
Put another way, if I am the CEO of a bridesmaid, it is pretty easy for me to ignore any potential looming issues in my business if my stock price represents a full valuation—why would I want to take on tough decisions if my stock price basically tells me that investors are happy with the status quo?
Unfortunately, none of this probably makes a sale more likely. Buyers generally have to pay a premium to get a deal done and that gets hard if a bridesmaid’s stock price already fully reflects that expected premium. Additionally, the perpetual state of being for sale usually diminishes, rather than enhances, franchise value, with predicable results for chances of a successful exit. At some point, one might expect, these bridesmaids’ chickens will come home to roost in the form of either a no premium sale or a “take under” on the one hand or some tough sledding as management has to confront some real business issues on the other hand, but who knows? Maybe the Canadians will buy one or all of them.
Notwithstanding the recent news stories about FCB, I would put them in a different category than the bridesmaids. Sure, they have a couple of attributes that make people confuse them with the bridesmaids—they started out as a “blind pool”, a general perception that the board was playing a trade and, now that the trade has paid off, is interested in an exit, and frequent rumors that they are exploring a sale—but there is one extremely important difference: they are actually building a franchise. I think it was a stroke of genius for FCB to hire Kent Ellert as CEO—he is a super capable guy and well on his way to creating a core deposit funded, commercially oriented, pure play Florida powerhouse. He has done a great job on the loan side and is working hard to continue to improve the deposit mix, which is always a challenge.
Their biggest issue, however, is shedding the image of a bridesmaid. I think that their stock trades too much based on what someone could pay for them rather than what they are worth. For most banks, that would be a good thing rather than a bad thing, but I think FCB’s expected take out price puts a ceiling on, rather than a floor under, their stock price.
Again, in contrast to a lot of banks out there, I think that FCB could create a lot more stockholder value in the long run by focusing on its own growth path. Maybe they exit down the road if some of the larger regionals’ valuations ever improves to the point that they could pay a substantial premium for (what should then be a much larger and more profitable) FCB, but for the foreseeable future, I think the real opportunity for FCB is to just keep executing on doing what it is doing.
My hope is that the FCB board will take such steps as it can to help FCB be seen as other than a bridesmaid, which might include remixing the board somewhat to add more Florida-centric business types. I don’t think that there is anything wrong with any of the current directors—it looks like they are all extremely sophisticated and oriented 100% towards stockholder value and I am guessing that a lot of them have substantial Florida connections—but my gut feeling is that a lot of investors, rightly or wrongly, see the board as playing out a trade. Adding some well-established, well-connected Florida business types might not make any difference in terms of the performance of the board (which I think is quite strong) but may be useful in terms of sending a signal to the market.
In addition, the FCB board could indirectly address these rumors through some type of strong statement in connection with FCB’s upcoming earnings release. Obviously, most of the time, it is not in a bank’s best interest to comment on market rumors—and, for all I know, they could actually be in the process of selling themselves—but, some type of reiteration of their commitment to pursuing current opportunities for growth might be warranted.