You know what tastes great together (other than chocolate and peanut butter)? The combination of an asset generation engine that produces a lot of high yielding loans and a liquid balance sheet funded by low cost, sticky deposits. While there are a number of banks that fall into one or the other of these categories and may have been patiently waiting to find their complimentary opposite, there is no reason why this natural pairing should not happen more frequently—just like in the classic Reese’s commercial, this combination could easily occur more spontaneously and without any elaborate or lengthy courtship.
Asset generators (i.e., banks that grow loans substantially faster than deposits) buying deposit rich franchises with low loan to deposit ratios is nothing new. Capital One’s 2005 acquisition of Hibernia is a classic (and perhaps most the extreme) example of, and template for, this type of transaction. In its quintessential formulation, a bank with a national lending business that generates lots of high yielding loans significantly faster than it can gather deposits buys a bank in a slower growth market with lots of sticky, low cost deposits that is “under-loaned.” Mixing my metaphors (obviously I have dessert on my mind), the cherry on top of this sundae is that the CEO of the acquired bank remains to run the legacy banking operations. Ideally, the end result is a bank that can grow high yielding loans at a rapid pace funded by a deep well of low cost deposits.
Great combination, right? Unfortunately, there is one glaring issue with this model—traditionally, for a deal to occur, a deposit franchise has to (finally) decide to sell, the timing of which can obviously be hard to predict or rely upon. However, instead of waiting in the wings for an aging CEO to finally cash in his chips or hoping that an elaborate and oblique courtship conducted through intermediaries bears fruit, there is significantly simpler and more direct option for confident asset generators: make a public and unsolicited bid.
I mentioned in an earlier post that I think one of the reasons why public unsolicited bids were so rare in banking is because of the general “clubbiness” of the industry (I have some thoughts on why that exists that I will share in a later post) in general and, in particular, the concern that by making such a bid, a potential buyer, if unsuccessful will have prejudiced itself in the event that the bank later decides to put itself up for sale. I think that both the general and particular concern are much less of an issue for an asset generator with a national lending business because, almost by definition, the CEOs and boards of those type of institutions are less likely to be bound by, or troubled by the breach of, any of the more parochial conventions regarding combinations prevalent in any particular markets. In addition, such asset generators, since they are probably largely indifferent as to the geographical location of a deposit franchise, can easily treat these opportunities like the proverbial bus—if missed, another will appear.
Further, many of the characteristics that would make any particular deposit franchise a perfect target for an asset generator—low loan to deposit ratio, slow growth market, etc.—probably also mean that the target has earnings issues and difficulty in providing acceptable (current or future) returns to stockholders. In such a case, a properly priced (i.e., not a “low-ball”) bid should prove attractive to both stockholders and the target’s board of directors—particularly if the latter is both informed as to, and being candid about, the target’s prospects as a stand alone entity.
Finally, with respect to those asset generators who would need local management to run a deposit franchise, an unsolicited bid (again, if properly priced) could conceivably be a blessing in disguise—not only could the CEO get a premium for his stock and retain his job, but it also might be a way for him to solve his growth and profitability issues without ever actually admitting they exist.
In terms of likely candidates for either side of this type of delicious combination, there are a number of obvious choices. On the asset generator side, Triumph Bancorp (Nasdaq: TBK) has a clear familiarity with this model, as does Bank of the Ozarks (Nasdaq:OZRK), though their success with their “spin-up” branches and the sheer size of their funding needs, combined with their enviable asset betas, may signal a move towards the more predictable route of just paying up for deposits in a targeted fashion. On the deposit franchise side, almost any publicly traded bank in California’s Central Valley would be a good choice, as would a bank like MidSouth (NYSE:MSL) that has a good deposit franchise, but is experiencing earnings challenges due to the decision to drastically limit exposure to a particular industry.
While the idea of a public unsolicited bid may have its clearest application in bringing together two banks that effectively represent opposite sides of a balance sheet, some banks with slightly more traditional loan and deposit makeups may also want to consider more aggressive methods of securing deposit funding, particularly as the tide goes out with respect to deposit costs and the quality of deposit franchises.
Lastly, as potential bidders contemplate this step, they should be mindful that there is no time like the present, as rising rates and increased emphasis on core deposits may narrow the valuation multiple advantage that many strong asset generators now have compared to deposit franchises. Taking a wait and see approach to acquiring a deposit franchise may significantly limit an asset generator’s options and will almost certainly make the transaction more expensive.