Buyers to Bank On

The U.S. banking landscape has seen a fair number of mergers and acquisitions lately. We regularly evaluate potential targets, but in this piece we focus on the value created or destroyed by acquirers. We think this is especially relevant in light of some recent deals in which the buyers have gotten the better part of the bargain.

In the past few months, there have been a few headline-grabbing deals. The most recent one was M&T Bank's (MTB) announcement of the Hudson City Bancorp acquisition for roughly 0.8 times tangible book value and only a modest premium to Hudson City's previous closing price. We think this deal, much like M&T's earlier purchase of Wilmington Trust, reflects a buyer's market for banks. Hudson City was a jumbo mortgage lender waylaid by low rates and loss of market share to the government-sponsored enterprises, while Wilmington Trust was crippled by a deteriorating book of construction loans. In our view, buyers are likely to maintain the upper hand over the next 12-24 months as much of the industry continues to struggle with depressed profitability due largely to revenue headwinds and higher capital requirements.

Indeed, the median price for bank deals in the past few quarters has been at or below tangible book value--usually a good bargain for the acquirers. Thus, we think it is a good idea to invest in those acquirers that sport a proven record rather than hunting for would-be targets, as the potential for value creation may actually be larger in the long run.

From our coverage, we selected a subset of the most acquisitive banks and examined the value that has accrued to shareholders as a result of tangible book value growth and dividends, as well as share price appreciation. Within that group, those that have fared the best in the past decade include Wells Fargo (WFC), Prosperity Bancshares (PB), PNC Financial Services (PNC), and New York Community Bancorp (NYB). These institutions have shown an aptitude for creating shareowner wealth as measured by tangible book value per share growth plus dividends paid.

Methodology
Our goal was to select the best acquirers in our 54-bank coverage list. The first step was to determine which firms were truly acquisitive and which were not. We looked at all the acquisitions each bank had completed in the past 10 years, including whole acquisitions, partial or branch purchases, and FDIC-assisted transactions. We then compared total assets acquired with total current assets. Those companies that have more than 25% of their balance sheet coming from past purchases were deemed to have a modus operandi at least partially based on acquisitions. Fifteen companies passed our initial screen.

In our view, the finest firms are those that generate the most shareholder wealth. We measure this by calculating how much tangible book value per share grew in the last decade. To get a complete picture and not unnecessarily ding big dividend payers, we added the sum of dividends paid to the ending book value per share amount. We ranked the banks based on this metric but included book value per share (plus dividends) growth and share price appreciation for added color. Comparing each bank's metrics with our coverage median, we were able to see which banks know what they are doing when they go out shopping and which do not.

The Best Acquirers
Based on tangible book value plus dividend growth, the top four banks are New York Community Bancorp, Wells Fargo, PNC, and Prosperity Bancshares. These are also the top four as measured by book value plus dividend growth, although the relationship between tangible book value growth and share price performance is less than exact. Notably, NYCB's and Wells' tangible book values have grown 290% and 450%, respectively; combined with dividends, growth is a whopping 850% and 730%.

The Worst Acquirers
In stark contrast, we have Regions Financial Corporation (RF), Susquehanna Bancshares , and Boston Private Financial Holdings . Even accounting for dividends paid, Regions has managed to destroy a significant amount of shareholder wealth in the past decade, shaving off more than one tenth of tangible book value--a detail that has not eluded the market. Susquehanna and Boston Private have increased their tangible book values per share by a measly 19% and 25%, respectively, way below the 54-bank median of 160%.

Sources: Company filings, Morningstar estimates, TR Bank Insight.

Opportunities
 New York Community Bancorp. NYCB has acquisitions in its DNA. In the past decade, it has completed 10 acquisitions and is always looking for bolt-on growth. The largest deal was the purchase of AmTrust Bank from the FDIC in December 2009. Before then, the bank's presence was largely confined to the New York/New Jersey area, but with AmTrust, NYCB's reach extended to Ohio, Arizona, and Florida. More important, this acquisition expanded NYCB's deposit base almost 70% and helped reduce the company's funding costs virtually overnight. Despite the sizable dividend the bank pays, we are not as keen on NYCB's top brass as we are with other banks' because profitability has been middling in the past decade. This is notwithstanding the bank's laudable credit quality and lean operations, which is why we give NYCB a standard stewardship rating. However, we think the stock could be an attractive dividend play.

 Wells Fargo. Wells Fargo has done an excellent job as an operator and acquirer over the past decade and receives an exemplary stewardship rating as a result. However, with roughly 10% national deposit market share following its 2008 acquisition of Wachovia, Wells' opportunities for further expansion are limited. That said, we still believe the stock is undervalued and also the least risky name among the big four U.S. banks.

 PNC Financial. We have long viewed PNC Financial as a superior acquirer, and its results over the past decade support our view. Before it doubled in size by purchasing National City in 2008, PNC had established itself as a turnaround specialist by successfully integrating Mercantile Bancshares, Yardville National Bank, and Sterling Financial. More recently, PNC expanded in the Southeast with the purchase of branches from BankAtlantic and Royal Bank of Canada. We think PNC is poised to continue creating value as it expands its footprint by purchasing troubled peers.

 Prosperity Bancshares. Prosperity is one of our favorite banking franchises. Not only has it shown its ability to create shareholder wealth and return a fair amount of money to shareowners, but also we like its consistency in posting above-average profitability even during the most challenging times. Hence, we give Prosperity an exemplary stewardship rating. In our opinion, this is a good example of a management team that is able to effectively control the three major costs of a financial institution. Prosperity's funding costs are below the average, its credit costs are ultralow, and its operational costs, as shown by its efficiency ratio (noninterest expenses/net revenue), are lower than many of its peers'. This is despite numerous acquisitions, which usually push the acquirer's costs upward, at least temporarily. However, Prosperity's in- or near-footprint acquisitions have made it easy for this Texas lender to integrate its systems and have kept the company from wandering into regions where it lacks expertise. The market has not been oblivious to this fact, and we think Prosperity's stock is currently fairly priced, although definitely worth keeping an eye on.