Compared to a year ago, fewer bankers expect their institutions to make an acquisition in the next 12 months, as they focus on navigating through the financial fallout of the COVID-19 pandemic.
About one-third of executives polled by the trade publication Bank Director say they expect their bank will make an acquisition in 2021. That’s down from 44 percent of respondents a year ago who said they expected to buy another bank in 2020.
Acquiring branches or loan portfolios also “looks slightly less attractive compared to a year ago,” according to the Bank Director survey.
“The barriers to deal-making may prove difficult to surmount in today’s uncertain economic and political environment. With pressures on small businesses and the commercial real estate market exacerbated by remote work and social distancing measures, the recovery of the U.S. economy – and bank M&A – may hinge on conquering the coronavirus,” the publication reported in relation to the 2021 Bank M&A Survey results.
Nearly six in 10 bankers said they were still open to an acquisition, although they plan to focus primarily on organic growth, and just 28 percent overall “want to be active acquirers,” according to Bank Director. The remaining 14 percent said M&A was an “unlikely growth path” for their bank.
Deal flow has been curbed by the economic uncertainty stemming from COVID-19 and the restrictions some states have in place. As well, banks’ financial performance could be negatively affected as loan losses rise, leading to reduced share prices that make it harder to structure a deal, said attorney Jeff Kuras, a partner and co-chair of the financial institutions practice at Honigman LLP.
In his outlook for bank M&A, Kuras echoes the sentiments identified in this year’s Bank Director survey.
“There’s current uncertainty over how long this thing will last, what the effect of the shutdowns are going to be on the health of these banks and that uncertainty is going to continue for a while,” Kuras told MiBiz. “Uncertainty is not good for bankers looking to do major transactions.”
The “social aspect” of bank deals also will hold back deal flow. The pandemic gets in the way of face-to-face negotiations and due diligence, making it difficult for executives and directors to get a deal done.
“The ability to evaluate that over Zoom is something for this industry in particular that is going to be harder for them to get really comfortable with,” Kuras said.
Feeling a chill
Among their top reasons in pursuing a sale, banks cited an inability to provide a competitive ROI to shareholders on their own, CEO succession and an inability to operate efficiently, according to the Bank Director survey.
Top barriers to deals in 2021 included concerns about the asset quality of potential targets, pricing expectations, a lack of suitable targets, the culture and integration of staff, and demands on banks’ capital.
When the pandemic hit in the spring, federal regulators eased rules on how banks account for loans that are restructured or payment deferrals for borrowers. That makes it harder for a prospective buyer to completely identify the quality of a seller’s loan portfolio, said Jeff Ott, an M&A attorney at Grand Rapids-based Warner Norcross + Judd LLP.
A concern about credit quality “has really put a chill” on bank deals and makes it hard to predict for 2021, Ott said.
“There are questions out there on the part of would-be acquirers as to what really is the credit quality of the potential target institution,” said Ott, who doesn’t anticipate any major changes in the bank M&A market until at least mid 2021, given the uncertainty about how long the pandemic persists and its effect on the banking industry.
Among the key questions: “When are they going to start seeing — if they do see — increases in non-performing loans? When’s that going to hit?” Ott said. “I think the potential acquirers are cautious.”
Despite concerns about acquisition targets, bankers answering the Bank Director survey showed confidence in their own credit quality.
About two-thirds said they believe that less than 5 percent of the commercial loans they modified in the pandemic will end up in default. Nearly three in 10 expect the default rate among commercial borrowers who modified loans will be 5-10 percent.
In Michigan, banks remain well-capitalized, although they and their regulators are watching capital levels “very closely,” Honigman’s Kuras said.
Stock value also comes into play in future deal flow and ranked seventh on a list of 16 deal barriers cited by survey respondents.
Deals of all sizes typically involve stock as part of the financing. Banks generally have seen their shares fall during the pandemic. Although bank shares have partially rebounded, they have limits on their ability to use stock in a transaction, Kuras said.
“You don’t want to do a deal using your currency that you believe is currently undervalued,” he said. “Waiting for that to correct itself a bit might shelve some deals that may otherwise be attractive or make some sense.”
Through October, 92 bank deals had closed across the U.S., well off the pace of deal flow in 2019, according to S&P Global. Activity did pick up with the fall, with 11 deals alone in October involving banks and thrifts.
In West Michigan, Sparta-based ChoiceOne Financial Services Inc. closed July 1 on the $20.9 million acquisition of Muskegon-based Community Shores Bank Corp. Last month, the two banks completed their integration, with the three Community Shores offices in Muskegon and Ottawa counties taking on the ChoiceOne name.
The Community Shores acquisition followed ChoiceOne’s $108 million deal for Lapeer-based County Bank Corp. in 2019. Combined, the two deals more than doubled the size of ChoiceOne, which has 33 offices in West and Southeast Michigan and $1.82 billion in assets as of Sept. 30.
Most recently, St. Joseph-based Edgewater Bancorp Inc. agreed to sell to United Federal Credit Union, also in St. Joseph. The deal, valued in the range of $28.9 million to $31.6 million, could close in the first half of 2021 pending regulatory and Edgewater shareholder approvals.
The acquisition of community banks by credit unions has been on the rise the last several years. S&P Global counted 16 credit union-bank mergers in 2019, nearly double from 2018.
Transactions between banks and credit unions slowed in 2020 because of COVID-19, although Honigman attorney Michael Bell expects pent-up demand on the sell side to unleash once the pandemic that “took sellers off the table” eventually wanes.
“The moment that happens, I expect there to be a lot of sellers,” said Bell, who specializes in credit union-bank transactions. “I have a lot of buyers. I would expect there to be a lot of activity in 2021, assuming this pandemic gets handled in some way. That’s the unknown.”
Overall, Bell describes his outlook as “really bullish.”
“I expect there to be a nice increase next year,” he said.