Bank M&A Complicated by Failures

NEW YORK ( TheStreet) -- Sterling Bancshares ( SBIB) looked to be making a solid decision last August when it entered into an agreement to purchase nearly two dozen branches from First Banks Inc., a privately held bank headquartered in St. Louis.

The deal seemed simple enough. Sterling would acquire 19 branches in its home state of Texas, and the accompanying $500 million in deposits at those branches for a 6% deposit premium, as well as $230 million in selected loans. First Banks would be able to further shore up its capital base and redeploy some to its remaining franchises in California, Florida, Illinois, and Missouri.

But the companies failed to gauge the changes in the M&A environment brought on by the financial crisis, even for a smallish, supposedly straight-forward deal like this one. Regulators are facing a flood of failed banks whose assets need homes, and capital requirements are still in flux. At the time of the announcement, the transaction was expected to close at some point in the fourth quarter, but last week Sterling and First Banks jointly announced its termination because they could not get the necessary regulatory approvals before Dec. 31.

It's a familiar scene. Last year, of the 119 whole bank acquisitions announced, just 60 have been completed so far, according to data provided by SNL Financial. Of a separate 83 branch deals announced, only 48 have gone through. In addition, another 49 whole bank and branch acquisitions were canceled in 2009, SNL says, a figure not reflected in the aforementioned announced deal numbers. Meanwhile, 114 FDIC-assisted transactions were done in the United States in 2009. For comparison, 146 and 287 whole bank acquisitions were completed in 2008 and 2007, respectively, according to SNL, and FDIC-assisted deals totaled 26 in 2008 and just three in 2007.

"What's happening in the current environment is that the regulators are taking a lot longer to approve transactions so there is no chance creating a problem by approving a deal," says Brett Rabatin, a Sterne Agee analyst who covers Sterling Bancshares.

Other examples of deals that didn't make it to the finish line include the proposed hookup between OceanFirst Financial ( OCFC) and Central Jersey Bancorp ( CJBK); and plans for First Capital Bancorp ( FCVA) and Eastern Virginia Bankshares ( EVBS) to merge. Both deals were scuttled with parties citing delays in obtaining regulatory approval as a reason for the cancellations.

Chip MacDonald, a partner at law firm Jones Day specializing in banking and finance, says that even with "stresses in the system and all the proposed regulator changes, it's almost surprising there are not more" canceled deals.

Logic would seem to dictate that the troubled financial sector would see a pickup in consolidation in order to avoid escalating bank failures. But the extra scrutiny by regulators seems necessary given that currently 552 U.S. banks are considered so-called problem banks by the Federal Deposit Insurance Corp., thanks to the credit crisis. More than 200 banks are expected to fail in 2010.

These terminated deals and others, while not new to the banking landscape, are an added repercussion of the financial crisis that has virtually taken bank M&A off the table unless it's a purchase of a failed institution with the assistance of the FDIC. Some observers suggest that regulators are overwhelmed with the number of failed banks.

Then there's the inherent appeal of the FDIC-assisted transactions to consider as to why more hookups between healthy companies aren't getting done. Not only can an acquirer get branches and deposits on the cheap, but the government provides downside protection by sharing the exposure to whatever troubled assets the acquired bank holds.

If a bank does a non-assisted transaction "and the FDIC comes in and swoops up a bank in a similar market with better franchise value , shareholders will be upset," says Ken Thomas, a Miami-based banking consultant and economist.

Lawrence Kaplan, a former senior lawyer at the Office of Thrift Supervision and currently part of law firm Paul, Hastings, Janofsky & Walker's banking and financial institutions group, says it's possible that one of the parties has balance sheet issues that come out during the regulatory review process, such as a worsening credit picture.

An acquiror's capital levels are a key concern for any deal and "if the regulators get spooked or have concerns, they could slow down the process" or impose conditions in order to approve the deal, which may not be suitable or appealing to the involved parties, Kaplan says.

Regulators are also paying more attention to the structure of the combined companies and/or controlling parties of these deals and digging into whether a buyer has the capacity and appropriate risk profile to purchase a target, Kaplan says. This is particularly important as private equity investors mull deals in the sector.

Two weeks ago, Royal Bancshares of Pennsylvania ( RBPAA) canceled an agreement to sell its bank subsidiary to a private investor group because it could not secure sufficient capital to satisfy regulators.

In October, Frontier Financial ( FTBK), which was being acquired by a SP Acquisition Holdings, a so-called blank check company, could not obtain regulatory approvals within its desired timeline, and the purchase was canceled.

"Things are either going to be squeaky clean, or if there is a chance for some indigestion -- meaning there are some challenges to the acquisition -- the regulators are making sure the acquirer has the ability to work out those issues," Kaplan says. "You still have your healthy deals going on."

On the other hand, bankers -- particularly sellers -- in this semi-post crisis environment also have somewhat unrealistic expectations of how fast a deal can get done, others say.

Banks are either "misjudging the regulatory environment or, one of the parties for the deal needed to do the deal quickly," MacDonald says.

"The regulators are asking harder, more probing questions and to a certain extent the regulators may be doing less at the regional levels and more is going to Washington and that equals time delay," MacDonald says. "They're getting more input from Washington ... so that there is consistency throughout the system. It's not a problem. It's the attitude in the current environment that you can't be too cautious."

Some banks, at risk of leaving their branches, customers and employees exposed during a time of uncertainty during an acquisition, are deciding to throw in the towel instead of leaving the company further at risk.

"We just got to the point where the regulatory approval -- we had not gotten it -- and neither company could continue on in that state of limbo," says John Presley, managing director and CEO of First Capital. Presley declined to comment further on the termination of the deal.

But Kevin Mukri, a spokesman for the Office of the Comptroller of the Currency, which regulates national banks, says the regulator's standards haven't changed as a result of the crisis.

"We haven't tightened or loosened any of the standards," Mukri says, adding that in terms of time lapses between deal announcements and closings, "we're pretty quick on it," so long as the OCC is able to verify the capital requirements needed.

The OCC also encourages interested parties looking to start or buy a bank to undertake a discussion with the regulator beforehand to give a sort of heads up, he adds.

"We have not seen any inordinate delays on our end in approving ... on proposed deals," says William Ruberry, a spokesman for the Office of Thrift Supervision. "What we have seen is that there are fewer applications that have come our way," especially for new institutions.

A spokesman for the FDIC did not immediately comment.

In the case of Sterling, the lack of quick regulatory approval ended up being a blessing in disguise, analysts say.

Oppenheimer analyst Terry McEvoy notes that Sterling's credit quality deteriorated since it announced the deal and that it had to restate third-quarter results in November, which clearly put pressure on its capital levels, he says.

Analysts were concerned that Sterling would have had to raise common equity in order to get the deal done, despite successfully repurchasing preferred stock owned by the U.S. government last year, which may or may not have been received well after Bank of America ( BAC), Wells Fargo ( WFC) and Citigroup ( C) each completed large common equity offerings in late 2009.

Sterling Bancshares Chairman and CEO J. Downey Bridgwater last week declined to comment further regarding the decision.

"While it would have been nice to have those branches, it takes a potential capital raise off the table," Sterne Agee's Rabatin says.

Written by Laurie Kulikowski in New York. >>See our new stock quote page.

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