This week we sit down with Brady Gailey from KBW to discuss his outlook for bank M&A as we head into 2022.

The views, information, or opinions expressed during this show are solely those of the participants involved and do not necessarily represent those of SouthState Bank and its employees. 

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Intro: Helping community bankers grow themselves, their team, and their profits. This is The Community Bank Podcast.

Erik Bagwell: Welcome to the community bank podcast. I’m Eric Bagwell, director of sales and marketing for the correspondent division of SouthState Bank, and joining me is Caleb Stevens. Caleb is a business development officer covering Kentucky, Florida, and maybe a few banks scattered in between and he also helps us on the podcast.

Caleb Stevens: Yeah.

Erik Bagwell: Caleb, what’s going on?

Caleb Stevens: Not very contiguous states, but that’s the world of post-COVID, is a lot of times you’re on zoom calls with folks and you’re not actually traveling as much still traveling some, but it’s easier than it used to be outside to cover and surf banks.

Erik Bagwell: No doubt. We used to joke that we threw darts at a map to sign accounts and it’s kind of does look like that now that we throw darts, but I promise we don’t, there is a method to the madness. So, let’s talk about our show today, we have Brady Galey. Brady has been with us. It’s been over a year. I hadn’t think it’d been that long, but he was with us in September of 2020. Brady is a bank analyst with K.B.W and we kind of go in-depth with him, kind of the M & A landscape what’s out there. Brady’s got some great advice for those that are looking to sell a bank and what buyers are looking for. So, we’re excited about this interview with Brady. So, let’s just go straight to it, hope you guys had a great Thanksgiving, and then we’re getting into the holiday season. So, thanks for listening.

Music 01:26

Erik Bagwell: Well, Brady Galey thanks for joining us today. How are you?

Brady Gailey: I’m doing well. Thanks for having me, guys.

Erik Bagwell: Coming off of a big Thanksgiving and I know I’ve already told Caleb today that I’m not eating. I’m going to eat healthy this week. That’s all I’ll say, so you may be the same way.

Brady Gailey: That’s right.

Erik Bagwell: Brady, you’re with K.B.W and we’ve had you on before. Give a little background of you and your career for those that may not have heard of you or missed an episode that we had with you probably spent about 10 or 12 months ago. So, tell us a little bit about yourself?

Brady Gailey: Yeah, sure thing, Eric. So, I started my banking career actually at the Old Bankers Bank back in 2003. While I was at the Banker’s Bank, I did asset, liability, modeling for banks. I did Alco, and then consulting where I did branch site surveys and consulting on strategic plans for banks, CEOs, and boards of directors. Then I spent my last couple of years working in investment banking at the Banker’s Bank. Where we mostly did small bank M & A, and also trust preferred raises back when those were around. In 2007, I moved to K.B.W, which stands for Keith Beret and Woods, an investment bank focused solely on financial services owned by Steeple. So, I moved to K.B.W when I was seven and have been in their equity research groups, since then I cover about 35 publicly traded banks, mostly in the Southeast and the Southwest, including banks in Carolinas, Georgia, Florida, Tennessee. Then I hop over to Texas and Oklahoma have a couple in Denver, but it’s a group of about 35 banks. They’re fairly active banks that I cover lots of M & A, lots of IPOs, lots of capital raising, and obviously in the Southeast and Southwest, it’s in a pretty attractive geography, a lot of good growth and M & A and a lot of activity.

Erik Bagwell: Well, probably the last time we talked I’m looking at my notes is actually September of 2020, the pandemic had changed everything about banking. Tell us we’re one year removed. How things have changed in your world and particularly how’s the last year impacted the world of bank M & A?

Brady Gailey: So, no one really knew what to expect in banking headed into the middle of a pandemic. The market tends to assume the worst and tough times investors were very cautious on credit quality and ultimate losses. The bank stocks early on fell notably and at one point bank, the average bank stock was down about 50%, thats early on in COVID, that’s measured by K.B.W regional bank index. We bought the Kardex, but it did snap back in 2020 and bank stocks ended up being down only about up 12%. Then if you look at what they’ve done here today, they’re up to over 30%. So, bank stocks are very much back, post the COVID volatility.

Let’s say investors nowadays, are getting excited about the fed, getting closer to increasing interest rates, which is obviously good for most banks with better net interest margins and better EPS. K.B.W actually upgraded the entire bank sector to overweight back in September of this year. Which is the first time we’ve done that in a while, that upgrade was really driven by better upcoming loan growth, which we started to see in the third quarter and we think the continues in the fourth quarter and end to 2022, and higher interest rates and the optionality most banks have of deploying their excess cash liquidity into higher earning assets like bonds and loans, you asked about M & A. Your M & A mostly took a halt in the world of banking, kind of during the depths of COVID.

You look at pre-COVID back in kind of 2018, 2019, we were seeing about, 250 M & A deals annually, about 3, 4, 5% of banks consolidating, each year. 2020 that fell notably we only saw closer to a hundred deals. So, a big slow down, although things have been picking pretty nicely this year, as things normalize. One thing that COVID did was notably increase the need for M & A, FinTech, really took notable strides during COVID, just because of the need to do so much electronically and remotely. So, spreading technology costs over a larger platform became a lot more important through the pandemic and yet that’s another thing, causing the banks to consider M & A, a lot more aggressively now. Rates near zero really cut into the average earnings, most banks have looked for EPS growth via acquisitions or merger of equals and size and scale matter, now more than ever. That’s really driving a lot of the activity we’re seeing in M & A, which we think only increases from here. And I think banks are; will focus on larger in size and more meaningful deals back when you would see banks, buy a smaller target bank. It’s only 5% of pro assets you don’t see that much anymore. It’s 20, 30, 50% of pro assets banks are looking for larger in size deals now.

Erik Bagwell: Well, Brady for our listeners who maybe haven’t followed some of the more recent deals that have been announced. What are you seeing in terms of value ranges that are being received and how do those valuations maybe compare to times past?

Brady Bagwell: I mean, I remember when I started in banking. Yeah. You’d see banks sold for, 4 or 5 times tangible book value and it is very different today from back then.

Erik Bagwell: Yeah.

Brady Gailey: I’d say the average takeout multiple today are running around 125 to 175 of tangible book value, really, it’s the underlying bank’s earnings power that ultimately drives the takeout price and if you look at price to earnings those takeout multiples are trending in kind of that low double-digit to mid-teens range right now. Your price to tangible book value can really be more of a limiting factor in selling your company. It’s rare nowadays to see a bank sold for 2 or 3 times tangible book value. So, your price, to tangible book can really be more limiting, your buyers are increasingly sensitive to tangible book value dilution nowadays, there’s a metric that we call the Tangible Book Value Dilution Earn Back and that’s basically with a deal, how quickly you can earn back that tangible book value dilution. Most bank buyers want to be able to earn that back within about 3 to 4 years is ideally less than that. Looking specifically at kind of one-day premiums when you’re looking at a buyer that has a, buyer and the seller that is publicly traded one-day premiums on publicly traded targets are really more reserved nowadays as well. It’s rare to see any really outsized one day per premiums, especially when you’re looking at larger kind of big bank M & A, you will see some nice one-day premiums for really smaller more micro-cap banks, occasionally.

Erik Bagwell: Brady, there’s a lot of challenges, obviously, in the M & A world, and Seso has probably added to that, as banks have gotten more experience with Seso, is it still impacting the M & A business and if it is, how is that?

Brady Gailey: So, Seso is not a friend for bank M & A it does result in more day one tangible book value dilution, which as we just talked about, bank buyers are very sensitive to. So, it’s more tangible book value dilution, which makes pricing deals harder, and with Seso, you basically have a double count of one piece of the loan mark and that double has to be run through the provision line. So, the quarter that you close it you will see an outsized provision. So, it’s, definitely made M & A harder and unfortunately, it’s taken away some of the takeout premium for the sellers.

Erik Bagwell: Well, let’s see if we can pull out your crystal ball here for a second, as you kind of look into 2022, I mean, you mentioned prior to COVID, we were losing 250 banks give or take a year. I mean, you run that trend out 10 years. That’s probably half the banks we have now, which is crazy to think about because I think there were 18,000 or so back in the eighties, and here we are just under 5, you run 250 a year out for 10 years and that’s 2,500 or so I’m not doing the mental math maybe accurately, but I think that’s about right. So, as we kind of look at 2022. What are some of the trends and maybe predictions that you have for the future?

Brady Gailey: I think M & A will remain very active in 2022 and beyond, as we’ve talked about the need for M & A was notable pre-COVID, and post-COVID it’s even more notable. So, I think, there’s a long runway to see a lot more M & A. I think the recently higher valuations for bank stocks also help M & A, it helps deals come together more easily, which is positive when a bank buyer has a better currency, they have more ability to pay. So, yeah, you have targets that get higher takeout prices and everybody’s happy. So, I think higher valuations are another reason why we’ll see more M & A, and I think we’ll see a specific M & A focus.

That’s not necessarily on buying the peer down the street, but it’s on buying, non-bank companies, like fee income generating companies or FinTech companies, one of the things that banks have been reminded of recently with spread income coming under pressure, just with rates at zero is that fee income is very important revenue, diversification away from so much spread income can really help reduce earnings volatility, driven by interest rates. So, I think, non-bank M & A FinTech related fee income related is also going to be something that’s very active for many years to come.

Erik Bagwell: Brady, tell us about some of the recent transactions that have stood out to you for one reason or another?

Brady Gailey: So, we are seeing some larger in size bank deals nowadays. Recently we’ve seen some great activity in the state of Texas. We saw Arkansas-based home bank, buying happy state, which was a big deal in Texas. In Houston, we saw a merger of equals between allegiance and C.B.T.X, a Community Bank of Texas. So, that’s creating about a 11 billion in asset franchise and helps them and cross that important $10 billion thresholds, as you guys probably value when you cross over 10 billion banks are subject to Durban, and that takes away about half of your interchange fee income. So, the average bank crossing 10 billion will see a hit of 4 to 5% of earnings, which is painful. So, that’s why M & A is one avenue the banks have really used to cross that important 10 billion in asset threshold.

So, allegiance and C.B.T.X, they crossed that they’re now 11 billion in assets. More recently we saw Simmons Bank in Arkansas by another Houston based bank, a spirit of Texas. So, it was pretty good activity in Texas and honestly throughout, Southeast. So, I’d say another thing I’d say is a lot of investors and banks are talking about the regulatory environment towards the bank M & A, we have obviously had a new president now, and there are some changes happening at the fed and we’re seeing some larger deals like in North Carolina, a first citizen is in the process of buying C.I.T that deal was announced over a year ago and still lacks fed approval. And we’re just seeing some larger in size bank deals take a little longer to get regulatory approval. So, I’d say banks and investors are, they’re just a little apprehensive and nervous about ultimately longer-term what that regulatory backdrop is, whether they look at M & A favorably or not.

Erik Bagwell: Well for our folks listening who maybe their bank executive and they’re maybe selling is maybe on their radar, either in the short term or maybe in the long term and that could be, as you mentioned, for a number of reasons, could be the headwinds of in compression could be the need for scale, could be succession planning issues, a number of things. But for the folks out there who may be selling is on their radar, any advice to them as they try to clean up their balance sheet and prepare may be to have some discussions, anything that they can expect on the process that maybe they’re not aware of on the front end.

Brady Gailey: So, I would say, and the first thing is to build your bank like you’re going to own it forever. A bank buyer can tell when it’s a bank that’s been billed for a quick flip in a sale. A lot of bank buyers are very focused on acquiring good core sticky, low-cost deposits. So, I’d say the deposit side of the balance sheet is key I’d say, I would really focus more on the currency that you’re getting in a deal focus more on that than your price detains will book value or any sort of day one premium. If sometimes a lower takeout price can actually lead to a better and well-received deal where if you have a buyer that’s, publicly traded where the buyer stock price does well by the time you get around the deal close, you have a better deal versus some very high. The buyer stretches for the ultimate price and the highest takeout in an at announcement where a buyer announces a deal, the market doesn’t like it, that stocks down 10%
Potentially on day one from announcements, I would really focus less on the day one premium and really more on the currency that you’re getting and the return potential upside from that currency.

I mean, obviously, you want asset quality as clean as you can, but buyers are very sensitive to that nowadays. I think you want to look for buyers that have some nice overlap with the seller’s footprint that creates ample cost save opportunity and when there’s better cost saves, a lot of times a buyer can afford to pay a higher price. So, I think having a market buyer sometimes is very helpful. Obviously, just hire a good investment banker that knows the market and that knows your most likely buyers and I would if you think about selling your company I would go ahead and start the process of reaching out and talking informally talking to some of the bigger banks that you think you’d want to team up with a lot of buyers will be in a dialogue and a discussion with sellers for years before they pull the trigger. They want to get to know the management team. They want to have dinner or bird hunt with the CEO to really get to know him and get to know his franchise. So, yeah, I would if you’re starting to think about selling your bank for the next couple of years, I’d go ahead and start reaching out at least building relationships.

Erik Bagwell: Well, Brady, this has been great, you’re a good friend, an old colleague, and have given us some great information today and some good advice. We appreciate you being on man and hope you have a great holiday season that’s coming up.

Brady Gailey: Great Caleb, thanks for having me and I’ll see you guys again soon.

 

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