November 10, 2017 7 The Death of the Double Dip

November 10, 2017

The Death of the Double Dip

By: Nancy A. Bush, CFA NAB Research, LLC Distributed by Banks Street Partners, LLC

There have been few quarterly reporting periods in our long career that really stand out in our memory. Mostly these two week long recitations of net interest margins and loan growth metrics—among other numbers that have utterly no meaning to the average person—blend into one long quarterly drone, broken by the occasional revelation of something different and interesting. And thus it was in the third quarter of 2017, when several pronouncements by Southeastern CEOs indicated a much different banking environment in the months and years to come.

The first of these “things have changed” comments came from Kelly King, CEO of BB&T Corp. (BBT), in his bank’s earnings call on October 19. Mr. King announced that his company—which has long been a bank that grew in traditional banking businesses through a long string of bank acquisitions—would be undergoing a process of “re-conceptualization” in the coming quarters. That process will involve the possible shedding of businesses and banking operations that may be judged to be not sufficiently additive to profitability, a greater reliance on digital delivery and a comprehensive look at the bank’s massive branch network, the greater use of robotics and AI in the bank’s operations, and on and on. And while Mr. King was adamant that the company would continue to grow—likely beyond the $250 billion-in-assets mark that would mark its accession to “systemic importance”—he also said that the acquisition of bank branches was no longer a priority for BB&T.

And he was not the only one. SNL reported on October 24 that Mr. King’s southeastern peer, the management of Regions Financial (RF), had announced in their earnings call that they would similarly eschew bank deals in favor of investment in technology and investments in non-bank activities. Indeed, none of the large banks of our acquaintance—including U.S. Bancorp (USB), which would be the bank most enabled by its reputation and it TBV multiple—seem terribly keen to do any kind of branch network-building, but seem to be even more intensely focused on operations and enhanced long-term profitability than they have been at any time since the Financial Crisis.

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Rank by Price / Tangible Book Value for U.S. Banks > $50B in Assets Rank by Return on Average Equity for U.S. Banks > $50B in Assets Total Total Assets P/TBV Assets ROAE Rank Company Name Ticker State ($000) (%) Rank Company Name Ticker State ($000) (%) 1 Bank of New York Mellon Corp. BK NY 354,397,000 339.8 1 Fifth Third Bancorp FITB OH 142,264,000 24.08 2 State Street Corp. STT MA 235,986,000 304.2 2 SVB Financial Group SIVB CA 50,754,287 14.75 3 First Republic Bank FRC CA 84,320,096 268.6 3 U.S. Bancorp USB MN 459,227,000 12.69 4 U.S. Bancorp USB MN 459,227,000 267.9 4 State Street Corp. STT MA 235,986,000 12.26 5 SVB Financial Group SIVB CA 50,754,287 243.0 5 Northern Trust Corp. NTRS IL 131,400,200 11.89 6 Northern Trust Corp. NTRS IL 131,400,200 239.8 6 Comerica Inc. CMA TX 72,017,000 11.29 7 M&T Bank Corp. MTB NY 120,401,804 233.9 7 First Republic Bank FRC CA 84,320,096 10.78 8 BB&T Corp. BBT NC 220,340,000 225.9 8 JPMorgan Chase & Co. JPM NY 2,563,074,000 10.44 9 Huntington Bancshares Inc. HBAN OH 101,988,126 207.4 9 Huntington Bancshares Inc. HBAN OH 101,988,126 10.22 10 PNC Financial Services Group, Inc. PNC PA 375,191,000 195.0 10 Bank of New York Mellon Corp. BK NY 354,397,000 9.98 11 JPMorgan Chase & Co. JPM NY 2,563,074,000 182.4 11 PNC Financial Services Group, Inc. PNC PA 375,191,000 9.75 12 Wells Fargo & Co. WFC CA 1,934,939,000 180.1 12 KeyCorp KEY OH 136,733,000 9.55 13 Comerica Incorporated CMA TX 72,017,000 179.9 13 Wells Fargo & Company WFC CA 1,934,939,000 8.95 14 KeyCorp KEY OH 136,733,000 178.8 14 Capital One Financial Corp. COF VA 361,402,000 8.82 15 SunTrust Banks, Inc. STI GA 208,252,000 176.8 15 SunTrust Banks, Inc. STI GA 208,252,000 8.79 16 Regions Financial Corp. RF AL 123,271,000 165.5 16 M&T Bank Corp. MTB NY 120,401,804 8.73 17 Fifth Third Bancorp FITB OH 142,264,000 156.8 17 BB&T Corp. BBT NC 220,340,000 8.66 18 Zions BanCorp. ZION UT 65,564,000 152.5 18 Zions BanCorp. ZION UT 65,564,000 8.21 19 Citizens Financial Group, Inc. CFG RI 151,356,000 145.8 19 Bank of America Corp. BAC NC 2,283,896,000 8.17 20 Bank of America Corp. BAC NC 2,283,896,000 143.4 20 Regions Financial Corp. RF AL 123,271,000 7.41 21 Capital One Financial Corp. COF VA 361,402,000 131.9 21 Citigroup Inc. C NY 1,889,133,000 7.19 22 Citigroup Inc. C NY 1,889,133,000 105.2 22 Citizens Financial Group, Inc. CFG RI 151,356,000 6.97 Median 181.3 Average 201.1 Source: S&P Global Market Intelligence Pricing as of 11/09/17 ROAE is annualized as of most recent quarter

Given that the nation’s very largest banks (the “SIFI” banks) are pretty much precluded from doing bank deals due to deposit share limitations and now the second largest tier of banks have become somewhat deal-allergic, what does that mean for the future of bank mergers? The data already show an absolute dearth of large bank deals in the wake of the Financial Crisis, and indeed large deal volumes have been declining since the utterly insane year 1998, when everybody seemingly merged with everyone else, sometimes creating nasty headaches in the process. We just cannot imagine any scenario—the regulatory forbearance of the Trump administration notwithstanding—under which the larger tier of banks would throw scarce capital at deals in an environment in which branch banking is apparently so fast losing its allure.

M&A Bank Deals Exceeding $5 Billion Total Deal Value from 1995 –Current 9 $300,000 $249,549 8 $250,000 7

6 $200,000

$55,867 5 $41,346 $103,505 $150,000 4 $22,020 $62,651 $72,993 $40,321 3 $100,000 $22,060 $18,795 $20,731 2 $50,000 $5,590 $49,329 $9,138 $5,373 1

0 $0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Total Deal Value ($B) (RHS) # of Deals > $5B (LHS) Source: S&P Global Market Intelligence

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But as we know so well here in the Southeast, the real action in deal-making has come not from the large regional banks but within the community ranks, and the ascendance of the “mega-community” banks—those community banks that have grown to and beyond the $10 billion-in-assets size—is promising that future deal making in that segment will have its own new set of wrinkles. For one thing, the laws of mathematics will increasingly apply—that these community giants (not an oxymoron, really) will have less interest in smaller community banks and instead will concentrate their attention on the franchises in the $3 billion-$5 billion size range and higher, and will increasingly be interested in banks that will enlarge their geographic reach and enhance their existing business mix.

M&A Activity for Banks > $50B in Assets from 1995 - Current 20 18 18

16 14 14 12 12 11 11 10 10 9 9 8 8 7 6 6 6 6 6 5 5 4 4 3 3 3

2 1 1 0 0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

# of Bank Buyers > $50B in Assets Source: S&P Global Market Intelligence

The “double dip” has long been an active concept in bank deal-making, and we have to question whether it may not be a merger factor whose time has passed. It is, of course, the expectation on the part of some bank CEOs that the sale of their banks will result in not only an initial premium, but that their stock holdings in the acquirer will at some point down the road get an additional pop when their new partner sells itself to a larger company. The concept of the double dip gained currency—no pun intended—for good reason, as banks like First Union hoovered up mid-sized franchises back in the 1990s and early 2000s and paid their managements handsomely (often with board seats and other perks) for their trouble.

We asked Terry Turner, CEO of Pinnacle Financial Partners (PNFP) of Nashville, on his views for the expectations of sellers recently, and whether the “double dip” mentality still existed. Mr. Turner is in a unique position to know the lay of the bank merger land, as he is the region’s premier consolidator of banks, as well as the head of a company that has been stunningly successful in converting acquired banks to Pinnacle’s own unique competitive lending culture. For this success, his stock is presently selling at 2.9x tangible book value— thus making his $20-plus billion company extremely unlikely to be acquired by any larger regional or national bank.

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Rank by Price / Tangible Book Value for U.S. Banks Between $10B-$25B in Assets Rank by Return on Average Equity for U.S. Banks Between $10B-$25B in Assets Total Total Assets P/TBV Assets ROAE Rank Company Name Ticker State ($000) (%) Rank Company Name Ticker State ($000) (%) 1 Community Bank System, Inc. CBU NY 10,839,220 363.5 1 Western Alliance Bancorp. WAL AZ 19,922,221 15.60 2 Home BancShares, Inc. HOMB AR 14,255,967 357.1 2 Bank of Hawaii Corp. BOH HI 17,268,302 15.01 3 Western Alliance Bancorp. WAL AZ 19,922,221 303.6 3 Bank of the Ozarks OZRK AR 20,768,493 11.65 4 Bank of Hawaii Corp. BOH HI 17,268,302 296.2 4 FCB Financial Holdings, Inc. FCB FL 10,229,332 11.31 5 Pinnacle Financial Partners, Inc. PNFP TN 21,790,371 287.1 5 Commerce Bancshares, Inc. CBSH MO 24,979,141 11.11 6 Sterling Bancorp STL NY 16,780,097 275.5 6 Texas Capital Bancshares, Inc. TCBI TX 24,400,998 10.95 7 South State Corp. SSB SC 11,169,110 267.5 7 Flagstar Bancorp, Inc. FBC MI 16,880,000 10.88 8 First Hawaiian, Inc. FHB HI 20,565,627 266.5 8 Cadence BanCorp. CADE TX 10,502,261 9.87 9 PacWest Bancorp PACW CA 22,242,932 254.6 9 Cathay General Bancorp CATY CA 15,728,417 9.85 10 MB Financial, Inc. MBFI IL 20,116,535 248.4 10 TCF Financial Corp. TCF MN 23,005,038 9.79 11 Prosperity Bancshares, Inc. PB TX 22,143,263 248.2 11 United Community Banks, Inc. UCBI GA 11,129,027 9.37 12 Chemical Financial Corp. CHFC MI 19,354,308 247.4 12 BancorpSouth Bank BXS MS 14,760,394 9.32 13 Commerce Bancshares, Inc. CBSH MO 24,979,141 243.7 13 Hope Bancorp, Inc. HOPE CA 14,150,021 9.26 14 Renasant Corp. RNST MS 10,323,687 241.9 14 Washington Federal, Inc. WAFD WA 15,253,580 9.18 15 Great Western Bancorp, Inc. GWB SD 11,690,011 241.3 14 Sterling Bancorp STL NY 16,780,097 9.18 16 First Interstate BancSystem, Inc. FIBK MT 12,206,473 241.2 16 MB Financial, Inc. MBFI IL 20,116,535 9.14 17 Bank of the Ozarks OZRK AR 20,768,493 234.8 17 UMB Financial Corp. UMBF MO 20,279,503 9.10 18 United Bankshares, Inc. UBSI WV 19,129,978 225.6 17 First Hawaiian, Inc. FHB HI 20,565,627 9.10 19 First Midwest Bancorp, Inc. FMBI IL 14,267,142 215.8 19 Community Bank System, Inc. CBU NY 10,839,220 8.88 20 Texas Capital Bancshares, Inc. TCBI TX 24,400,998 214.0 20 PacWest Bancorp PACW CA 22,242,932 8.84 21 Cathay General Bancorp CATY CA 15,728,417 210.7 21 Fulton Financial Corp. FULT PA 20,062,860 8.83 22 BancorpSouth Bank BXS MS 14,760,394 209.7 22 Trustmark Corp. TRMK MS 13,884,655 8.77 23 Old National Bancorp ONB IN 15,065,800 202.9 23 Great Western Bancorp, Inc. GWB SD 11,690,011 8.66 24 United Community Banks, Inc. UCBI GA 11,129,027 201.8 24 South State Corp. SSB SC 11,169,110 8.64 25 Capital Bank Financial Corp. CBF NC 10,139,985 199.3 25 Old National Bancorp ONB IN 15,065,800 8.31 26 FCB Financial Holdings, Inc. FCB FL 10,229,332 197.2 26 First Midwest Bancorp, Inc. FMBI IL 14,267,142 8.24 27 Valley National Bancorp VLY NJ 23,780,661 197.1 27 Central Bancompany, Inc. CBCYB MO 12,807,279 7.82 28 Fulton Financial Corp. FULT PA 20,062,860 193.7 28 First Interstate BancSystem, Inc. FIBK MT 12,206,473 7.73 29 Banner Corp. BANR WA 10,443,086 192.8 29 Capital Bank Financial Corp. CBF NC 10,139,985 7.66 30 Cadence Bancorp. CADE TX 10,502,261 189.4 30 Banner Corp. BANR WA 10,443,086 7.56 Median 241.2 Average 242.3 Source: S&P Global Market Intelligence Pricing as of 11/09/17 ROAE is annualized as of most recent quarter

Mr. Turner said that the hope of the “double dip” likely still persisted in some corners of the community banking world, but that the managements of the banks that had chosen to ally with him (Bank of North Carolina most recently and Avenue Bank before that) instead saw Pinnacle’s record of consistent profitability and growth as the more attractive alternative for their futures. And who can blame them? In today’s banking world the “grow or die” imperative seems to us to be pretty strong, and thus the attempts of banks like BB&T and Regions to regain the momentum that we believe has been lost to the Pinnacles and South States of the world.

What about mergers of equals as an alternative strategy for smaller community banks? These remain a possibility—but a remote one—in our experience, and for a host of reasons. The need for one side to exit in an MOU—best illustrated in the BB&T and Southern National merger in 1995—remains a major obstacle, as smaller community banks are often dominated by long-extant large shareholders and often by family holdings. But these companies need to think seriously about the competitive issues as these street-smart large community banks gain footholds in more communities and have the wherewithal to attract the best and the brightest—and the best connected—community lenders. An MOU may not be the most attractive alternative for community bank managements that were hoping for big cash-outs, but it may become one of the few solutions remaining.

Atlanta | Charlotte | BanksStreetPartners.com November 10, 2017 7 The Death of the Double Dip

Yes, the deal-making landscape is changing, but in retrospect, why would we have expected otherwise? The regulatory changes that were enacted in the wake of the Financial Crisis combined with the generational and demographic changes taking place in America were guaranteed to speed up the evolution of banking away from the branch-based model. Add to that the competition from fintech—and the increasing adoption of fintech methods and models when possible—and we see the remaking of the banking system as gaining incredible momentum and swerving in new and unexpected directions. (Crypto-currencies, anyone?) Merger expectations must similarly evolve—and quickly—or banks thinking in old ways and with old expectations risk stasis and irrelevance, and a much-diminished future.

To read NAB Research’s disclosures for the preceding commentary, please follow this link: http://www.BushOnBanks.com/disclosure.shtml

This commentary was provided by Nancy A. Bush, CFA of NAB Research, LLC and is being distributed by Banks Street Partners, LLC. The views of the author do not necessarily represent the view of Banks Street, and Banks Street has neither directed nor had editorial oversight over the content. Material in this report is from sources believed to be reliable but no attempt has been made to verify its accuracy. Past performance is no guarantee of future results. Banks Street Partners actively seeks to conduct investment banking in the financial institutions and services sector, including with the companies listed in this report. To learn more about Banks Street Partners, please visit www.BanksStreetPartners.com.

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