Notes from the Ambassador Bank Vault February 28, 2017 Summary

26 Pages·2017·10.11 MB·English

Notes from the Ambassador Bank Vault February 28, 2017

Mergers & Acquisitions: A Look at New York State
Don’t You Let That Deal Go Down

Summary

The sharp increase in bank stock prices since Donald Trump’s election has fueled speculation that merger
and acquisition activity will accelerate. Based on anecdotal evidence, however, it appears that opinion is
divided whether superior operating conditions will lead to significantly more deals. Our conversations
with investors revealed their broad belief that deal volume will increase because buyers have stronger
currencies and can pay higher premiums that sellers will readily accept. (I’m gonna make him an offer he
can’t refuse!) Conversely, bankers and deal lawyers generally opined that the underlying causes of higher
stock prices – talk of lower taxes, less regulation, and favorable interest rates – could encourage banks to
remain independent. Succession and other social issues, rather than strict economics, are among the
reasons why community banks sell.

The number of willing sellers probably won’t change much, but the odds of finding an interested buyer
should be greater than in recent years, and result in moderately more deals in 2017. Potential sellers will
likely see more opportunities to realize higher deal premiums in 2017. In other words, prospective sellers
should be abler to find a willing buyer with the capacity to pay the asking price.

Deals, however, are likely to be smaller in size - there are fewer mid-sized banks and smaller banks have
more reasons to exit due primarily to the lack of economies of scale necessary to overcome earnings
challenges. Our data dependent analysis suggests deal pace will follow recent trends until there are
strong signs that the economy either picks up significantly or falls precipitously. The consensus forecast
for GDP growth is moderately higher in 2017 vs. 2016. There were 246, 279, and 282 announced deals
nationally in 2016, 2015, and 2014, respectively.

Since the onset of the Great Recession, bank mergers have been rare in both Upstate New York and the
greater New York City metropolitan area. We define Upstate New York (“Upstate”) as the region north and
west of New York City and Long Island. Upstate is more rural and includes the cities of Albany, Buffalo,
Rochester, and Syracuse. New York City, and its associated markets, contrast vividly (culturally,
demographically, economically, and politically) from the rest of the state. As a result, most of New York’s
financial institutions cater to either Upstate or New York City. Generalizations, however, are meant to be
broken; and exceptions include Bank of America Corporation (NYSE: BAC), JP Morgan Chase & Co. (NYSE:
JPM), and M&T Bank Corporation (NYSE: MTB), which operate across the state.

Since the start of 2008, there have been 40 merger transactions with New York sellers. Only nine deals were
announced since January 1, 2015, with the largest being the purchase of Buffalo-based First Niagara
Financial by KeyCorp (NYSE: KEY) on July 29, 2016.

Rick Weiss Matt Resch Rob Pachence Eric Tesche Michael Rasmussen
610.724.7133 610.351.1633 610.351.1633 610.351.1633 610.351.1633
[email protected] [email protected] [email protected] [email protected] [email protected]
Highlights

• New York has 130 regulated depository institutions, of which 58 are publicly-traded banks and thrifts.
Excluding money center banks, 17 companies have assets greater than $2 billion. The top five banking
institutions in the Empire State combine for 67% of the state’s deposit market share. JP Morgan Chase
leads with 37% of the total deposit market share.
• As of February 27, 2017, there were 277 bank and thrift deals announced nationally (only 3 involved New
York-based sellers) since January 1, 2016. The pending acquisition of Suffolk Bancorp (NYSE: SUBK) by
People’s United Financial (NASDAQ: PBCT), which was announced on June 27, 2016, is the largest deal with
a New York State seller agreed to in the past 12 months. Effective January 1, 2017, the merger agreement
between Astoria Financial (NYSE: AF) and New York Community Bancorp (NYSE: NYCB) was terminated.

• Future deals involving New York State sellers should be smaller in size as many banks have assets less than
$2 billion and bigger in-state banks appear to be interested buyers, rather than sellers. Among New York’s
publicly-traded banks and thrifts, 12 have total assets between $2 and $10 billion; and are generally well-
capitalized, profitable, and trade at healthy multiples.

• New York’s smaller community banks largely avoided lasting damage from the Great Recession. Many of
these banks, moreover, are accustomed to operating in slower-growing markets and have generally
satisfied shareholders (primarily retail) via acceptable returns on equity along with steady dividends.

• Companies with stronger currencies are typically the more active acquirers. Among the larger in-state
institutions, the more logical buyers of New York State’s community banks appear to be Community Bank
System, Inc. (NYSE: CBU), NBT Bancorp, Inc. (NASDAQ: NBTB); Sterling Bancorp (NYSE: STL), and Tompkins
Financial Corporation (NYSE: TMP).

• Among the larger out-of-state institutions, the more logical buyers of New York’s community banks should
be BankUnited, Inc. (NYSE: BKU), Berkshire Hills Bancorp, Inc. (NYSE: BHLB), Northwest Bancshares, Inc.
(NASDAQ: NWBI), Peoples United, Provident Financial Services, Inc. (NASDAQ: PFS) and Webster Financial
Corp. (NYSE: WBS). Investors Bancorp, Inc. (NASDAQ: ISBC) appears to be sidelined due to regulatory issues.

• Bank and thrift merger premiums should increase significantly due to the stronger currencies of potential
buyers. It remains to be seen if acquirers will be more disciplined than in previous M&A cycles.

• On an individual basis, banks are sold and not bought; and not necessarily for pure economic reasons.
On an aggregate basis, however, it appears that major changes in the overall economy and regulatory
environment have a more significant impact on bank merger activity.

• Depending upon the deal price, acquiring core deposits may be preferable vs. organic growth. This
becomes even more vital in a rising interest rate environment as core deposits become more valued.

• On a national basis, the core deposit premium (at announcement) was 7.1% for the six months ending
February 28, 2017, vs. 5.6% and 5.1% for the year ending December 31, 2015, and 2104, respectively. Core
deposit premiums have edged higher, but are far below core deposit premiums that were paid 10 years ago
by acquirers (median premiums for 2006 were 19.6% and 16.4% for banks and thrifts, respectively).

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• Despite more ability and willingness on the part of buyers to make acquisitions, consolidation activity could
be restrained by managements’ desire to remain independent for social and other reasons, rather than
strictly adhering to the discipline of maximizing shareholder value. Mergers of equals often make sense
financially but rarely occur due to social factors. The difficulty of forming a de novo bank probably restricts
deal activity, as sellers have one less career path option.

• Effective cyber-security is a growing concern and involves much more than a one-time technology upgrade.
Management and staff must exercise proper corporate governance and prove to regulators that complex
operational risk issues are under control.

• Companies that invest in technology and enhanced management systems should seek strategic partnerships
to realize economies of scale. One of the bigger cost elements related to compliance is staffing, and smaller
banks, in particular, are more apt to sell as they often lack the critical mass of interest-earning assets and/or
other revenue drivers to offset fixed costs. Anecdotal evidence suggests banks are frustrated by the lack of
supervisory guidance regarding the level of systems and personnel needed to satisfy regulatory
requirements.

• Banks of all sizes need to upgrade risk management systems, which will weigh down efficiency ratios and
earnings in the short-run. Complex customer relationship management systems, asset/liability procedures,
and credit review processes should help profitability and reduce risk over time, but it is difficult for investors
to assess these infrastructure improvements.

• Institutions with significant commercial real estate loan concentrations face more regulatory scrutiny. We
believe this issue has factored into the strategic planning process of a number of institutions.

• Improved asset quality continued through the December 2016 quarter, which should increase confidence
among acquirers that they are not buying “problems”. Banks that have superior asset quality or at least
exhibit signs of improving credit are more desirable targets.

Table of Contents
Summary ...................................................................................................................................................... 1
Highlights ..................................................................................................................................................... 2
Recent New York Deals ................................................................................................................................ 4
Valuation Summary ..................................................................................................................................... 5
Investment Thesis ........................................................................................................................................ 8
New York Market Demographics ............................................................................................................... 12
Appendix A: New York Bank & Thrift Highlights ........................................................................................ 15
Appendix B: Deposit Market Share by County ........................................................................................... 17

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Recent New York Deals

Figure 1: Recent Bank Deals

Price/ Price/ Core
Deal Tangible LTM Deposit
Completion Value Book Earnings Premium
Buyer/Target Name Status Date* ($MM) (%) (X) (%)

People's United Financial, Inc./ Suffolk Bancorp Pending 6/27/2016 402.3 198.3 21.4 11.7
Norwood Financial Corp./ Delaware Bancshares, Inc. Completion 7/31/2016 15.2 114.5 25.7 0.7
KeyCorp/ First Niagara Financial Group, Inc. Completion 7/29/2016 4,171.8 173.7 19.3 NA
Preferred Bank/ United International Bank Completion 11/20/2015 22.1 109.3 50.8 2.1
Cathay General Bancorp/ Asia Bancshares, Inc. Completion 7/31/2015 126.0 167.4 23.8 17.1

Sterling Bancorp/ Hudson Valley Holding Corp. Comp letion 6/30/2015 538.2 188.4 NM 9.4
Bridge Bancorp, Inc./ Community National Bank Completion 6/19/2015 141.3 184.6 31.3 9.5
Bank of the Ozarks, Inc./ Intervest Bancshares Corporation Completion 2/10/2015 228.5 110.6 13.7 2.8
Salisbury Bancorp, Inc./ Riverside Bank Completion 12/5/2014 27.3 108.8 15.1 1.4
Bridge Bancorp, Inc./ FNBNY Bancorp, Inc. Completion 2/14/2014 5.4 40.6 NM -5.3

Provident New York Bancorp/ Sterling Bancorp Comp letion 10/31/2013 343.1 167.9 17.1 8.1
Hana Financial Group Inc./ BNB Financial Services Corporation Completion 8/30/2013 11.3 53.1 NM -7.9
NBT Bancorp Inc./ Alliance Financial Corporation** Completion 3/8/2013 230.7 212.1 19.1 12.4
Provident New York Bancorp/ Gotham Bank of New York Completion 8/10/2012 40.5 128.5 16.8 4.1
Modern Capital Partners L.P./ Madison National Bancorp Inc. Completion 4/2/2012 33.8 111.3 NM 2.2

BankUnited, Inc./ Herald National Bank Comp letion 2/29/2012 70.0 183.2 NM 7.9
Valley National Bancorp/ State Bancorp, Inc. Completion 1/1/2012 230.1 189.9 23.7 9.7
Bridge Bancorp, Inc./ Hamptons State Bank Completion 5/27/2011 6.3 136.2 40.6 4.4
Community Bank System, Inc./ Wilber Corporation Completion 4/8/2011 101.8 140.6 13.4 4.6
Chemung Financial Corporation/ Fort Orange Financial Corp. Completion 4/8/2011 28.8 129.7 26.3 3.6

People's United Financial, Inc./ Smithtown Bancorp, Inc. Comp letion 11/30/2010 60.1 50.8 NM -4.0
Millbrook Bank System, Inc./ SNB Bancorp, Incorporated Completion 10/1/2010 6.0 186.1 NM 8.0
Investor group/ Community Bank of Orange, National Association Completion 10/6/2008 NA NA NM NA
U.S. Bancorp/ Mellon 1st Business Bank, NA Completion 6/2/2008 NA NA NA NA

Deals announced through February 23, 2017
*Announcement date is listed for pending deals
**Buyer advised by Ambassador Financial Group
Source: S&P Global Market Intelligence

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Figure 2: Recent Thrift Deals

Price/ Price/ Core
Deal Tangible LTM Deposit
Completion Value Book Earnings Premium
Buyer/Target Name Status Date* ($MM) (%) (X) (%)

Wallkill Valley Federal SLA/ Hometown Bancorp, Inc. (MHC) Pending 12/16/2016 7.0 88.7 NM -1.0
Community Bank System, Inc./ Oneida Financial Corp. Completion 12/4/2015 142.1 204.4 27.4 11.6
Putnam County Savings Bank/ CMS Bancorp, Inc. Completion 4/28/2015 25.4 113.7 40.2 1.7
Kearny Financial Corp. (MHC)/ Atlas Bank Completion 6/30/2014 NA NA NA NA
Northfield Bancorp, Inc. (MHC)/ Flatbush Federal (MHC) Completion 11/2/2012 18.2 120.0 NM 3.8

Berkshire Hills Bancorp, Inc./ Beacon Federal Bancorp, Inc. Comp letion 10/19/2012 130.4 116.8 22.6 3.7
Wallkill Valley Federal SLA/ Highland Falls Federal SLA Completion 7/6/2012 NA NA NA NA
Investors Bancorp, Inc. (MHC)/ BFS Bancorp, MHC Completion 1/6/2012 10.3 25.3 NM -9.5
Investor group/ Community FSB Holding Company Completion 9/8/2011 NA NA NA NA
Berkshire Hills Bancorp, Inc./ Rome Bancorp, Inc. Completion 4/1/2011 73.3 119.6 19.3 NA
Quontic Bank Acquisition Corporation/ Golden First Bank Completion 12/1/2009 NA NA NA NA

Deals announced through February 23, 2017
*Announcement date is listed for pending deals
Source: S&P Global Market Intelligence
Valuation Summary

As of February 27, 2017 (the date we went to press), the median price-to-trailing 12-month earnings and price-
to-tangible book multiples for New York State banks and thrifts (ex. MHCs) billion were 20.8x and 189%; and
18.0x and 175%, respectively. As of the same date, mid-Atlantic banks with total assets between $500 million
and $50 billion were trading at median multiples of 18.2x and 164%, respectively. The core deposit
premium was 5.2%. Mid-Atlantic thrifts with total assets between $500 million and $50 billion were trading at
median multiples of 21.0x and 151%, respectively. The core deposit premium was 8.1%. Nationally, the
median price-to-trailing 12 month earnings and price-to-tangible book multiples for banks with total assets
between $500 million and $50 billion were 19.0x and 174%, respectively. The core deposit premium was
7.7%. Nationally, the median price-to-trailing 12 month earnings and price-to-tangible book multiples for
thrifts with total assets between $500 million and $50 billion were 21.4x and 149%, respectively. The core
deposit premium was 6.8%. Many of the stock prices of those banks and thrifts are based on tangible book
value, rather than earnings.

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Figure 3

Median Bank Trading Multiples
35 300
%)
30 250 ue (
x) al
( 25 V
S 200 k
P o
E 20 o
TM 150 e B
L 15 bl
e to 10 100 angi
c T
Pri 5 50 e to
c
0 0 ri
P
0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6
0 0 0 0 0 0 0 0 0 0 1 1 1 1 1 1 1
0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2
Q
4
Price/LTM EPS Deal: Price/LTM EPS
Price/TBV Deal: Price/TBV

Includes all publicly traded U.S. banks
Source: S&P Global Market Intelligence
Figure 4

Median Thrift Trading Multiples
35 300 %)
30 250 ue (
S (x) 25 200 k Val
P o
E 20 o
LTM 15 150 ble B
o gi
e t 10 100 an
c T
Pri 5 50 e to
c
0 0 ri
P
0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6
0 0 0 0 0 0 0 0 0 0 1 1 1 1 1 1 1
0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2
Q
4
Price/LTM EPS Deal: Price/LTM EPS
Price/TBV Deal: Price/TBV

Includes all publicly traded U.S. banks
Source: S&P Global Market Intelligence
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Figure 5

SNL U.S. Bank & Thrift
Price / Tangible Book
210
2/23: 198.11
200
190
180
% +28.2%
170
160
Election Day
150
11/8: 154.55
9/30: 150.87
140
9/30 10/14 10/28 11/11 11/25 12/9 12/23 1/6 1/20 2/3 2/17

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Investment Thesis

New York Appears Ready For Moderate Bank Consolidation

There have been approximately 7,900 bank mergers (excluding government-assisted) since 1990 – over 4,100
banks were sold between 1990 and 2000. There were also roughly 2,000 bank failures in the United States
since 1990. As a result, the number of banks has declined from approximately 15,000 in the mid-1980s to
roughly 5,500 today.

The chart below shows the correlation between GDP and the number of bank mergers. The largest change in
the number of deals occurs in those years when GDP contracts significantly. We surmise that a poor economy
typically leads to credit quality problems, which in turn, stymies deal flow as potential buyers are reluctant
to assume another banks’ troubled assets. For example, the number of banks deals dropped 49% from 2007-
2008 when the economy soured. Conversely, deal volume picks up when the economy starts to improve as
evidenced by the number of transactions in 2010 compared with 2009.

Figure 6

Deal Volume vs. U.S. GDP
600 6.00%
500
4.00%
e 400
m 2.00% P
u D
ol 300 G
al V 0.00% U.S.
e
D 200
-2.00%
100
0 -4.00%
9 1 3 5 7 9 1 3 5 7 9 1 3 5
8 9 9 9 9 9 0 0 0 0 0 1 1 1
9 9 9 9 9 9 0 0 0 0 0 0 0 0
1 1 1 1 1 1 2 2 2 2 2 2 2 2
Deals GDP

According to a recent forecast by Kiplinger, the U.S. Gross Domestic Product is projected to be 2.1% for 2017,
roughly inline with the growth rate for 2016. The projected economic growth rate in the U.S. continues to be
deliberate, which suggests that recent merger and acquisition trends are likely to continue. The law of
numbers, moreover, implies that the number of deals should decline over time as the industry continues to
shrink. There has not been a year since the 1990s when the number of merger transaction reached 300,
although 2006 was very close! Merger and acquisition activity in the Empire State, however, is likely to
increase from a very low base as only three deals were announced with publicly-traded New York State
sellers since January 1, 2016.

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On a national basis, there were 246 bank and thrift deals in 2016, compared with 279 deals for the 12 months
ending December 31, 2015. New York fits in with our macro-thesis that the banking industry needs
consolidation in order to alleviate irrational pricing decisions and achieve economies of scale. We also
believe deals will occur mainly in the New York City metropolitan markets where buyers have a better
chance of accelerating earnings growth, although franchises located in slower-growing markets can be
desirable because of their core deposits.

Merger activity has been fairly steady across the nation, but has lagged in New York State despite several mid-
sized community banks with the financial wherewithal and managerial talent to accomplish successful
acquisitions. Banks, however, are sold and not bought - as the saying goes, “you can lead a horse to water, but
you can’t make him drink.” Smaller companies, in particular, face earnings issues and ever-increasing
regulatory demands, but management and board teams show much resiliency to cope with these
challenges. Market expectations seem to have been geared up since the presidential election, although we
suspect there is still a pricing disparity between sellers’ expectations and buyers’ ability to pay market
premiums without incurring significant earnings dilution. In the meantime, bank valuations appear pricey
based strictly on fundamentals.

New York State merger and acquisition activity will probably occur selectively - based upon strategic needs
and situational opportunities - rather than in a wave of deals caused by macro operating or regulatory
concerns. The announced sale of Suffolk Bancorp to People’s Financial was apparently based, in part, on
commercial real estate loan (“CRE”) concentration issues. Although the merger agreement between Astoria
and New York Community was terminated, the deal was apparently was caused, in part, by pressure from
Astoria’s institutional shareholder base. The underlying reason behind First Niagara’s sale to KeyCorp was the
poor shareholder returns due to earnings disappointments and ill-advised acquisitions.

Among the larger community banks in New York State, Community Bank System, Inc. (NYSE: CBU), which has
total assets of $8.7 billion, and NBT Bancorp, Inc. (NASDAQ: NBTB), which has total assets of $8.6 billion will
face challenges if and when its total assets exceed $10 billion. Among other items mandated by the Dodd-
Frank Act, institutions that exceed $10 billion are capped on fees it can charge retailers, face more extensive
stress tests, and are directly regulated by the Consumer Finance Protection Board. We suspect that the bad
blood between the two parties in Congress will prevent or delay many changes to the Dodd-Frank Act that
directly affect banks which exceed $10 billion.

Increased CRE loan concentration has attracted more regulatory scrutiny. Bank regulators, including The
Office of the Comptroller of the Currency (“OCC”), the Board of Governors of the Federal Reserve System
(“Fed”), and the Federal Deposit Insurance Corporation (“FDIC”) have greater concerns regarding low
capitalization rates and fast-appreciating property values. These agencies also noted that CRE loan
underwriting standards have eased and certain risk management practices at some institutions that cause
concern include a greater number of underwriting policy exceptions and insufficient monitoring of market
conditions. The agencies specified supervisory criteria that they intend to focus on to reduce portfolio risk: (1)
total construction, land development and other land loans representing 100% or more of total risk-based
capital; (2) total CRE loans representing 300% or more of total risk-based capital; and (3) if the outstanding
balance of the institution’s CRE and/or construction loan portfolio increased 50% or more during the prior 36
months.

Institutions with outsized CRE loan portfolios may expect regulators to require more detailed plans to
identify, measure, and monitor CRE concentrations; raise underwriting standards; slow growth; and/or to
raise capital. We believe that some management teams will prefer to sell the institution instead. Anecdotal
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evidence suggests some New York institutions are slowing growth and/or tightening underwriting standards as
a result.

Despite more widespread shareholder activism, consolidation activity could be restrained by managements’
desire to remain independent for social and other reasons, rather than strictly adhering to the discipline of
maximizing shareholder value. Considerations for potential sellers include the flattening yield curve, ongoing
technology and cyber-security costs, regulatory demands, succession planning, edgy shareholder activists, and
attractive deal premiums.

On a national scale, the stock price performance of acquirers was generally strong over the past three
years or so. From the time that deals were announced in 2014, 2015, and 2016 through February 23, 2017,
the stock prices of buyers have outperformed the SNL U.S. Bank and Thrift Index by a median of 8.2%. We
generally attribute such performance to the overall market and deals that were reasonably valued and made
sense strategically. We opine that low premium deals afford higher price potential on a combined basis
because management does not need to extract cost savings that hurt, rather than help, long-term profitability.
Examples of recent New York deals are shown below.

• On June 27, 2016, People’s United Financial, which is headquartered in Bridgeport, CT, announced an
agreement to acquire Long-Island-based Suffolk Bancorp. At the time of announcement, the transaction
was valued at approximately $402 million and the consideration is all-stock. The transaction was valued at
approximately 196% of tangible book value and 20.4x trailing 12-month earnings. The core deposit
premium was 11.7%. Suffolk’s stock price soared 27.7% over the two days following the announcement
whereas People’s stock price fell 6.3% over the same time period.

• Honesdale, PA-based Norwood Financial Corp. (NASDAQ: NWFL) completed its acquisition of Walton, NY-
based Delaware Bancshares, Inc. on July 31, 2016. The combined company has total assets of $1.1 billion
and 27 branches. As of June 30, 2016, Delaware had total assets of $378 million and six branches in
Delaware County, New York. The merger between Norwood and Delaware was valued at approximately
$15 million. At the time of announcement, the transaction was valued at approximately 116% of tangible
book value and 16x trailing 12-month earnings. The core deposit premium was 0.8% at the time of
announcement.

• KeyCorp (NYSE: KEY) acquired First Niagara Financial Group, Inc. on July 29, 2016. Announced on October
30, 2015, the aggregate deal value was $4.2 billion and the consideration was stock and cash. First Niagara
was headquartered in Buffalo, and had total assets of approximately $39.4 billion. First Niagara also had a
meaningful presence in Connecticut and Pennsylvania. At completion, the deal was priced at 147% of
tangible book value and 20.9x trailing 12-month earnings. KeyCorp’s stock price sank 7.7% over the two
days following the announcement.

• Syracuse-based Community Bank System acquired Oneida Financial Corp. on December 4, 2015. Based in
Oneida, Oneida had total assets of approximately $798 million. The transaction had an aggregate deal value
of approximately $142 million and was valued at 220% of tangible book value, 28.2x trailing 12-month core
earnings and carried a 13.4% core deposit premium at completion. CBU’s stock price increased 2.2% over
the two days following the deal announcement.

(cid:1) Due to Office of the Comptroller (“OCC”) regulations that preclude a federally-chartered thrift from
being acquired for a three year period following its initial mutual to stock conversion, thrifts that
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