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Invictus Consulting Brings Out M&A Banking Market Report

January 30, 2014

Banks that acquire without considering the impact of their target's regulatory capital requirements, but instead concentrate on earnings accretion, are doing a disservice to their shareholders, according to Bleeders and Leaders: Redefining the 2014 U.S. M&A Banking Market, a new report from Invictus Consulting Group . According to a release, the report focuses on M&A as one solution to the return on investment problems besetting community banks. It incorporates the results of capital stress tests of virtually every U.S. bank with assets below $10 billion using a proprietary formula that helps identify and rank acquisition targets, and calculates the best M&A option for each bank to improve shareholder value. Invictus CEO and co-author Kamal Mustafa said that too many bank executives and M&A professionals are wrongly focusing on the gross earnings of acquisitions, distorting the perception of market pricing. He writes that transactions conducted without considering the implications of regulatory capital are "flawed." In addition, the report found that although banks have improved considerably since Invictus Consulting Group's October 2012 M&A analysis, shareholders of about half the banks in the country would still be better off if the bank undertook some form of M&A activity, the new report finds. About 1,400 banks-or 20 percent of the total- are so poorly positioned that they must or should sell to survive. In performing the M&A analysis, Invictus adopted a methodology based on the important idea that not all asset risk is equal, thus accounting for the difference in capital requirements among banks. In essence, rather than focusing on a bank's return on assets, the Invictus formula measures asset return divided by the necessary regulatory capital needed to support those assets (labeled the Invictus Return on Required Capital Ratio). Invictus discovered that several recent bank M&A transactions resulted in entities with dangerously low regulatory capital. Though many of these acquisitions were "accretive to earnings," they also had: -Dangerous mixes of high-return and high-risk assets that required more capital support. -Loans heavy with pre-recession vintages, meaning that they have higher margins but greater risk. Analysis shows that: -828 community banks, or 12 percent of the U.S. market, have low capital levels and poor earnings. This group-the "Must Sells"-have limited strategic options. The report notes that these banks may undertake very little M&A activity in the near future, although they are the ones that need it the most. -573 banks should sell. These banks have better capital adequacy, but have poor earnings. The report classifies the "must sell" and "should sell" banks as bleeders. -815 banks have sufficient regulatory capital levels, but mediocre earnings. These banks must buy to improve shareholder value and earnings potential. -1,110 banks should buy another bank. They should focus on selective acquisitions to help earnings and keep capital levels steady. -3,395, or about 50 percent of U.S. community banks, are categorized as Balanced. They have sufficient capital and good earnings. While they do not need to buy, they are in a strong position to do so. Invictus sees: -Limited organic growth for the industry, reflecting declining loan and refinancing demand, increased competition for new loans, and falling net interest margins. -Serious long-term capital adequacy issues that could erode shareholder value rather than enhance it if regulatory capital issues are not suitably taken into account. Despite the regulatory capital dangers, banks in the "Must Sell" category have generally been holding out and distorting the market, the report said. These banks have been lulled into a false sense of security and expect that because of other transactions involving similar lending institutions, they can command higher multiples in the marketplace. The reality is that for these banks, capital requirements and a low interest rate-spread environment will destroy their value, the report said. The Invictus report sees these banks having significant problems going forward, including depleted capital levels, weakening competitive position, regulatory pressure and potential interest rate shock. The smarter among this group of banks will actively seek a buyer and agree to the best deal they can get, according to the paper. The report includes both public and private banks. The data can be customized by state and geographic region upon request. Invictus Consulting Group is a bank financial risk management and advisory firm. ((Comments on this story may be sent to ))

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