FDIC-assisted deals to dominate 2010 deal landscape

Cleaner balance sheets and an improving economy likely will lay the groundwork this year for a return to more normal merger and acquisition activity after a quiet 2009, but investment bankers agree that, while the foundation will be laid, it is not clear when deal volume among healthy companies will resume.

Investment bankers also agree on why: The anticipated flood of bank failures in 2010, a total that many say will eclipse last year's 140, will distract many would-be buyers from traditional deals. Relatively strong banks on the hunt for deal targets likely will have their hands full poring over the failures that will litter the landscape. Banks that work with the FDIC to buy up the assets of failed institutions typically enter into attractive loss-sharing arrangements with the agency, which has made FDIC-assisted deals appealing over the past several quarters.

That is sure to continue throughout much of this year and likely beyond, William Hickey, a principal and co-head of investment banking at Sandler O'Neill & Partners LP, told SNL after presenting at Bank Director magazine's annual Acquire or be Acquired conference in Phoenix on Feb. 1.

"There will be some deals done, I think, among healthy banks, but they will be overshadowed by FDIC-assisted deals," Hickey said. "We're a long way from the end on that front. ... Regulators are closing about six banks each week this year. So take however many weeks there are left in the year, multiply that by six, and that's about how many FDIC-assisted deals we have before us. … So no matter what else happens, we still have to work through a lot of those deals."

John Duffy, chairman and CEO of Keefe Bruyette & Woods Inc., agreed that failures in 2010 are sure to exceed the level of 2009.

"We're not close to being done," Duffy said during a presentation at the conference. Duffy said some potential buyers, too, are wary of pending regulatory changes being debated in Washington. As such, many healthy banks still are leaning toward "preserving capital" rather than deploying it.

Some of the most dramatic changes that could happen would be among the regulators themselves, said Robert Clarke, a former U.S. comptroller of the currency. He said some regulatory bodies could be merged. He also suggested that it would be wise for large banks and their holding companies to be supervised by the same regulator, a change that would diminish the regulatory role of the Federal Reserve.

"I think now is the time" for such changes, Clarke said at the conference.

Such distractions aside, however, Duffy said there is good reason to believe that the worst of the financial crisis is behind the banks as a group, a development that could indeed make 2010 the year in which the industry re-establishes its collective health and sets the stage for a rise in M&A activity in coming years.

Duffy said commercial real estate losses will remain a nagging concern for banks this year, and overall nonperforming assets will remain elevated for several quarters. But the pace of falling home prices is slowing in more markets than not, helping to minimize the greatest thorn in banks' sides over the past two years, and the nation's jobless level — a lagging indicator — may have already peaked, signaling that the economy is healing and that banks' credit woes are easing.

"We're getting the sense that more banks are getting to the curve or ahead of the curve, as opposed to behind it," Duffy said. "We think the worst is over."

Michael McClintock, a managing director of investment banking at FBR Capital Markets, said at the conference that banks that want to be in a position to buy in the year ahead should be sure to fortify their capital levels now, ensuring that they have substantial funds to absorb the costs any potential deal target would pose. There will be chances "to take advantage of your weak competitors," he said.

In an improving operating environment, Hickey said capital-rich banks "will have a lot of opportunities. And with interest rates sure to rise from historical lows later this year or next, he said, bank valuations likely will fall because bank stocks tend to decline when rates rise. This could give would-be sellers motivation to sell before rates rise, he said, creating "a target-rich environment."

But he said that, ultimately, FDIC-assisted deals will be the M&A story of 2010, even more so than last year. Indeed, in an unscientific poll of conference attendees, organizers found that 82% expect the industry will not see normal M&A levels until 2012. Yet 52% said they expect their bank to do some kind of a deal during 2010, suggesting that activity will be high but likely focused on nontraditional transactions, including government-assisted deals.

"The year will be dominated by FDIC deals," Hickey said.

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