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Scoreboard, Winter 2000
With Share Prices Depressed,
Deals Were Way Down in
1999
Outlook for Improvement Hangs on Fundamentals,
and
Analysts Disagree on Trend
by Mary Beausoleil
While other economic sectors were exuberantly setting new deal-making
records in 1999, the bank and thrift sector languished. Not only was
deal activity far less than in 1998 — which set a mark so extraordinary
it's not surprising that it wasn't topped — but it was far less
than in most years of the decade.
Only two years in the decade had fewer deals than the 339 in 1999, and
one must go back to the beginning to find them. In 1990 and 1991, with
a recession going on, there were just 216 and 305 deals, respectively.
In all other years until last year there were more.
In terms of total deal values, 1999 fared much better. The $75.7 billion
for the year was the third-highest total of the decade, following 1998
and 1997. That shows how banks have grown over the decade: A year that
ranks third from the bottom in numbers ranks third from the top in deal
values.
What is the outlook for 2000? It will depend largely on what happens
to bank stock prices.
Currency
Devalued
The main reason for the slow year in 1999, of course, was that bank
stocks were clobbered, with the frequent buyers club generally being
hit hardest.
It started in the late summer of 1998 with the financial crisis in Asia,
and except for brief interludes of improvement, it hasn't let up.
Eventually it became clear that the Asian disaster wasn't going to turn
into a worldwide depression, but other worries took over. Interest rates
are up, and could rise again. Credit quality has deteriorated, although
in most cases not seriously, but fears about a worsening persist because
it's the top of the cycle and could turn at any moment. The credit cycle,
unlike Y2K, is something that Wall Street analysts and Main Street bankers
— some of them, anyway — have experienced before.
In addition, several large banks issued earnings warnings for 1999,
many because of setbacks with past mergers. They either experienced
integration problems or failed to produce promised revenue gains.
Other factors also played a role. The Y2K bug didn't bite, but it was
a truly unique event and therefore unpredictable, and it soaked up billions
of dollars in preventive maintenance. It no doubt contributed somewhat
to the reduced deal activity, although probably more in the first two
quarters than the last two.
There's a vicious cycle at work, too. The reduced stock prices depress
deal activity, and depressed deal activity contributes to the reduced
stock prices. Some of the earlier run-up in bank stocks was on merger
speculation — still a factor in some individual cases.
A
Fundamental Question
Whether fundamentals improve or worsen is a major question now.
Anthony J. Polini and Salvatore J. DiMartino, analysts at Advest Inc.,
expect them to worsen. They wrote in a recent research report, "By the
time we return to a stable interest rate environment with reasonable
near-term prospects for rate reductions going forward, banks and thrifts
will likely be at least knee deep in slowing revenue growth and rising
nonperforming assets." They also see competitive pricing pressure continuing.
In sum: "We expect industry growth rates to slow, profitability ratios
to moderate, and consolidation activity to wane," they wrote.
Susan
Webber, who is a consultant serving the financial services industry
and president of Aurora Advisors Inc. in New York, is also concerned
about rising interest rates, possible inflation arising from higher
oil prices and overblown stock market sectors, and declining credit
quality.
She
also notes that when so many people are spending more money than they
earn, as they are now, if they stop doing that or start saving, the
change could precipitate a recession and hurt banks a good deal. A general
stock market decline would also affect the spending of millions of people,
and Webber cited several indicators of a classic market top. So she
is somewhat pessimistic on the outlook for general improvements in bank
stock prices and consequent increases in M&A activity.
And
the view toward consolidation has definitely dampened on Wall Street,
although who knows for how long. Webber sees one of the "salient events"
of 1999 in the switch in M&A outlook of Edward Crutchfield, First Union
Corp.'s chief executive officer. After issuing several earnings warnings
and watching the stock fall early last year, Crutchfield said First
Union wouldn't be looking for acquisitions anytime soon. It was a concession
to the facts of life, but it was still a sharp switch for a company
that had done dozens of deals during the decade.
Webber
noted that Crutchfield and John McCoy, the former CEO of Bank One Corp.
who resigned after a series of disappointments for that busy acquirer,
were both particularly visible figures in the M&A landscape during the
1990s.
"Who
knows if they are a harbinger of things to come?" she said.
Analyst Sean Ryan thinks fundamentals will improve, and then M&A activity
will pick up.
Ryan said we are in a period now that is much like 1994, when the Fed
was also raising interest rates amid concerns about revenue growth and
credit quality. But instead of worsening, things improved, and bank
stocks had a three-year run of great performance. Ryan thinks it will
happen again.
Interest rates have already risen, and each new hike brings them closer
to where they will top out, he pointed out. Asset quality has deteriorated
somewhat, but only from what were abnormally high levels; it is just
reverting to the norm and will level out.
"Asset
quality and interest rates are legitimate items of concern," he said,
but in the end, stock prices are going to follow earnings, and earnings
for most are showing healthy growth.
Then M&A activity will benefit from the "hydraulic effect": A rally
in fundamentals will be followed by an even greater rally in takeover
activity. That could happen by mid-year, he said.
Until January, Ryan was with Bear, Stearns & Co., but he sat out much
of last year, with respect to making public pronouncements, after he
criticized First Union and put it high on his list of takeover prospects.
Now, Ryan and a partner have started an independent research company,
Byrne, Ryan & Co., based in White Plains, NY, and he can say anything
he wants.
Does he still consider First Union a prime takeover target?
"Absolutely,"
he said.
A large institutional shareholder is exerting pressure for improvement,
and the board will eventually see that a sale is in shareholders' best
interests, Ryan said.
The
End is Near
The end to pooling-of-interest accounting, expected early in 2001, has
been widely viewed as favoring more M&A activity this year, especially
for big deals.
But nearly everyone agrees that sellers will have to accept lower prices
if that is to happen, assuming stock prices stay about the same. Sellers
can't have their deal and eat a huge takeout premium too, many say.
Anyway, sellers should look at more than the buyer's absolute price.
In a pooling, what matters most is whose stock the selling shareholders
are getting in exchange, and the relative proportion they will own in
the resulting company.
Another event from late 1999 could influence the drive, or lack of one,
to get in last-minute poolings this year. Zions Bancorp. announced near
the end of 1999 it would postpone its merger with First Security Corp.
because it was going to have to restate financial results back through
1996. The Securities and Exchange Commission was requiring some earlier
Zions deals previously accounted for as poolings to be accounted for
as purchases instead, apparently because Zions broke the poolings rules
by repurchasing too much of its own stock.
It remains to be seen whether the SEC moves against other acquirers
in the same way. If it does, the restatements will almost have the effect
of ending poolings three years ago, because the market will be forced
to evaulate their financial results apart from the goodwill — a
development expected in any case after poolings are actually abolished.
Or, perhaps the SEC's move against Zions will be like the one it made
against SunTrust Banks Inc. in 1998, delaying SunTrust's acquisition
of Crestar Financial Corp. The SEC made SunTrust restate some financial
results because of SunTrust's allowance for loan losses. Where most
saw simply good, conservative reserves policy, the SEC saw potential
earnings management.
That case didn't turn into an industry-wide trend, but banks paid attention
and in some cases adapted their reserves policy.
In any case, nobody expects bank consolidation to stop. Banks may not
be the hottest sector, but the deals are far from over.
—
Mary Beausoleil, Editor
(201) 963-1000
mbeausoleil@snl.com
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