Given its performance and capital levels, Chemical Financial Corp. had long been thought of as a market consolidator in its home state of Michigan, but it remained on the sidelines — until now.
On Friday the $4.3 billion-asset Chemical, of Midland, announced a deal to buy the $840 million-asset O.A.K. Financial Corp. in Byron, Mich., for $83.9 million in stock, or 1.08 times O.A.K.'s tangible book value. O.A.K.'s Byron Bank would be merged with Chemical Bank, increasing Chemical's branch count in the Grand Rapids market from 14 to 31.
Eliot R. Stark, a managing director based in Michigan for the investment bank Capital Insight Partners Inc., said the deal resembled a merger of equals, despite the size disparity, because both shareholder bases stand to benefit. Though such deals have been missing from the landscape during the financial crisis, he said he expects to see more banks pairing up as decent performers look for ways to reward shareholders.
"In the boom years, the sellers just wanted the best price. Well, those premiums are long gone," Stark said. "So I think we are going to see more banks figuring out they can benefit their shareholders together better than they can separately."
Chemical executives said that the deal is a boon to the company in Grand Rapids, often considered the bright spot in the state's blighted economy, and that other deals could follow.
"We've been trying to find a good partner for a while. With Byron, we found a straightforward transaction between two strong Michigan banking institutions. It is a great strategic fit and cultural fit," David B. Ramaker, Chemical's chairman, president and chief executive, said in an interview. "We think this was a good opportunity, and we think our capital places us in a position to look for additional opportunities. We are not done looking."
Daniel Cardenas, an analyst with Howe Barnes Hoefer & Arnett Inc., called the deal a positive for Chemical.
"This looks like a good transaction," Cardenas said. O.A.K. "has manageable credit issues and a nice franchise." Chemical will not have "overpaid for it. The Chemical guys are pretty savvy, and I think they will execute the integration pretty well."
Chemical's is expected to jump from 14th place to sixth in deposit market share in Grand Rapids with the deal, which is to close next quarter.
O.A.K. is primarily a commercial bank, which would complement a Chemical loan portfolio that is evenly divided between consumer and commercial products, Cardenas said.
O.A.K.'s president and CEO, Patrick K. Gill, who would become Chemical's western Michigan market chairman, said O.A.K. wanted the leverage of a larger bank to better serve its customers and began considering strategic options last year.
"This is a merger by desire," Gill said in an interview. "The opportunities we are seeing are increasingly sophisticated, and we needed to look for ways to acquire the capacity to serve that market. So creating an affiliation with Chemical was certainly attractive to us."
Cardenas agreed that O.A.K.'s motivation was strategic, rather than one of despair. However, its somewhat thin total risk-based capital ratio of 10.75% at the end of the third quarter could have faced stress given its commercial real estate portfolio, he said. Commercial real estate made up 44% of O.A.K.'s portfolio at the end of the third quarter.
Chemical appeared to be mindful of that portfolio in striking the agreement, including a clause that would reduce the deal value by $1.50 for every $1 in loan losses between $10 million and $15 million; should O.A.K. lose $15 million, for example, the deal value would drop by $7.5 million. Chemical did not specify what would happen should losses exceed $15 million, and Ramaker declined to answer questions related to that contingency in the deal.
Reducing the consideration for loan losses has become a common practice in dealmaking. Other examples include the $65 million stock deal by Tower Bancorp Inc. in Harrisburg, Pa., for First Chester County Corp., which was announced last month. That deal includes a sliding scale that would lower the purchase price based on delinquencies.
Analysts said that Chemical is one of the better-positioned companies in the Michigan market for acquisitions, since its credit problems are relatively minor and it has a war chest of capital.
"I view Chemical as the acquirer of choice in Michigan, mostly because there are few other banks healthy enough to make deals," Cardenas said. "So they get to find the markets they want to be in and cherry-pick the deals they want."
Chemical earned $7.5 million in the first nine months of 2009, down 60% from a year earlier. Its nonperforming assets totaled $157.5 million at the end of the third quarter, up 60% from a year earlier, representing 3.69% of total assets. On average, nonperforming assets made up 4.60% of total assets for banks in Michigan at the end of the third quarter, according to data from the Federal Deposit Insurance Corp.
Chemical had a total risk-based capital ratio of 15.7% at the end of the third quarter, well above the 10% needed for well-capitalized companies.
Ramaker said Chemical would consider other deals like the one for O.A.K., as well as those some have struck with the FDIC for failed banks. He would not say whether the company would consider raising additional capital for future acquisitions.
