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Comerica's agreement to buy Sterling Bancshares apparently scuttles an activist shareholder's plans to take over the target bank, but it doesn't mean he's on the losing end.
January 18
Executives at Comerica Inc. have highly valued Texas expansion for a long time — maybe too much in some eyes, after its big deal announcement Tuesday.
Comerica, which moved its headquarters to Dallas four years ago and has credited growth in the Lone Star State with helping to carry it through the financial crisis, prevailed in the bidding for Sterling Bancshares Inc. of Houston with an offer valued at 2.3 times tangible book.
The all-stock, $1.03 billion deal would expand Comerica's Texas branch count, now 95, to 152. Of particular benefit, said Chairman and Chief Executive Ralph Babb, is that the purchase would take Comerica into several markets where it has little or no presence, such as San Antonio, and would strengthen its position in Houston.
But several analysts on Comerica's conference call questioned the price, noting the proposed multiple is significantly above those of most recent bank deals. The price added to a growing sense of discomfort among some observers that premiums in mergers and acquisitions had come too far, too fast.
"You have Comerica, trading at 1.3 times tangible book, buying a franchise for 2.3, and you think that's going to go higher? Are we in the very early stages of this? Are we going to get back to the tangible book multiples we saw in the late '80s, late '90s?" Chris Mutascio, an analyst with Stifel, Nicolaus & Co. asked on the call.
Brian Klock, an analyst for Keefe, Bruyette and Woods, said Sterling "fits well geographically, culturally, and with Comerica's business model. But the premium, in my opinion, was a little too expensive, and I'd rather have had some cash in the deal" so existing Comerica shareholders wouldn't be so diluted.
At least in part, the Sterling deal simply reflects the going rate for Texas banking properties — over the last few decades, strong economic growth in the state and a scarcity of acquisition targets have meant that area banks have long traded hands at rich valuations.
The deal value is "not out of line, and especially on a historical basis," Babb said on the conference call. Because of "the scarcity value of the metrics I was talking about, its value to anyone wanting to build our kind of franchise here, made it a very strategic fit for us."
Dory Wiley, the Dallas-based CEO of Commerce Street Capital, which has a long history in bank M&A in the state, including working on some of Sterling's own acquisitions, agreed with Babb's assessment after the call.
"How many times has there been a multiple-billion-asset franchise that you could get for 2.3 times book in Texas?" Wiley said. "From 1996 to 2006, you're going to pay 3.25 to maybe 3.5 times book. We were selling banks for four to five times books."
While even 2.3 is a far higher multiple than a bank similar to Sterling would normally receive in another part of the country, Wiley said, he was confident that Sterling would justify the price under Comerica's management.
"That franchise was very underutilized," he said. "There's cross-selling, larger legal lending limits and expansion opportunities."
Moreover, Wiley said, he suspects that Comerica has given itself a very comfortable margin for credit error with its $330 million writedown of Sterling's loan book, making the resulting price-to-book ratio appear higher than it might have otherwise. Comerica's loss estimates of 12%, or $330 million, of Sterling's loans, is large but not unusually high for an institution with substantial commercial real estate exposure.
Despite the beating Comerica’s stock took on Tuesday — it fell 8.3% — "there will be a point when pricing comes back, when people say they really got a good deal on this," Wiley said.
Sterling has long had an attractive franchise, but after the financial crisis investors and regulators alike appeared to focus on its blemishes. Burdened with bad commercial real estate loans and other nonperforming assets, Sterling was forced to operate at above well-capitalized ratios and ran into several other bumps, such a restatement of its third-quarter 2009 earnings. The company drew the attention of the activist investor Donald Adam, whose TAC Capital owns 9.9% of its stock. Before the announcement of the deal, Sterling and Adam appeared to be on the verge of a proxy fight. (
Comerica's offer is much higher than the valuations fetched in December by Whitney Holding Corp. of New Orleans and Marshall & Ilsley Corp. of Milwaukee.
Whitney fetched 1.7% times book; M&I, 1.4 times. In November, Wilmington Trust Corp. of Delaware fetched 1 times tangible book. Unlike those companies, Sterling has returned its Troubled Asset Relief Program capital, so Comerica did not have to work a hefty federal aid repayment into its purchase price.
On the basis of relative share price, the Comerica deal is largely in line with the recent deals. The company agreed to pay 30% more than Sterling's closing share price last week. That is lower than the premiums slated to be paid for M&I and Hancock. Wilmington is to be sold at a discount.
But the valuations in those other transactions were higher than some analysts thought they should have been, given the depth of the target companies' problems. Comerica declined to address the subject on the call, but KBW's Klock said in a subsequent interview that competition for the bank was likely heated.
"I think there were at least two other large banks in competition, BB&T and BBVA, that were interested," he said. "Both have strong enough balance sheets that they could make a serious bid … and that doesn't rule out another Texas bank" making an offer.
The deal took the spotlight off of Comerica's earnings, but the company's overall numbers were impressive. The bank's $96 million, 53 cent-a-share profit for the quarter heftily beat analyst expectations, in large part because of falling loss provisions, which dropped from $122 million in the third quarter to $57 million in the fourth.
Comerica's results also suggested that it is among the vanguard of banks enjoying a gradual economic recovery. The company's overall loans outstanding held steady, with a 3%, $713 million increase in its commercial and industrial loan balances offset by continued commercial real estate loan declines. Its outstanding lines of credit rose.
While he is not tremendously excited about the price of the Sterling deal, Klock said, those numbers deserved some attention of their own.
"Their credit improvement is already significantly better than their peers'," he said. "And their guidance is a significant release of reserves."
