Illinois Bank's High Price Tag Turns Heads

A deal for a small community bank outside of Chicago on Tuesday was a reminder that good banks still can fetch good prices — even in a down market.

That discovery prodded Freestar Bank in Pontiac, Ill., to sell itself for $47 million to First Financial Corp. of Terre Haute, Ind. Officials at the $400 million-asset Freestar were unsure if it would receive decent bids when they began exploring a sale earlier this year, its chief executive said.

"What would be the marketability of a strong bank that's not in trouble, that has a strong lending portfolio?" said Freestar Bank President and CEO David Kuhl. "We were surprised that we found there were people willing to take a look at strong entities."

The sale of the 13-branch Freestar is the priciest community bank merger since April, when a pair of lenders in the Northeast sold for nearly two times their tangible book value.

Freestar is going for 166% its tangible book in an all-cash deal at a time when most banks are trading — and selling — for just over or under book value.

"The price that we are getting is a very fair" one, he said.

Its relatively lofty price is a function of several market dynamics.

The $2.5 billion-asset First Financial is a highly profitable, highly liquid bank that has long wanted to get bigger in Illinois. It is willing to pay to do that.

"We've been interested in areas where Freestar has been doing business for years," said Norman Lowery, vice chairman and CEO of First Financial, which has 51 branches in Illinois and Indiana. "There's really not a lot available in those markets."

There are precedents for paying a substantial premium to enter a new market, most notably Comerica Inc.'s $1 billion purchase of Sterling Bancshares Inc. of Houston earlier this year. Investors were initially concerned that Comerica had agreed to pay too much.

So far, Lowery said he has gotten only limited, but mostly positive, feedback from his investors about Freestar. First Financial's shares rose 0.53%, to $30.08, on Tuesday.

The company is paying "a fair price" for Freestar because "it puts us in markets that we've desired to be in," and it is "a very well run bank," Lowery said.

First Financial's last deal was the purchase of the deposits of the failed First National Bank of Danville, Ill. in July 2009. The company may consider other acquisitions after it integrates Freestar, Lowery said.

It is hearing from more small banks "that are at least considering" selling, given the challenges in banking right now.

Freestar is heavily involved in agriculture lending and also specializes in home and business mortgages. It has a very low ratio of nonperforming assets, in part because agriculture lending has been stronger than other loan categories through the downturn. Its returns on equity are relatively strong, and its profits rose in the first half, mostly from setting aside less money to cover bad construction loans.

Like other banks, regulatory and economic burdens have weighed on its top line. Interest income declined in the first six months as expenses rose, sending its year-over-year ratio of expenses to revenue up to 69% from 64%.

Freestar's decision to sell comes down to the capital constraints of its special tax status, Kuhl said. Freestar is a Subchapter S corporation, which is a structure common among agriculture banks that lets them pay federal income taxes at the shareholder level instead of the corporate level. The downside is they cannot have more than 100 shareholders, according to the Subchapter S Bank Association's website; and they must be individuals, not institutions.

"For us to continue to grow in the markets we serve requires capital," Kuhl said. Raising capital from its limited shareholder base would be "difficult," he said.

The banks that fetched nearly twice their book value were: Bancorp Rhode Island Inc. of Providence, which agreed to sell to Brookline Bancorp Inc., and State Bancorp Inc. of Jericho, N.Y., which sold to Valley National Bancorp.

Raymond James & Associates Inc. and the law firm Barack Ferrazzano Kirschbaum & Nagelberg LLP advised Freestar. First Financial was advised by the law firm of Krieg DeVault LLP.