CenterState's Step Up from Bargain Basement Reflects New Bank M&A

Now that it is more upbeat about the economy, CenterState Banks (CSFL) is skipping the bargain bin.

Its agreement to pay a premium for Gulfstream Bancshares in Stuart, Fla., is an about-face for a company that in recent years has gobbled up six failed banks and shared credit risk with sellers in two other acquisitions.

"Our other deals in the cycle have had protection … but real estate values are trending in the right direction and that gives us more confidence to do a healthy-bank deal," says John Corbett, CenterState's president and chief executive. "This is the totally different end of the spectrum of acquisitions."

More banks are switching to open-bank deals after spending the last several years preying on failed and troubled banks. The slowdown in failures is partly responsible for the return to traditional dealmaking, but other forces are at work on CenterState, in Davenport, Fla., and other banks.

The market for publicly traded banks is moving away from trading at a multiple of tangible book — a sign of stability — to trading at a multiple of earnings, and Corbett says his $2.35 billion-asset company is now trying to juice its earnings.

"A lot of the deals we did had good strategic value to the deposit base and location, but didn't have a good loan book or they wouldn't have failed," Corbett said. "Now, we are at a point where, with the low loan-growth environment, we need to get that profitability so that we can accelerate the value of the bank."

CenterState agreed to pay $76.9 million in cash and stock for the $572 million-asset Gulfstream. The $42.90-per-share deal, announced Tuesday, equals 143% of Gulfstream's tangible book value.

In Gulfstream, CenterState is picking up a rarity in Florida: a business bank. The bank's $368 million loan portfolio is 27% commercial and industrial, and 75% of its commercial real estate is owner-occupied. The bank focuses on lending to medical practices and homeowners associations. It also banks affluent customers.

CenterState expects a 22% cost savings, lower than the typical 30% or so on the average deal, but Gulfstream's four branches are in markets where CenterState is absent.

It is projecting "mid-single-digit" dilution to tangible book value, which it expects to earn back in 3 1/2 to four years, as well as "high-teens" earnings per share accretion in 2014 and "low teens" thereafter.

"This is not just another bargain-purchase gain deal," Corbett said. "We are looking to build the earnings and are willing to take a little dilution to jack up the earnings per share."

Gulfstream has an efficiency ratio of 52%, compared with CenterState's 70% efficiency ratio. Corbett declined to give any projections for the combined efficiency ratio following cost cutting, but he said that the deal would put it a year ahead of schedule on its efficiency goals.

The deal price is another positive sign for M&A in Florida, which has been made up of failed-bank transactions and discounted deals during the downturn. Several observers referenced the announcement in May that Banco de Credito e Inversiones would acquire City National Bank of Florida for 1.5 times its tangible book value. The seller, based in Miami, had assets of $4.7 billion.

"From the standpoint of pricing, look at what is happening," says Joseph Fenech, an analyst at Sandler O'Neill. "Florida seems to be really picking up."

Corbett called the improvement in pricing a "sign of the times."

"What you're starting to see is that whole-bank M&A was really tough because the real estate market had us all scared to death of everyone else's loan portfolio," Corbett says. "Now, things are coming up nicely."

Yet the new wave of deals is a sign that the economy is not all the way back and banks are still struggling to increase revenue.

Lee Bradley, senior managing director of Community Capital Advisors, an Atlanta consulting firm, says several of the banks that lived on failed-bank deals are going to face profitability pressures as the financial benefits of those deals begin to wane.

"I've asked the same question of a lot of banks here in Atlanta — what are you going to do when the loss share runs out?" Bradley says.

Last week CenterState announced earnings of nine cents per share, compared with analysts' consensus of 12 cents. The miss was driven by a decline in revenues from correspondent banking and its bond-sale division.

CenterState "was an underperformer even during the heyday of the real estate boom in Florida," Fenech said in a research note last week. "We were hopeful that M&A would help to kick-start the company to an improved profitability profile, mostly via improved efficiency. However, it's now been about 18 months since the last acquisition, and from a profitability standpoint, the company remains sort of stuck in neutral."

The deal with Gulfstream makes strategic and financial sense but time will tell if it strengthens its profitability, Fenech said in an interview.

"The opportunity to improve efficiency is there, but the track record of extracting them is mixed," Fenech says. "Whether it helps, that is an execution question and we won't know the answer for a while."