Investors Will Need Time to Adjust to 'New Era' in Bank M&A

For many bank investors, the days of generous dividends and stock buybacks could be coming to an end — and that's a bitter pill to swallow.

That was the view a panel of M&A experts shared Wednesday while explaining the negative market reaction to two recent bank deals. Shares of New York Community Bancorp in Westbury have plunged nearly 20% since it announced plans to buy Astoria Financial. The stock price of KeyCorp in Cleveland has slid about 8% since it agreed to buy First Niagara Financial Group.

Those deals illustrate the beginning of what promises to be one of the biggest periods for deal-making since the financial crisis, panelists said. But it could take some time for investors to feel comfortable with banks using excess capital for splashy acquisitions.

"People got very, very comfortable with stock buybacks and big dividends," said Emmett Daly, a principal at Sandler O'Neill, describing those options as "not strategic" to long-term growth. "I think you're just moving into another phase of the M&A cycle."

Shareholders have been "struggling" to evaluate the latest big acquisitions, focusing too narrowly on tangible book value and earnback periods, said Gary Howe, a managing director at Lazard. "Those factors, while important, are less relevant in a stable-credit and growing-earnings environment," he said, noting that investors should focus on the deals' potential for long-term returns.

The comments were part of a broader panel discussion on financial services consolidation hosted by Mergermarket Group.

The latest purchases by the $92 billion-asset Key and the $44 billion-asset New York Community are part of a growing industry shift toward bigger deals involving mid-cap banks, panelists said. The KeyCorp and New York Community acquisitions — valued at $4.2 billion and $2 billion, respectively — were the second- and third-largest deals announced this year. (The biggest was Royal Bank of Canada's $5.3 billion purchase of City National in Los Angeles.)

The banking industry in October agreed to 34 deals collectively valued at $8.2 billion — by far the best single month for M&A this year, according to data compiled by Keefe, Bruyette & Woods.

M&A "has absolutely exploded," Daly said. "We all knew it was coming. I was just a question of who, what and where."

KeyCorp and New York Community have drawn investors' ire for their deals. Key's purchase of First Niagara, for instance, was criticized by investors as being too expensive and too dilutive to tangible book value. New York Community spooked shareholders by announcing plans to restructure its balance sheet, raise capital and cut its dividend in conjunction with buying Astoria.

Still, panelists said they believe those deals are only the beginning of a new wave of activity.

"I think now you've got 18 to 24 months of huge deal activity," Daly said.

Shareholders' reactions to last week's deals also highlight the importance of shareholder engagement, panelists said.

"You have to manage investors," said Venkat Badinehal, a managing director at Deutsche Bank Securities, noting that the Key and New York Community deals generated a unique set of concerns among investors.

The panel also discussed the growing role of shareholder activism, with Daly estimating that such intervention has accounted for nearly a quarter of recent bank deals, including Astoria's sale to New York Community. (Sandler O'Neill represented Astoria in its negotiations.)

Astoria had been facing pressure from New York investment firm Basswood Capital Management.

"A lot of these investors got in during the crisis when [banks were] a distressed play," said Joseph Vitale, a partner at Schulte, Roth & Zabel. "Now they are looking for some sort of exit."

Regulators in recent years have also taken a more favorable view of activist investors that push boards to take a fresh look at unprofitable balance sheets, Vitale said. "Most people at the Fed and the FDIC still think there are too many banks … and that many of the banks don't have a business plan that's particularly attractive in a low-rate environment," he said.

Activists are "impacting the psyche" of the industry by going after bigger banks, said Brian Moon, a managing director at Wells Fargo Securities.

For instance, activist investor Carl Icahn recently wrote a letter to AIG Chief Executive Peter Hancock, urging him to break the company up to avoid being designated as a systemically important financial institution.

Activists, which have racked up a number of victories forcing the sale of smaller institutions,may have more success next year pushing for changes at bigger banks.

"Activism will claim one large financial institution, in terms of meaningful change" in 2016, Howe said, declining to name any specific target.