U.S. bank merger recovery could get hurt by recent turkeys

By Dan Freed and Dan Wilchins

NEW YORK (Reuters) - The recent pickup in U.S. bank merger activity could slow down in the coming months after regional banks that announced deals last week were punished in the stock market, bankers said.

When KeyCorp (NYSE: KEY) said on Friday that it agreed to buy First Niagara Financial Group, (NASDAQ: FNFG) shares of both banks dropped fell, with KeyCorp dropping 7 percent and First Niagara slipping nearly 1 percent.

When New York Community Bancorp (NYSE: NYCB) agreed to buy Astoria Financial Inc, (NYSE: AF) the acquirer's shares fell 12 percent, and Astoria's shares fell 7.7 percent.

It's not unusual for an acquirer's shares to drop after a deal is announced, but the shares usually do not drop so steeply, or sometimes even rise. In August, for example, BB&T Corp (NYSE: BBT) said it would buy National Penn Bancshares (NASDAQ: NPBC) for what was then about $1.8 billion. National Penn Bancshares' shares rose 17 percent the day after the deal was announced, and BB&T's shares edged about 0.25 percentage point higher.

After the KeyCorp and New York Community Bancorp deal met with the frosty reception from investors, two bankers that spoke to Reuters said that deals they are working on now could take longer to negotiate, because both sides want to be sure the price they agree to is reasonable to investors. The bankers declined to be named, because they did not want to speak publicly about deals that have not yet been announced.

"These deals were terrible for M&A because the market hated them," said one of the bankers. The bankers estimated that the delays could be a few months, but any talk of deals taking longer is unusual, as bankers are often inclined to talk up their business.

Any slowdown in merger activity would come just as bank consolidation was starting to ramp up. In late September, the U.S. Federal Reserve approved M&T Bank Corp's (NYSE: MTB) purchase of Hudson City Bancorp, (NASDAQ: HCBK) three years after the deal was first proposed. Approval for that deal took more than three times as long as the government usually takes, and many bankers saw the greenlighting of that deal as a sign that the Fed is willing to allow regional banks to acquire again, after a recent de facto freeze on bigger deals.

For the year so far, there have been 275 deals totaling $19.59 billion, Reuters data show. (see graphic) Most of those deals have involved community banks — just three have involved a bank paying more than $1 billion for another, totaling $11.4 billion in value.

There were enough mergers in October to have some analysts going to the record books — if November and December were similarly active, the quarter would be the strongest in a decade, according to a report from KBW. In anticipation of a rising number of deals, investment banks have been hiring M&A bankers who focus on the sector.

Bank mergers are, to many analysts, a critical part of making the U.S. financial system stronger, and any slowdown in consolidation is negative for that recovery. The United States has some 6,350 banks, and with interest rates near zero, income from lending has hardly been growing for years, data from the Federal Deposit Insurance Corp show. Meanwhile, regulatory costs are rising as banks have to follow new rules and report more data to regulators, a burden that weighs particularly on smaller banks.

Both KeyCorp and New York Community Bancorp were believed to have overpaid in their deals, analysts and investors said. KeyCorp, for example, is paying 1.7 times a measure of First Niagara's net worth called "tangible book value," and New York Community Bancorp is paying 1.5 times Astoria's tangible book value. The average for the last seven quarters has been closer to 1.4 times, according to a research report from KBW.

The Key deal is "almost certainly a ticking time bomb of value destruction," wrote veteran financial stock analyst Tom Brown in a blog post on Monday.

Beth Mooney, Chief Executive of KeyCorp, told Reuters that First Niagara is a good strategic fit with her bank, and will be able to cut costs and increase revenue for both companies and to reward shareholders.

The New York Community Bank stock declines were "kind of a slap on the wrist saying we don't mind you doing deals but let's be more shareholder friendly when you're negotiating those prices," said Peter Kovalski, a portfolio manager at Alpine Funds in Purchase, New York who helps run $4 billion of assets.

New York Community Bank CFO Thomas Cangemi said the deal will create value for shareholders over time because his bank trades at a higher valuation than Astoria.

POSSIBLE ACQUIRERS

Many on Wall Street are still hopeful about future deals. Analysts have been sending around lists of possible acquirers and sellers. A recent list from analysts at KBW included Synovus Financial Corp, (NYSE: SNV) a bank with about $28 billion of assets based in Columbus, Georgia, and Flushing Financial Corp, (NASDAQ: FFIC) a bank based in suburban New York with more than $5 billion in assets, as potential targets.

A Synovus spokesman declined to comment, but the bank's chief executive said on a recent conference call that the bank is evaluating acquisitions. A Flushing Financial spokeswoman did not respond to questions.

Emmett Daly, investment banking principal at Sandler O'Neill, said the share price declines following last week's deals were a "temporary setback," but he still thinks the recent round of acquisitions will pave the way for more acquisitions of banks worth $1 billion or more. Several bankers noted that the macro factors that could spur deals, including relatively low rates, and higher regulatory compliance costs, are not going away.

M&T's trouble getting the Hudson City deal may provide another reason for any recovery in bank M&A to be tepid. The acquirer needed three years to win approval for the deal after regulators found problems with its systems for preventing money laundering, according to its regulatory filings.

"The Fed made it exceedingly clear that if you come into the deal with any issues at all, the deal will get thrown right back into your face, and lots of banks have a lot of issues," said H. Rodgin Cohen, a lawyer at Sullivan & Cromwell who advises banks on mergers and acquisitions and advised M&T on that deal.

Those concerns are still putting a damper on the number of regional bank mergers in the pipeline, Cohen said, adding that sellers do not want to announce a deal they cannot actually complete.

(Corrects spelling of Beth Mooney in 13th paragraph)

(Reporting by Dan Freed and Dan Wilchins in New York, editing by John Pickering)

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