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How to Profit on a
Distressed Transaction
March 28, 2013
Jeff K. Davis, CFA
Mercer Capital
About the Speaker
Jeff K. Davis, CFA
[email protected]
Jeff K. Davis is the Managing Director of Mercer Capital’s Financial Institutions Group. Prior to rejoining Mercer Capital,
Davis spent 13 years as a sell-side analyst providing coverage of publicly traded banks and specialty finance companies to
institutional investors evaluating common equity and fixed income investment opportunities. Jeff was most recently Managing
Director of Guggenheim Securities, LLC, and was previously head of the Financial Institutions Group at FTN Equity Capital
Markets. While at Mercer Capital in the 1990s, Jeff led the firm’s financial institutions practice, providing valuation and
transaction advisory services.
Jeff is a speaker at industry gatherings, including SNL Financial/University of Virginia’s annual analyst training seminar, the
ABA, various state banking meetings as well as security industry gatherings. Additionally, he regularly makes presentations
to boards of directors and executive management teams.
He is a periodic guest on CNBC, Bloomberg TV and Bloomberg Radio and is quoted in the American Banker, the Wall Street
Journal, Reuters, Forbes and other media outlets. Presently, he is an editorial contributor to SNL Financial.
About Mercer Capital
Mercer Capital assists banks, thrifts, and credit unions with significant corporate valuation requirements,
transactional advisory services, and other strategic decisions.
Mercer Capital Experience
•
•
•
Nationwide client base
•
More than 1,000 valuation opinions rendered for depositories
Clients range from smaller community banks with assets less than $50 million to the largest U.S. depositories
Clients range from the rural to the metropolitan, the troubled to the most successful, and the simplest in terms of
capital structure to the most complex
Services for Depository Institutions
Mercer Capital pairs analytical rigor with industry knowledge to deliver unique insight into issues facing depositories. These
insights underpin the valuation analyses that are at the heart of Mercer Capital’s services to depository institutions.
•
•
•
•
•
•
•
Bank valuation
Financial reporting for banks
Goodwill impairment testing
Litigation support
Loan portfolio valuation
Tax compliance
Transaction advisory
Contact a Mercer Capital professional at 901.685.2120 to discuss your needs in confidence.
How to Profit on a Distressed Transaction
Jeff K. Davis, CFA // March 28, 2013
Mercer Capital’s 2013 Webinar Series
How to Profit on a
Distressed Transaction
Jeff K. Davis, CFA // March 28, 2013
“Do not let other peoples’ problems
become your problem”
Chris Mercer
2
© 2013 Mercer Capital
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1
How to Profit on a Distressed Transaction
Jeff K. Davis, CFA // March 28, 2013
M&A Pricing Tiered by Asset Quality
Median Price /
Earnings (x)
Median Price /
TBV (%)
Median Core
Deposit Premium
(%)
Median NPAs /
Assets
Median ROA
NPAs less than 2.5%
22.4
173
9.7%
0.43%
0.70%
84
85%
NPAs 2.5% - 5.0%
21.5
157
7.8%
3.35%
0.30%
10
10%
NPAs greater than 5.0%
nm
109
-7.1%
5.72%
0.16%
5
5%
NPAs less than 2.5%
18.2
120
2.2%
0.49%
-0.16%
34
57%
NPAs 2.5% - 5.0%
22.6
130
1.1%
3.34%
-0.74%
14
23%
NPAs greater than 5.0%
nm
55
-5.5%
9.50%
-3.94%
12
20%
NPAs less than 2.5%
22.2
140
5.8%
0.85%
0.52%
45
45%
NPAs 2.5% - 5.0%
36.1
107
2.1%
3.59%
-0.22%
24
24%
NPAs greater than 5.0%
28.7
65
-2.2%
7.78%
-1.85%
32
32%
NPAs less than 2.5%
24.4
134
4.5%
1.12%
0.48%
30
41%
NPAs 2.5% - 5.0%
34.0
97
-0.2%
3.89%
0.37%
13
18%
NPAs greater than 5.0%
21.0
89
-1.1%
6.71%
-0.81%
30
41%
NPAs less than 2.5%
18.2
128
4.0%
0.89%
0.78%
62
52%
NPAs 2.5% - 5.0%
19.5
116
2.0%
3.46%
0.44%
26
22%
NPAs greater than 5.0%
14.3
76
-1.2%
8.45%
-0.40%
32
27%
Overall Total / Median
21.9
118
1.63%
3.46%
0.27%
474
NPAs less than 2.5%
20.2
133
4.20%
0.67%
0.61%
265
56%
NPAs 2.5% - 5.0%
22.1
118
1.63%
3.46%
0.34%
91
19%
NPAs greater than 5.0%
23.8
77
-3.02%
7.91%
-0.60%
118
25%
Number of Transactions
2008
2009
2010
2011
2012
Source: Mercer Capital and SNL Financial, LC
3
Credit Migration Positive
Announce
Date
Seller
Credit
Mark
Cycle
Loss
YE07
5.0%
May-10
South Financial
13.0%
24.0%
4.5%
Oct-10
Wilmington
Trust
13.0%
17.0%
Dec-10
Marshall &
Ilsley
12.1%
21.1%
Dec-10
Whitney
6.0%
13.2%
Jun-11
RBC Bank
(USA)
11.2%
NA
Jan-11
Sterling
Bancshares
12.0%
15.7%
Aug-12
Hudson City
1.5%
NA
0.5%
Sep-12
Citizens
Republic
6.8%
19.1%
0.0%
Sep-12
West Coast
Bancorp
5.0%
19.1%
Jan-13
Virginia
Commerce
4.0%
11.5%
Feb-13
First M&F
5.4%
14.8%
Noncurrent Loans as a % of Total Loans and Leases
4.0%
3.5%
3.0%
2.5%
2.0%
1.5%
1.0%
Assets $1-10B
Assets $100M-$1B
Source: FDIC and SNL Financial
4
© 2013 Mercer Capital
www.mercercapital.com
2
How to Profit on a Distressed Transaction
Jeff K. Davis, CFA // March 28, 2013
Key Question: Why Troubled?
§  Asset quality
§  Capital need within the bank
§  Regulatory orders
§  Parent capital structure
§  Combination of above
§  Directionally—is the bank headed up, down or
sideways?
5
Troubled Bank Considerations
Positive
Negative
§  Potentially very high return
§  Even if asset marks are ok, has
franchise value been lost?
§  Something can be rectified …
reduce classifieds, boost capital …
§  Usual … cost saves/ op leverage,
market share gain or market
extension
§  Greater leverage to a rebounding
economy
§  Tax benefits—subject to limitation
§  Low return if all issues are not
known and accounted for
§  Greater execution risks
§  More taxing of management
§  Potentially greater negative
leverage to an economic
downturn
6
© 2013 Mercer Capital
www.mercercapital.com
3
How to Profit on a Distressed Transaction
Jeff K. Davis, CFA // March 28, 2013
National, GA, FL, IL and TX Bank Profile
US $100M - $1B
Georgia
Florida
Illinois
Texas
YE12
YE11
YE12
YE11
YE12
YE11
YE12
YE11
YE12
YE11
Pre-Tax ROA
0.81%
0.78%
0.62%
0.22%
0.33%
0.03%
0.85%
0.78%
1.15%
1.12%
NPLs / Loans
2.4%
3.1%
3.6%
4.6%
3.4%
4.6%
1.6%
1.9%
0.6%
0.7%
NPLs + Past Due / Loans
3.5%
4.4%
5.8%
7.1%
4.3%
6.0%
3.0%
3.3%
1.8%
1.9%
Net Charge-Offs (%)
0.63%
0.88%
0.75%
1.18%
0.74%
1.23%
0.30%
0.40%
0.11%
0.16%
Leverage Ratio
10.3%
10.1%
9.9%
9.1%
9.4%
8.9%
9.5%
9.4%
9.7%
9.6%
C&D / Risk-Based Capital
na
na
48%
54%
37%
46%
12%
14%
29%
30%
Income- & Owner CRE / RBC
na
na
193%
209%
266%
282%
99%
102%
114%
116%
4,216
4,284
228
242
209
227
560
577
562
596
Number of Banks
Source: FDIC
7
Assisted vs. Non-Assisted Deals
400
350
300
Number of Deals
250
200
150
100
50
0
2008
2009
2010
Whole Bank/Thrift Non-Assisted Deals
Source: Mercer Capital and SNL Financial, LC
© 2013 Mercer Capital
www.mercercapital.com
2011
2012
YTD 2013
FDIC-Assisted Whole Bank Deals
8
4
How to Profit on a Distressed Transaction
Jeff K. Davis, CFA // March 28, 2013
Problem Bank Universe
FDIC "Problem" Banks
1,000
500,000
884
900
450,000
813
400,000
702
Number of Institutions
700
651
350,000
600
300,000
500
250,000
400
200,000
300
200
150,000
252
116
100
Aggregate Assets ($Millions)
800
100,000
80
76
52
50
2005
2006
50,000
0
0
2003
2004
2007
2008
Number of Problem Banks
2009
2010
2011
2012
Total Assets ($M)
Source: Mercer Capital and FDIC Quarterly Banking Profiles
9
U.S. Bank Capital Profile
Bank Median of Decile (%)
Decile Based on
Leverage Ratio
Leverage Ratio
Total RiskBased Ratio
Texas Ratio
NPAs / Loans +
OREO
2012 ROA
Number of
Banks
1st
17.81
34.46
5.1
2.12
0.92
707
2nd
13.35
22.37
12.3
2.69
0.90
709
3rd
11.74
19.16
14.2
2.80
0.84
708
4th
10.82
17.37
14.8
2.70
0.86
709
5th
10.20
16.41
16.0
2.65
0.86
695
6th
9.68
15.67
16.5
2.80
0.85
725
7th
9.22
14.95
16.5
2.61
0.81
704
8th
8.75
14.54
15.2
2.36
0.84
708
9th
8.22
13.80
14.7
2.09
0.80
715
10th
6.99
11.76
43.5
5.56
0.28
710
Source: SNL Financial
10
© 2013 Mercer Capital
www.mercercapital.com
5
How to Profit on a Distressed Transaction
Jeff K. Davis, CFA // March 28, 2013
Parent Capital Structure Issues
§  Significant number of “stranded” parent companies
§  Parent has used debt, TruPS, TARP, etc. to create equity
in the subsidiary bank … “double leverage”
§  Bank equity may be positive, but parent common is not
§  Difficulty compounds if there is a need for new capital
§  Asset marks / NPA disposal calculus
§  DTA / NOL retention subject to 382 limitations
§  Pricing/ownership % for new capital to generate an acceptable IRR
11
U.S. Large BHC Capital Profile
Bank Holding Company Median of Decile (%)
Decile Based on
TCE / Tangible
Assets
TCE / TA
1st
14.94
Double
TruPs / Tier 1
Leverage Ratio
Capital
TruPs / Total
Risk-Based
Capital
2012
ROA
Number of BHCs
filing Y-9C
96
0.00
0.00
0.95
112
2nd
11.54
99
0.00
0.00
0.90
114
3rd
10.21
100
0.00
0.00
0.87
112
4th
9.54
100
0.00
0.00
0.94
113
5th
8.83
103
5.06
4.40
0.81
112
6th
8.25
107
3.74
3.25
0.80
116
7th
7.57
110
12.04
10.69
0.86
113
8th
6.78
115
15.16
13.61
0.75
111
9th
5.76
121
17.51
15.76
0.61
115
10th
2.72
151
27.64
22.36
-0.02
114
Source: SNL Financial
12
© 2013 Mercer Capital
www.mercercapital.com
6
How to Profit on a Distressed Transaction
Jeff K. Davis, CFA // March 28, 2013
U.S. Small BHC Capital Profile
Small Parent Holding Company Median of Decile (%)
Decile Based on
TCE / Tangible
Cons. Assets
Tang. Com. Equity /
Double
TruPs / Equity +
Tang. Cons Assets Leverage Ratio
TruPs
TruPs / Cons.
Assets
2012 ROA
Number of BHCs
filing Y-9SP
1st
17.43
97
0.1
0.0
0.92
406
2nd
13.42
99
0.2
0.0
0.95
405
3rd
11.75
99
0.4
0.1
0.93
407
4th
10.79
100
0.9
0.1
0.84
405
5th
10.00
100
1.0
0.1
0.82
401
6th
9.36
100
2.0
0.2
0.83
407
7th
8.61
100
3.1
0.3
0.71
410
8th
7.81
111
5.2
0.5
0.66
403
9th
6.66
127
10.3
1.0
0.59
409
10th
3.81
152
34.4
1.8
0.07
406
Source: SNL Financial
13
Parent Capital Structure Issues
§  ~1,800 banks & thrifts issued $38B of pooled TruPS
§  Per Fitch … 341 deferring trust preferred issues ($4.8B) @
YE12; 215 defaulted ($6.5B); 284 issues redeemed since 1Q10
§  Most deferrals were in 2009-2010; default event after 5 years
§  4Q12 saw 5 new deferrals and 14 cures, 5 via lifting of
regulatory enforcement action
§  50 cures in 2012 vs. 41 in 2011
§  113 TARP deferrals ($2.4B) in Feb 2013 vs. 131 in Nov 2012;
one new deferral; 18 cures, 9 via TARP auction exit
14
© 2013 Mercer Capital
www.mercercapital.com
7
How to Profit on a Distressed Transaction
Jeff K. Davis, CFA // March 28, 2013
Parent Capital Structure Issues
§  Difficult to negotiate with creditors, especially TruPS in pools
§  If a senior creditor exists (e.g., lender to a holding company
secured with the bank’s shares), then it may be a less complex
situation, but not necessarily salvageable
§  If bankruptcy reorganization via Chapter 11, then pre-packaged
via agreement with senior creditors (e.g., CIT Group in 3Q09) or
sale of the bank via section 363
§  Limited 363 transaction history in the sector, but five-year TruPS
deferral limit implies much possible by 2015
15
Parent Capital Structure Issues
§  Process is important … stalking horse bidder, etc.
§  TruPS’ indenture precludes selling substantially all assets
(fraudulent conveyance) ... BBX and BBT had to revise their
Nov 2011 deal to satisfy
§  Parent creditors have rights … recovery for TruPS rose after
holders pushed Talmer on pricing and process for First Place
Bank
§  Gradually healing sector and real estate markets implies fewer
contentious circumstances by the time the 5-year mark occurs
16
© 2013 Mercer Capital
www.mercercapital.com
8
How to Profit on a Distressed Transaction
Jeff K. Davis, CFA // March 28, 2013
Limited History …
Purchase & Assumption
Pre-Packaged Bankruptcy
363 Transactions
Nov-11
BBT - Bank Atlantic
Apr-09
CIB Marine
Oct-10
SKBHC - American West Bank
Nov-11
Home Bancshares-Vision
Sep-09
CIT Group
Apr-11
First Bank Lubbock - Jefferson Bank
Aug-12
Home BancShares - Premier Bank
Sep-12
Strategic Growth - Mile High Bank
Oct-12
Talmer Bancorp - First Place Bank
Jan-13
First Bancshares - FNB Baldwin County
Jan-13
Western Alliance - Centennial Bank
Ongoing Capital Bancorp … 12 subsidiaries
17
Bridging Pricing via Contingency Payments
§  Transactions with contingencies remain limited
§  Can be a method to bridge pricing gap and disagreement
about the value of select assets
§  Challenges
§  Complexity
§  Who keeps score
§  Dispute resolution mechanism
§  Duration
18
© 2013 Mercer Capital
www.mercercapital.com
9
How to Profit on a Distressed Transaction
Jeff K. Davis, CFA // March 28, 2013
Bridging Pricing via Contingency Payments
Announced in 2009
Total Deal
Value ($
million)
Capital Contribution
Announced in 2010
Number of
Transactions % of Total
% of Total
Median
NPAs /
Assets
Total Deal
Value ($
million)
Number of
Transactions % of Total
% of Total
Median
NPAs /
Assets
$38
4%
9
15%
3.4%
$361
3%
12
12%
4.5%
53
5%
3
5%
1.5%
148
1%
7
7%
5.8%
Common Stock
410
40%
8
13%
0.7%
1,056
10%
9
9%
4.0%
Mixed Consideration
112
11%
8
13%
1.8%
7,999
77%
17
17%
3.9%
Cash
250
24%
28
47%
1.6%
772
7%
48
48%
1.7%
Unclassified
164
16%
4
7%
6.6%
37
0%
8
8%
0.6%
$1,028
100%
60
100%
$10,374
100%
101
100%
Contingent Consideration
Overall Total / Median
Announced in 2011
Total Deal
Value ($
million)
% of Total
Announced in 2012
Number of
Transactions % of Total
Median
NPAs /
Assets
Total Deal
Value ($
million)
% of Total
Number of
Transactions % of Total
Median
NPAs /
Assets
Capital Contribution
$67
1%
4
5%
6.8%
$21
0%
4
3%
11.0%
Contingent Consideration
133
2%
7
10%
6.2%
350
4%
8
7%
5.0%
Common Stock
1,373
20%
11
15%
1.3%
809
9%
13
11%
2.1%
Mixed Consideration
1,243
18%
17
23%
1.9%
4,161
48%
34
28%
1.7%
Cash
3,959
58%
30
41%
4.7%
3,311
38%
55
46%
1.5%
24
0%
4
5%
1.7%
81
1%
6
5%
9.2%
$6,799
100%
73
100%
$8,734
100%
120
95%
Unclassified
Overall Total / Median
Source: Mercer Capital and SNL Financial, LC
19
Valuation Perspective
§  Value the bank, then net the parent capital structure
§  Mark the balance sheet
§  Earning power valuation (stand-alone and with synergies)
§  DCF valuation (distributable cash flow with/without synergies)
§  Must value based upon the current (zero) rate environment …
where yields are/headed, not what is hoped for
§  Cost of capital applied should entail a sizable premium given
risks (i.e., threshold exceeds the buyer’s cost of capital)
20
© 2013 Mercer Capital
www.mercercapital.com
10
How to Profit on a Distressed Transaction
Jeff K. Davis, CFA // March 28, 2013
Prospective Return
Cash
Securities
Loans
Loan Loss Reserve
Deferred Tax Asset (net)
Total Assets
Bank
145
1,000
3,500
(53)
4,593
Deposits
Borrowings
Trust Preferred
Other Liabilities
3,850
450
93
Preferred
Common Equity
Total Equity
Total Liabilities & Equity
200
200
4,593
Equity / Assets
Assets
Equity
ROA
Net Income
Dividend to Maintain Equity @
Terminal Multiple P/E @
Investor Ownership @ BV
Investor Cash Flow
Internal Rate of Return
Ln Mark
LLR to
Pro
Equity to
Pro
5.0%
1.40%
Forma
145
1,000
3,325
(47)
4,423
8.00%
Forma
145
1,351
3,325
(47)
4,774
(175)
6
(175)
6
8.0%
12.0x
91.9%
(351)
14.8%
351
3,850
450
93
3,850
450
93
(175)
(175)
(175)
6
6
6
31
31
4,424
Year 1
4,966
397
0.50%
25
10
Year 2
5,165
413
0.60%
31
15
Year 3
5,371
430
0.70%
38
21
Year 4
5,586
447
0.80%
45
28
Year 5
5,810
465
0.90%
52
34
627
9
14
19
25
608
4.4%
Initial
4,775
382
351
351
351
351
0.7%
382
382
4,775
• 
Dynamic between capital
requirement, forward
profitability, value and the
investor IRR
• 
Use of tax asset (not shown)
if preserved and utilized can
be a significant IRR driver
• 
Issues are greatly
compounded if parent
leverage has to be resolved
• 
Investor hurdle rate has to be
high to offset risks
• 
Is a 15% IRR high? High in a
zero-rate environment?
8.0%
21
First Security Group (FSGI) Recap
§ 
FSGI announces a $90 million recap Feb 2013
§ 
60 million shares @ $1.50; TBVPS @ 9/30/12 was $6.55 on 1.8 million shares
§ 
$5 million rights offering for existing shareholders
§ 
Parent capital structure - nil TruPS and $33 million of TARP;
§ 
Treasury … TARP for common @ 26% of par; accrued dividends @ 100%; Treasury will
sell its position to sell its shares to investors
§ 
Pro-forma company leverage ratio to 8.5% from 2.5% @ YE12
§ 
~$50 million DTA (NOL) preserved
§ 
NPAs/assets 6.5% @ YE11 … most of ~$70 million of net proceeds down-streamed
into the bank to replenish capital and cover a $14 million loss on the sale of $36 million
of NPAs … pro forma NPAs @ YE12 2.5%
22
© 2013 Mercer Capital
www.mercercapital.com
11
How to Profit on a Distressed Transaction
Jeff K. Davis, CFA // March 28, 2013
Mercer Capital Articles
§  TruPS deferrals set stage for many more 363 reorganizations by 2014
http://www.snl.com/InteractiveX/article.aspx?Id=16512555&KPLT=2
§  Revisiting Carl Icahn's CIT debt and equity trades
http://www.snl.com/interactivex/article.aspx?id=15713998&KPLT=6
23
Final Thoughts
§  #1 value return driver that buyers control is the purchase price
§  Value the bank, not the parent/consolidated entity
§  Return drivers (or detractors)?
§  Profitability improvement
§  Growth
§  Multiple expansion
§  Focus on prospective IRR
§  Profitability x leverage x P/E = P/TBV … buyers are acquiring
earning power, not capital
24
© 2013 Mercer Capital
www.mercercapital.com
12
How to Profit on a Distressed Transaction
Jeff K. Davis, CFA // March 28, 2013
Questions?
Jeff K. Davis, CFA
615.345.0350
[email protected]
Mercer Capital
5100 Poplar Avenue, Suite 2600
Memphis, TN 38137
901.685.2120
www.mercercapital.com
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