The Price Is Right, but Who Will Buy? Depressed Share Prices and Market Stress Affect Potential Buyers and Sellers. Look for a Foreign Invasion

[ILLUSTRATION OMITTED] Kevin Rollins, former CEO of Dell, once asked what criteria determined the success of any merger. The answer, he claimed, was that it would have to be that the companies are stronger financially, that they took market share, and that they are on a very steady footing in terms of their performance. With the recent credit crisis causing a hemorrhaging of their market value, steady performance and strong financials are not phrases currently associated with many banks. But potential buyers can smell the blood in the water and may want to take advantage of this opportunity. The problem is, many of them are saddled with their own issues in a turbulent market rife with uncertainty. So even though are an enticing proposition, it is likely that activity on the whole will drop this year. If a buyer wants to take a chance to gain market share, there will be enough willing sellers out there. As bank executives face an increasingly difficult environment, they will examine more drastic strategic alternatives. Depressed stock prices and lower earnings will cause them to seek suitors if they can't right the ship themselves. Credit woes on the rise Banks that rely on construction lending have been hit especially hard. Delinquencies in construction and land development loans increased more than 300% in the third quarter compared to the same quarter in 2006, according to SNL Financial. And it's not just construction lending; delinquencies in loans of all types have risen more than 50% since 2006 (please note that OTS thrifts are excluded from the total figures since they do not report delinquencies in all of the categories banks do). Banks of all sizes in certain parts of the country are getting hit, but some smaller community banks that do not have the capital necessary to leverage themselves out of this slump face more draconian options. (See cover story, p. 22, for more input on CRE lending.) Facing stock depreciation and falling capital ratios as well, many buyers cannot afford to do a since they lack the currency to fund an offer. Compounding this issue is the current trouble in the trust preferred market, which has made raising additional equity more expensive. If a bank can afford to go after a fledgling target, it might not want to assume the risk. Buyers will be wary of taking on a sketchy loan portfolio on top of the troubles they are already facing themselves. They will also have to look at which companies make sense strategically. Through November of 2007, targets were offered a healthy 234% of tangible book. This is one of the highest premiums since 1998, second only to the 2006 mark of 246% (see Aggregate deal table, above). In the past few months, however, these premiums have been receding, and as the credit environment continues to deteriorate, sellers will begin to accept lower prices. Until an equilibrium is reached, the disparity between what the buyers are offering and what the sellers are willing to take should drive down aggregate volume and value. Foreign-bank shopping spree In a market like this, foreign firms will have a distinct advantage to swoop in and buy U.S. banks on the cheap. With the ever-declining dollar, foreign currency will have much more purchasing power in the U.S. and continued cuts to the federal funds rate will only prolong this effect. Foreign of U.S. banks have been ticking upwards the past two years, with 11 deals in 2006 and ten deals through the fall of 2007 (see Aggregate Foreign acquisitions table). These are the highest totals since SNL Financial began comprehensively collecting bank and thrift M&A data in 1989. The foreign deals are getting larger, too. The 2007 total of $22.7 billion in value through November already surpassed all other annual totals for foreign firms buying domestic targets. …

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