Uncategorized

First big domestic bank merger post-crisis

| February 8, 2019

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

The surprise merger announcement between BB&T and SunTrust provoked a sharp rally in SunTrust bonds. Reduce or exit positions in two of the SunTrust callable preferreds, as they lack change of control language and extension risk is material.

SunTrust bonds rally on merger announcement

In a big surprise in the domestic bank space, BB&T Corp. (BBT: A2/A-/A+) agreed to acquire SunTrust Banks (STI: Baa1/ BBB+ Pos/ A- CWP) in the largest deal since the financial crisis. Mergers have been all-but forbidden not only for the larger banks given the antitrust and market concentration limitations, but also for the larger regional banks. The near-failed effort for M&T Bank (MTB: A3/A-/A) to acquire Hudson City Bancorp took over three years to close after the announcement in Aug 2012, due to extra scrutiny on M&T’s anti-money laundering protocols. That acquisition by MTB was relatively small, or only 1/6th the equity market valuation of the BBT / STI merger.

The markets have already moved materially on some of the securities, which investors should act upon. Namely, the STI 5.05% NC22 and the STI 5.125% NC27 notes traded up considerably on the day of the announcement. The 5.05% notes are callable in June 2022 and have a floating reset of 3mL + 310.2 bp, and the 5.125% callable in Dec 2027 have an even lower reset of 3mL+ 278.6 bp. Both of these notes do not have change of control. Some investors are of the opinion that the potential move to investment grade justifies the move to $97.50 after the merger announcement. Reduce or exit this position anywhere close to this price as the extension risk is material. JPM 4.625% NC22 are investment grade, have a reset of +258 bp and are trading with a yield to call of 7.15%, which is a better measure for pricing perpetual risk.

The all-stock deal will combine BBT, the 10th largest and STI, the 11th largest domestic banks to be the 6th largest bank as measured by total assets with an expected balance sheet of $443 billion. This will put the yet-to-be-named pro forma company just behind US Bancorp (USB: A1/A+/AA-) with $465 billion and ahead of PNC Financial (PNC: A3/A-/A+) with $380 billion in total assets. What this means for the broader industry will be left for debate for months to come, but what seems clear is that since the shift in political winds in the US, the lower regulatory friction is likely to be positive for banks looking to grow through mergers.

Before we look to evaluate other merger candidates, it is important to evaluate the pros and cons of the BBT / STI deal:

Pros

  • Cost savings net of investments are expected to be $1.6 billion annually, which will help keep the pro forma company overhead ratio in the low 50s area.
  • Combination of complimentary business lines in lending and fee revenues, which are expected to be in the area of 40% of total revs.
  • Strong cultural over-lap will help make integration easy.
  • Commanding market share in a number of markets in the Southeast.

Cons

  • Company estimates deposit divestitures will be $1.35 billion, but with such tight market share overlap in 20 cities, this could be a low estimate and change the funding profile of the company.
  • Given the move for each BBT and STI from Category IV banks (as measured by assets) to a Category III bank, this will elevate the funding burden. Category III banks must maintain LCR and NSFR requirements at an expected range of 70-85% of what the SIFI banks are required to maintain.

Evaluating other merger candidates

As soon as the deal was announced, investors immediately began looking at what other regional banks could be potential merger candidates. This list is not long as there are few meaningful transactions that could happen, and none of which would be as large as the BBT / STI deal:

  • US Bancorp is the fifth-largest domestic bank at $465 billion in assets, though far behind Wells Fargo at $1.87 trillion in assets. USB tends to be very conservative in its management style, which has garnered it the respect of investors. This is evident in the tight spreads of the bonds, which tend to trade inside of peers. However, the geographic footprint of USB lacks presence in the Northeast or Southeast, which could leave the door open to anything from COF, CFG, RF or MTB. Each of those transactions has limited appeal either because of the riskier business at COF, the lower ROA at each of those banks versus USB, or the challenges in “selling” it to the markets.
  • Capital One Financial (COF: Baa1/BBB/A-) is already a roll-up story of its own with a multitude of small M&A transactions, as well as some big deals. With $363 billion in assets as of year-end 2018 this is the amalgamation of COF, NorthFork, Hibernia, GECC assets, and HSBC branches. Despite this acquisitive nature, COF only has a meaningful branch network in NY, VA, TX and LA, which leaves the door open on such acquisitions as FITB, RF, or MTB to name a few.
  • Citizens Financial Group (CFG: nr/BBB+/ BBB+) is the spin-off from RBS in 2014. With a good branch network in the Northeast, this bank is more likely to be an acquisition target given the low price/book of 0.8x, which leaves it with very poor acquisition currency and what would be dilutive measures in pretty much any purchase.
  • The “other run” banks that are likely reviewing a multitude of pitch books from investment bankers include: KEY ($139 billionn assets), MTB ($117 billion), HBAN ($106 billion), and CMA ($71 billion) from which point the drop-off in assets is rather steep for any other likely acquirers.

admin
john.killian@santander.us
1 (646) 776-7714

This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.

Important Disclaimers

Copyright © 2023 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.

In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.

The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.

In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.

Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.

The Library

Search Articles