October 12, Colombian banking system (NASDAQ: COLB) and Umpqua Holdings (NASDAQ: UMPQ) announced that the two small regional banks are joining together to form a bank of $ 50 billion assets in California, Idaho, Nevada, Oregon and Washington. Investors missed the deal, sending shares of Columbia, the buyer in the deal, down more than 14% on the day of the announcement. Shares of Umpqua, which received an almost 13% premium over its price the day before the announcement, also fell nearly 5% with its Columbia-linked shares.

Let’s see why investors were so shocked by the deal.

It’s a very strange chord structure

Initially, the deal looks like a merger of equals (MOE), where two banks attempt to scale up and spread a larger pool of revenue over a smaller spending space, while gaining the ability to invest more in it. their technology. Like other bank MOEs announced over the past year, the two banks will be parting ways with the brand; Columbia Banking Systems will become the holding company, but Umpqua will retain the banking subsidiary brand. Clint Stein, CEO of Columbia, will become CEO of the combined entity, and the board will be divided, with seven members from each bank.

However, the Columbia-Umpqua merger may not in fact be an MOE because Columbia paid a premium for Umpqua. Columbia previously traded at 184% of tangible book value, or TBV (what a bank would be worth if it went into liquidation). He bought Umpqua in an all-stock deal for $ 5.1 billion, valuing Umpqua at 189% TBV. In other bank MOEs, there is generally no bonus given to the technical seller because it is in the interest of both parties to make the agreement more financially interesting, as most of the stakeholders of each bank continue with the new institution, rather than part being bought out. Additionally, Columbia has only $ 18 billion in assets and Umpqua has approximately $ 30 billion in assets, so Umpqua shareholders will own 68% of the outstanding shares upon closing of the transaction.

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The financial structure of the transaction also has certain drawbacks, in particular for the shareholders of Columbia. The $ 5.1 billion purchase price will dilute the TBV per Columbia share by almost 6% (the TBV typically influences a bank’s share price). Management expects the bank to recoup this dilution in about 2.6 years, which is now considered too long a period by many investors.

Another potential problem is the increased regulatory control of large banking transactions. Recently, First Citizens BancShares, a regional bank based in North Carolina, and CIT Group, based in St. Louis, announced that it was extending its merger agreement by five months because the Federal Reserve has still not signed its $ 2.2 billion deal, which would create an asset bank of nearly $ 110 billion.

Stein almost said that there is currently more regulatory control at the Fed level:

Yes, there is currently a backlog, as I said, with approvals of this nature. So we expect it to be a longer approval process in what we just went through with our Bank of Commerce Holdings approval which went very quickly. And that’s why we anticipate a mid-2022 close for this.

The merits of the case

There are, of course, merits to the deal and the potential for it to be successful. Columbia expects the deal to increase its earnings per share by 23% in 2023, largely thanks to the expected cost savings equivalent to 12.5% ​​of the bank’s spending base combined, which is a significant boost. good amount of cost savings. It also ignores potential revenue synergies, some of which Stein sees in mortgage banking and through Columbia’s healthcare lending platform.

The deal also creates a strong deposit base, which is arguably one of the most important measures bank investors watch. Together, the new bank will have 44% of its deposits from non-interest bearing sources, meaning the bank pays no interest on those deposits. The cost of pro forma bank deposits will only be 0.08%, which is strong.

Management also expects the combined bank to be able to generate a return of 15% on average tangible equity (the technical rate of return on equity less intangible assets and goodwill), and a return of 1.3% on average assets, which measures how much the company uses its assets to generate a profit. Both are key metrics for bank investors and both are better than either bank has generated on its own, at least in the current low interest rate environment.

Can the Columbia-Umpqua merger work?

This agreement is not completely made for. If the combined bank management can achieve its promised financial indicators, including cost savings; avoid significant attrition of deposits; and find real revenue synergies, then this bank will be better in the long run and will probably be able to develop better technology as well.

But I see a lot of the same execution risk that might be seen in an MOE. There is the cultural aspect of merging these two banks, their management teams and different brands into a stronger entity. Then there is the realization of the revenue synergies that investors will ultimately want to see to make this transaction worthwhile. And of course, the additional regulatory review doesn’t help matters, not that one should think this deal won’t go through. With all of these factors, it’s understandable that some investors don’t consider the reward to be worth the risk.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.


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