A Buyout Blueprint For The Banks?
When Hugh L. McColl Jr. agreed to buy Boatmen's Bancshares Inc. at the end of August to create the fourth-largest U.S. banking company, a controversy erupted over whether the expansion-minded chairman and CEO of NationsBank Corp. had paid too much. Market reaction to the $9.6 billion price tag was swift: NationsBank stock dropped 7.8% the day of the announcement and 4% more over the next three days. Lost in the fray was the unusual scheme that will be used by McColl to finance the deal when it closes early next year. His strategy could markedly change the industry's attitude toward takeovers and help accelerate banking consolidation.
Bank takeovers are usually accomplished by swapping stock. McColl will instead use cash as well as stock, giving the deal the flavor of a leveraged buyout. He will get his leverage by using capital held by Boatmen's to help pay for the deal. The arrangement also will reduce the deal's cost to NationsBank shareholders, because fewer new shares will be issued.
"TURNING POINT." Diane L. Merdian, an analyst at Montgomery Securities, predicts that NationsBank's financing technique will attract imitators. This, she says, could not only encourage more big mergers but also put the fear of imminent takeover in-to capital-rich bankers. Traditionally, buyers have not rewarded bank targets for having excess capital, which currently means having a ratio of tangible equity to assets way north of 6.0%. "This deal will come to mark a turning point in bank mergers and acquisitions," Merdian wrote in a recent report. "Banks with excess capital are now more vulnerable to being acquired." "We have looked again at our merger models and in every case raised target prices as a result," says David S. Berry, analyst at Keefe, Bruyette & Woods Inc. William P. Boardman, Banc One Corp.'s head of M&A, adds: "It's very appropriate to look at the excess capital in the bank being acquired as a way of paying a part of the purchase price."
Hungry bank buyers won't have to look too far to find plenty of banks with extra capital (table). Merdian's list includes KeyCorp, First Security, and First Chicago. Berry points to Mercantile, U.S. Bancorp, and Summit Bancorp.
Debate over the appeal of NationsBank's move is linked to two different accounting methods used to structure mergers and acquisitions. Nearly all big bank deals have involved so-called "pooling" accounting, in which banks exchange each other's stock. The other method, upon which McColl's deal relies, is "purchase" accounting. It allows a buyer to offer any combination of stock and cash. Banks have mainly avoided this approach for large deals because it forces the buyer to write off goodwill--the premium paid in excess of book value--usually over 25 years. "It's like nuclear waste," says Richard M. Kovacevich, chairman of Norwest Corp. "It lasts forever. It's a huge expense with no associated benefit."
But purchase accounting is starting to win converts, since it lets buyers use cash and makes it easier for banks to repurchase their own shares. With the industry awash in capital, banks do not want to stop the aggressive stock buyback programs they have been announcing in droves. With regulators this year making it more difficult to repurchase shares under pooling, purchase accounting is looking a whole lot more attractive.
Purchase accounting still has plenty of critics. Goodwill write-offs don't reduce a bank's underlying or cash earnings, but they do hurt reported earnings, still the focus of most investors. The Boatmen's deal will require NationsBank to write off $245 million a year for the next 25 years.
And the critics argue that exploiting excess capital won't make an otherwise unappealing target look more alluring--or excuse overpaying either. "If you still want to pay a lot," says Goldman, Sachs & Co. analyst Robert B. Albertson, "you're going to get hurt." Though she praises McColl's fancy financing footwork, Montgomery's Merdian still thinks he paid too much for Boatmen's. And bankers could take leveraging too far; that's what both Merdian and Berry believe NationsBank is doing in the Boatmen's deal.
The marketplace, meanwhile, seems to be warming to NationsBank's strategy. Its stock has bounced back to where it was before the deal announcement, albeit in a strong bank market. And in the end, McColl's worldview on mergers may be the look of the future.