VSB Bancorp (VSBN) – Merger Arbitrage – 15% Upside

Current Price: $18.48

Offer Price: $21.18

Upside: 15%

Estimated Closing Date: Early Q3

Merger Agreement

 

This is a tiny all-stock bank merger that used to trade with a tight 1%-2% spread before the Covid-19 market fallout. Current upside  stands at 15%. Trading volume is quite limited. Borrow for hedging is available and cheap.

On the 23rd of Dec’19 VSB Bancorp agreed to be acquired by Northfield Bancorp in an all stock transaction. Consideration will depend on NFBK average price prior to closing, however as long as it stays below $16.27/share (far from the current price), target bank shareholders will receive 2.0463 NFBK per each VSBN share.

VSBN shareholder approval is required, however on the 20th of March it was announced that due to COVID-19 situation the meeting will be adjourned from the 28th of April to the 23rd of June. Both banks operate in NY where the virus situation is especially escalated, so similarly to EMPK merger, this delay is looks legitimate and likely is the result of the lockdown rather than changed sentiment towards the transaction.

As this is an all-stock transaction the offer price in dollar terms has been significantly impacted by the overall fall in stock prices. At the time of announcement, merger consideration stood at 1.62xTBV vs 1.02xTBV currently. However, with almost all of the banking sector (NFBK included) now trading materially below TBV, this relative change in merger consideration simply reflects current market valuations. VSBN shareholders still receive the same share of the merged company, so their decision should not be impacted by recent price actions.

 

The main risk is that the transaction gets cancelled due to current uncertainty in the banking sector and covid’s impact on the loan books. If balance sheet of either bank gets dis-proportionally impacted by lock-down then this might cause the other one or its’ shareholders to reconsider the transaction. 13% of VSBN loan portfolio is unsecured business loans and 14% construction loans – these two sectors might be the most risky in current situation. The rest of VSBN portfolio and majority of NFBK loan book is secured by real estate.

 

Northfield Bancorp

Northfield Bancorp owns Northfield Bank, which has total assets of $5bn and operates 37 locations in NY (12 are in Staten Island) and NJ. Its efficiency ratio (non-interest expenses/revenues) stands at 58%.

Previous acquisition – in 2016 NFBK acquired a similarly (to VSBN) sized HVC bank with $500m of assets for $55m in stock and cash.

Main part of NFBK loan portfolio consists of multifamily real estate (64%) and commercial real estate (15%). Non-performing loans stands at 0.29%.

The most recent Q4/annual report showed a 1% of BV increase QoQ and 6% YoY, however profitability decreased compared to strong Q3 and Q4’18. Q4 EPS decreased by 14% since Q3 and 5% compared to Q4’18. ROE has also decreased and currently stands at 5.84% vs 7.66% in Q3 and 6.55% Q4’18. ROA was reported at 0.82% vs 1.11% in Q3 and 0.92% in Q4’18.

 

VSB Bancorp

VSB Bancorp owns Victoria State bank, which has total assets of $370m and operates 6 locations in Staten Island (NY). Given its size VSBN is actually quite profitable, but less efficient than the buyer – its efficiency ratio is 64%, suggesting that there is scope for cost synergies in the merger.

As the company no longer reports with SEC, the most recent annual report available is of 2018 and I am assuming has not changed much during the recent year. It seems that 70% of VSBN loan portfolio was made of commercial real estate loans and only 1% belonged to retail clients, while second largest sector (14%) was construction loans. The bank also had 13% exposure to commercial business loans (most of them unsecured). Non performing loans made 0.23% of the portfolio at the time.

The most recent Q4 report followed a similar trend to NFBK. BV increased 1% QoQ and 8% YoY, however profitability decreased after the strong Q3 and Q4’18. Q4 EPS decreased by 38% since Q3 and 30% compared to Q4’18. ROE has also decreased and currently stands at 6.96% vs 11.71% in Q3 and 8.51% in ’18. ROA was reported at 0.72% vs 1.13% in Q3 and 0.78% in 18.

 

Note: Due to recent market crisis spreads have exploded for numerous M&A transactions. Although the return might seem attractive, the risk – both of transaction termination and materially larger downside – has increased substantially. There have already been several instances (e.g. TTLO) of merger cancellations.