Flagstar Bancorp (FBC) – Merger Arbitrage – 5%+ Upside

Current Price: $41.82

Offer Price: $44.05

Upside: 5%+

Expected Closing Date: Aug'21

Presentation

 

This is a quick note on a $2.6bn bank merger with 5% current spread that has been flagged by one of our members. It is likely this transaction will be rejected by target's shareholders and this might prompt higher bid from the buyer. With cheap borrow and limited downside to pre-announcement prices this is a low-risk option on the potential bid increase before/after the shareholder meeting in early August.

On the 26th of April, Flagstar Bancorp announced a merger with New York Community Bancorp. Consideration stands at 4.0151 NYCB shares per FBC share. 17m shortable shares are available on IB at 0.25% annual fee. Regulatory issues are unlikely, however, the transaction also requires approval of both FBC and NYCB shareholders. The meetings are set for the 4th of August. Closing is expected in late 2021, providing a potential 5.3% return in around 5 months. The downside to pre-announcement prices for both sides of the trade is a bit less than 5%. With the merger announcement, both banks have also issued positive Q1 results, so it should not impact the downside by much.

The deal seems great for NYCB - its assets will increase from $55bn to $87bn, add much cheaper FBC deposits, diversify the portfolio by reducing exposure to mortgage and commercial RE, expand geographical presence, etc. Most importantly, NYCB is paying only just a bit over 1x TBV, while the transaction is expected to be 16% accretive to EPS in 2022. The pro-forma profitability (ROE) is expected to increase from current 12-13% to 16%. As summed up by the CEO:

When I was appointed President and CEO of New York Community earlier this year, one of my top priorities was to seek out a like-minded partner that would provide NYCB with a diversified revenue stream, an improved funding mix, and leverage our scale and technology, as we transition away from a traditional thrift model. In Flagstar, we have found such a like-minded partner. The combination of our two companies will allow each of us to continue our transformation to a full-service commercial bank by broadening our product offerings while expanding our geographic reach with no branch overlap.

Overall, NYBC shareholder approval is very likely.

However, I am far more sceptical about the approval of FBC shareholders. At current prices, the merger comes at just 1.05x TBV, which is much lower than the target's historical valuation and Midwest peer M&A multiples (1.54x) and also offers no premium to Dec'20 valuation. FBC has been a beneficiary of the booming RE market and saw its profitability skyrocket in 2020 and Q1'21 due to massive gains on loan sales. Obviously, these profitability levels should drop back to normalized levels once the RE market cools off, however, I can not imagine FBC shareholders agreeing to sell the company for such price, especially, on the back of massive, albeit temporary, profitability tailwinds. FBC main shareholders are index funds and large asset managers (top 4 largest owners hold 40.7% shares), so I believe that most of them are waiting for the proxy firms' recommendations, which should come shortly as shareholder meetings are less than a month away. It is very likely that those recommendations will be negative, which could potentially push NYCB to adjust the exchange ratio upwards. As stated by the CEO, NYCB is looking to grow through acquisitions and there's a good chance that they won't drop a merger with FBC as there are not that many efficient similarly sized banks with cheap deposits and relatively complementary loan portfolios that also trade significantly below NYCB multiple (to make it accretive on TBV basis).

 

FBC historical performance

 

NYCB historical performance

 

Additional info

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