Community bank merger – 9-10% Upside
This is a rather standard community bank merger arbitrage with a 10% spread. Such mergers are typically straightforward and had high closing rates historically (previous examples on SSI NWYF, CCSB, FNHM, LDKB, FBC, SNNY, CROL, EMPK).
Fentura Financial is getting acquired by similarly-sized and Michigan-based peer ChoiceOne Financial Services. Consideration stands at 1.35 COFS shares. There’s plenty of cheap borrow available for hedging. The transaction is expected to close in Q1 2025. Shareholder meetings are scheduled for December 12. FETM’s daily trading volume averages c. $100-$200k, however there are usually only a few trades each day, so liquidity is quite limited.
Merger is conditioned on shareholder approval from both sides and regulatory consents – neither are likely to pose significant risk to the completion of the transaction.
Both banks operate only in Michigan, but there’s virtually no overlap in the specific cities they are located in. Based on deposit size, this is the 16th largest Michigan bank acquiring the 22nd largest. The combined company will only move up to the 11th place. I don’t expect regulators to oppose this transaction from antitrust perspective. Both banks have similar loan portfolios, primarily focused on CRE, multifamily, and 1-4 family loans, making the merger a natural fit operationally. Both seem to be reasonably-well-managed with very low nonperforming loan ratios and teen ROE lately.
COFS is used to growing through acquisitions. The merger with County Bank Corp in 2019 doubled the size of the bank. The same was true for the merger with Valley Ridge Bank back in 2006. So integration of a slightly smaller FETM should not pose any issues.
FETM’s shareholders are likely to support the merger. The offer values the bank at 1.44x TBV and 14.3x LTM PE. FETM shareholders will end up with 41% of the combined company, which seems pretty fair split considering FETM’s assets and equity will make up 41% and 39% of the new entity. Synergies from this merger are estimated at around $12m or 12% of the combined non-interest expense of both banks. Factoring in these synergies, COFS is acquiring FETM at just 7.2x PE.
Several valuation reference points:
- COFS, the acquirer, has similar profitability and currently trades at a comparable 1.6x TBV.
- Michigan peer MCBC was recently acquired at 1.74x TBV and 12.4x PE. MCBC was bigger, a bit more profitable, and more efficient than FETM. This merger closed in 4 months – similar timeline could be expected for FETM.
- Mercer Capital’s Bank Watch (September edition) shows similarly-sized Midwestern banks getting acquired at an average 1.52x TBV and 14.5x PE;
- According to the same report, Midwestern banks are, on average, trading at 1.16x TBV and 13.2x PE.
FETM management holds 10.4% of the shares, while another 7.2% is owned by 1st&Main, a PE firm focused on banks and fintech. It initiated the position at $18/share back in 2017 (compared to the current merger consideration of $43/share).
COFS has higher dividend yield than FETM, depending on how many dividends will be paid out till closing, the difference in yields will narrow the spread by 0.5%-1%.
The spread has been quite volatile historically.
Any idea on expected time to close?
Officially expected in Q1 2025. The MCBC deal mentioned above took 4 months to complete. FETM’s acquisition was announced in late July, so I wouldn’t be surprised if it closes at the beginning of Q1 (maybe January) rather than the end.
$COFS up 5.5%, FETM up 3%. any ideas what’s going on?
At least it is the case at IBKR, the FETM/COFS paired trade consumes much more margin than the NWYF/CAC trade (190% vs 115%) because in the short legs COFS’s margin requirement is 90% vs only 15% for CAC.
So it is expected that the FETM/COFS spread is wider and more volatile, because it takes 65% more capital to arbitrage the former .
COFS released results yesterday, so this probably was the core reason for the spike in the share price. But the spread is unchanged at around 10% as of now. Not much was said about the pending merger aside from CEO already welcoming FETM customers and employees (sounds premature, but probably also a sign of confidence that the merger will close).
One bank merger failed to get approval from regulators, and the sellers price dropped 33% today. The parties were asked to withdraw the merger application, despite supposedly being told earlier that there was no problem.
“Importantly, HomeStreet has been advised by its regulators that there were no regulatory concerns specifically related to HomeStreet that would have prevented approval of the merger.”
https://finance.yahoo.com/news/firstsun-capital-bancorp-homestreet-inc-213700061.html
Probably an unusual case, as most small bank deals succeed.
FSUN/HMST was an all-stock merger announced in Jan 2024 and expected to be closed “in the middle of 2024”.
At announcement, HMST was trading as if the merger were a done deal.
The market got more skeptical very soon after two weeks, then rebounded in confidence, and lost confidence again in April-Jun.
The spread was the widest in mid Jun, and narrowed gradually until the shock yesterday.
Judging by the roller-coaster ride in the spread, this was a very risky merger from the beginning.
I haven’t looked into the details, but a simple search turned up a story that FirstSun switched regulator from a national charter (regulated by OCC) to a Texas charter in May specifically to shop for an easier approval of this merger.
Among the bank merger deals currently covered by SSI, in the NWYF/CAC deal, CAC is also regulated by OCC.
Based on media coverage and company’s press releases, FSUN’s acquisition of HMST was opposed by OCC (FSUN’s primary regulator) presumably because of concerns re CRE exposures and insufficient capital injection in its business plan.
There was one key distinguishing factor here: the merger with HMST was initially supposed to be regulated by the OCC. However, they made it clear that gaining approval in that structure would not be possible due to OCC’s fears of yet another debacle following the NYCB situation and their exposure to CRE. As a result, FSUN changed the charter structure of its primary subsidiary, Sunflower Bank, to a Texas state charter bank to be regulated by the Texas Department of Banking, thus circumventing the OCC. They have clearly failed on this front. Details from both sides are still scant, but the issue revolves around this matter.
As for the implications for other SSI arbs, at least in the case of NWYF/CAC, the CRE concentration seems to be manageable at 240% and 264% of the risk capital, respectively. In contrast, HMST’s CRE concentration was around 500%. I cannot say the same for the FTEM transaction, as the company does not provide its CRE exposure breakdown. I am far from being an expret on banking M&A reg. risk, so I am not quite sure what the acceptable level of exposure is from the regulator. At least we know that initially, HMST and FSUN were clearly on the hook, given that part of the merger conditions included the sale of $300m in CRE portfolio. Both the fact that there is no such condition with the NWYF merger, as well as the meaningfully lower CRE exposure, makes me think that we should be fine with NWYF/CAC arb.
Sat in on shareholder vote call at 8AM ET. Deal approved.
Spread still 9%, COFS closed at $37.52 yesterday, implying $50.65 vs FETM last trade $46.50.
Bid-ask spread is very wide (3-6%), and the current ask for FETM is $48. So the real spread is probably much less than 9%.
And I think the largest perceived risk has been regulatory approval, not shareholder approval.
What do you expect the downside to be if the merger fails?
If the merger fails, I expect FETM will probably fall to around $35.9/share (being the July 24 pre-announcement price of $30 plus regional bank ETF KRE’s appreciation of 19.6%).
So a downside of about 25% from $48.
Probably more, because FETM’s price had some unusual appreciation prior to the July 25 announcement, suggesting some info leakage and that $30 was not the undisturbed pre-announcement price.
COFS just dropped their Q4 earnings, and the main takeaway is that management still expects the merger to close in Q1 2025. The spread is around 6-7%, but the bid/ask is pretty wide.
FETM merger has finally closed. Dt – thanks for sharing!