FirstMerit + Citizens Republic: Call it Zombie Love (or Financial Repression)
Updated (Re NOLs) -- In our last episode, we talked about the IPO of Capital Bank Financial (CBF), a small FL bank holding company which was once known as North American Financial Resources.
But now let’s move onto something really fun – sad really -- namely the acquisition of Citizens Republic Bancorp (CRBC) by FirstMerit Corporation (FMER). CBRC is the last bank in Flint Michigan, a part of the world that used to be the epicenter of American industry but is now notable for being the lacey fringe on the periphery of Canada. The acquisition of CRBC by FMER illustrates not only the idiocy of corporate managers, but the pernicious effects on US banks of the Fed’s ongoing financial repression.
FMER was down 11% on the news of the acquisition, which makes sense when you compare the profiles of the target and acquirer. FMER is a well-run institution with good nominal financial performance and a balanced economic capital profile. FMER has been rated “A” by Institutional Risk Analytics for the past three years. This time frame is important because most banks in the US started to recover around the end of 2009, when the tooth fairy over at the FASB changed accounting rules for illiquid assets. But I digress…
FMER has a default rate of about 100bp or 1% of total loans, which is dead on the peer average. Like most banks, the majority of risk is not on the loan book but instead the securities portfolio, as illustrated by the distribution of economic capital:
FMER Economic Capital
Lending $188 million
Trading $166 million
Securities $602 million
Total EC $907 million
Compare the economic capital for FMER to Tier One Risk Based Capital, a ratio of 0.8:1 results, which suggests that the bank is actually under-leveraged in terms of risk. Divide income by the economic capital and you get a RAROC of 6.7%, which is quite respectable. Most important, the results of FMER have been remarkably stable for years, suggesting strong management or at least good presentations skills.
Now look at CRBC, a bank that was puking blood, at least in a figurative sense, not even a year ago with a default rate north of 700bp. This is significant because CRBC is several years behind the rest of the industry in terms of cleaning up the balance sheet. The location in lovely Flint, MI, may have just a little to do with this horrific credit performance.
As late as the third quarter of 2001, CRBC was rated “F” by Institutional Risk Analytics and had a default rate of 719bp. This was not the high, however, which came a quarter before at 1,100bp. That is a “CCC” equivalent in terms of the Moody’s ratings system.
Since then CRBC has improved dramatically, but as of Q2 2012 the bank was still sporting a default rate of 220bp vs. just 66bp for the asset peers. That is almost three standard deviations difference between CRBC and its asset peers. And keep in mind that current charge offs are leading provisions for future losses by almost 3:1.
Moreover, the financials of CRBC are quite volatile. The Q2 2012 data is badly skewed by a number of transactions which make reading the financials a task. And this deal will not close until the middle of next year. Part of the skew is caused by clean-up transactions related to the sale, including some potentially valuable NOLs. At the start of 2012, CRBC had some $300 million in deferred tax assets on its books.
When you look at the economic capital profile for CRBC, the differences with FMER become apparent. The first thing to notice is that the smaller institution has no trading book, which is good. But notice that the economic capital numbers for CRBC have one more digit than the numbers for FMER.
CRBC Economic Capital
Trading $ 0
Total EC $2,374M
Or put another way, the EC model in The IRA Bank Monitor wants twice as much capital to support the risk inside CRBC as for the far larger FMER. Got your attention now? The ratio of EC to Tier One Risk Based capital for CRBC is 2.7:1 as of Q2 2012. The RAROC is a tad over zero. So what the analytics are telling us is that even today, with a much improved balance sheet, CRBC remains a value destroyer.
So here’s my questions for FMER:
First, what is it about the moribund MI and WI markets that is so attractive? OH and IN I can understand, but the same economic factors that caused this bank to get torn to pieces during the great recession are still there.
Second question concerns valuation. FMER is paying $900 plus million for CRBC and will also redeem $345 million in TARP paper held by Tim Geithner at the US Treasury. Hello?? Does $1.3 billion in total consideration for a bank that is the outlier in its asset peer group seem a tad rich? Maybe that is why S&P revised FMER’s outlook to negative from stable yesterday.
You could take the position that FMER’s repayment of the TARP and the NOLs are a wash, but the NOLs probably go away in the transaction. Even ignoring the TARP repyament, FMER arguably overpaid for CRBC by as much as 20% by my reckoning. Yuk.
Regards the Geithner watch, BTW, the latest chisme from Washington is that our hero is headed to NH to become presdient of Dartmouth College, where he can rebuild the personal balance sheet and credibility, and maybe take a seat on the board of Goldman Sachs. More on this soon but, again, I digress….
Finally, it needs to be said that the management of FMER may not be the true culprits is this situation. Banks as well as individual savers are victims of financial repression at the hands of the Ben Bernanke and the Federal Open Market Committee. A number of community banks vocally opposed the latest QE by the Fed, in part because purchases of paper by the central bank forces banks to take greater risks. As net interest margins in the banking industry steadily fall, look for ever more acts of stupidity like this transaction.
Buying a substandard bank in a poor geographic area does not strike this former FRBNY bank applications analyst as a safe and sound business practice as per 12 CFR. Other banks are cranking up the lending machine and reducing prudential standards to merely maintain revenues in the face of financial repression by the Fed and other global central banks.
Indeed, the acquisition of CRBC by FMER provides a stark illustration of the fundamental conflict between the Fed’s “dual mandate” and its legal responsibility to supervise the nation’s banks. More on that next week. Good weekend.