Quick Lessons from the FLIC Deal
Thursday September 5th saw ConnectOne (CNOB) acquire First of Long Island Corp. (FLIC) in an all-stock deal of around $284 million.
While other media outlets can give you the “official” story, I can give you some real lessons.
Note: any of the custom Victaurs data is available for any and all banks for paid subscribers.
Lesson #1: M&A does not have to mean “sell for a big premium”.
FLIC was trading in the mid 70s to TBV coming into the announcement and the deal was announced at a valuation of … mid 70s to TBV. So, before we get our hopes up for the M&A boom coming and big premiums for sellers, know that in some cases this is definitely a “buyer’s market”.
What’s more, FLIC was projected to have about an 8% or so 2025 ROTCE based on EPS & TBV estimates for 2025 (yellow triangle and row below). That “in theory” should’ve been worth about 100% of TBV based on the universe of public banks stocks.
Not much of this was the way the balance sheet looked and what was under the hood in the loan book, but the biggest lesson is, M&A does not automatically mean a premium sale.
Lesson #2: Loan marks don’t exist, until they do.
We have all heard about the impact of AOCI on TCE. And accounting rules force banks to recognize the “economic value” impact of underwater bonds for all to see in your financials while loans (and liabilities) stay hidden. But the economic value of underwater loans is there even though you don’t mark them like bonds. Read as: if you make a bunch of low-rate loans and rates go up, despite them not having a mark to market loss, they have still destroyed economic and shareholder value. And you won’t feel the instantaneous “mark”, but you will feel the slow bleed of below market income. And even though most aren’t aware, investors are.
Without taking a deep dive into the loan book, the deal announcement shows just this. This deal has a purchase accounting mark including a loan interest rate mark of $198 million which is really just quantifying the present value of where the loans are held on the books of FLIC relative to where those loans should be priced at today’s rates, based solely on rates. Contrast this to the $47 million of FLIC AOCI accretion.
It also shows how addictive M&A can become when loan marks turn into EPS accretion. But the broader point remains, loan marks don’t exist, until they do.
Lesson #3: Balance sheet management doesn’t matter, until it does.
Most CEOs rightfully focus on building their team, growing their footprint, trying to grow franchise value, and interfacing with investors. And they leave the “balance sheet management” to the CFO & Treasury teams. And for the most part those teams sit in the shadows doing the thankless work of making sure the balance sheet doesn’t get too out of whack. And that part of the banking business is one of the most important functions that no one talks about. And that the smart ones care about.
FLIC was a darling franchise over the years trading at 150% of TBV going back as far as 2016, 200% plus in 2017, and even 150% of TBV as recent as July of 2022.
But the big rates up and lack of great balance sheet management (along with the NY CRE focus) led to a collapse in premium. How this manifested itself in the financials was again not a big loan mark but rather a NIM that slowly bled away as and increasing COF ate into low asset yields. The value of any asset today is really just the present value of it’s future cash flows. And so in FLICs case as margin eroded and future cash flows eroded, the present value of that beautiful “core” income stream also eroded. And if you need other historical examples, think back to MTB and their takeout of Hudson City.
Balance sheet management doesn’t matter, until it does.
Lesson #4: Adding “core” is helpful, until it isn’t.
Wise bankers tell me that the way to build core franchise value is to grow organic loans and core deposits. And this is mostly true most of the time. But the FLIC story is one where it’s pretty clear that while a bigger “core” book was better (for compensation, RSUs, etc) but in the end it did not create excess franchise value expressed as a big premium to TBV.
Investment bankers & CEOs alike will tell you that adding core loans in most cases gives you a nice premium multiple. That people are willing to pay 200% or 300% of TBV for these beautiful high margin relationships. But that doesn’t have to be the truth, and the FLIC story proves it out. On paper they had a balance sheet full of “core” relationships which should’ve produced a beautiful takeout multiple, but it didn’t. Largely because of the point above on balance sheet management.
Which begs the question, would you rather load up the balance sheet with thin margin “core” that should create a great takeout multiple (in theory) or just compound book value like an NBN? Shout out to Colarion on the great write up on this. It’s a deeply philosophical question best had over your choice of beverage. As are these: Can highly profitable “non-core” banking become core? Is it better to run a large “core” book at thin margins? If I don’t want to sell, what does a premium multiple matter?
The truth is that yes core matters, but only if you are able to continue to grow Revenue per Share, Earnings per Share, and Tangible Book Value per share in excess of your peers. Grow those metrics and your value grows. And FLIC was unable to do that. FLIC did have asset growth over the years. But they were a laggard in the 3 categories that produce Shareholder Returns and ended up not getting a big premium takeout.
Lesson #5: Regulators are your best friend, until they’re not.
We all know this already.
But this deal screams “arranged marriage” and my opinion is that examiners came in and said some version of “you’re paying out more in your dividend than you’re earning, your CRE concentrations are too high, your earnings are going to suck for a while, and so we think you should raise capital or find a dance partner … or else we’ll be happy to help”.
And I think a lot of banks are already having this discussion behind closed doors and I’m hearing that and adjusted 10% CET1 ratio (CET adjusted for AOCI) is a new “standard” for rating agencies to ding you on if you’re below.
Be mindful of this going forward as you look at investing in banks going forward. Low CET1 ratios (adjusted or not) are going to be problematic and increase your risk to dilution via raises or take unders.
Here’s a list of other banks that have higher CRE concentrations to FLIC and similar situations. Some have already taken actions to stave off regulators and some haven’t. Some have more than meets the eye behind the static ratios. And some may have challenges moving forward.
Regulators are your best friend, until they aren’t.
Lesson #6: We’re all just a mistake or two away from being someone else’s cost saves.
The biggest cost saves in most M&A deals are typically the extra executive salaries. And to the victors go the spoils. So, if you don’t heed these few lessons you end up becoming someone else’s cost saves. We’ve all been there; shoot I’ve been there.
Stay humble & keep your eyes open to risks on the horizon. Let’s all avoid becoming someone else’s cost saves.
The best is ahead,
Victaurs
Bonus Lesson: NY Multi Family Just Got a Big Credit Mark.
For those looking at VLY, NYCB, and the like. Know that this deal put a live price on some of the nastiest assets out there. Shout out to Captain George on seeing this one early. 7% credit mark is no bueno.
