Description
The recent large bank mergers of SunTrust/BBT and Chemical/ TCF Financial, and the positive reception these transactions have received in the market has increased the likelihood of bank M&A. Investors Bancorp, a NJ (and NY) midcap regional bank, has several reasons why it is particularly likely to be acquired in this environment. At 1.2x BV and 15x EPS (on a still-overcapitalized balance sheet), ISBC is also a good risk adjusted way to play this theme.
ISBC was last written up back in 2013 during the second-step of its demutualization. The company IPOed in 2005, raised ~500MM and slowly grew (both through organic growth and M&A), increasing ROE while managing credit quality. The thought was they could replicate this following their second step conversion, use their capital to achieve a normal ROE (15-20%) and trade in line with the regional banking complex (1.7x TBV both then and now).
In May 2017 ISBC finished the 3-year waiting period post-second step, crossing a line that allows for a sale of the bank. Unfortunately for ISBC shareholders, just a few months before hitting this milestone, in August of 2016 the company was forced to enter into an agreement with regulators with regards to internal controls around the Bank Secrecy Act and Anti-Money Laundering compliance measures (BSA/AML). This had the effect not only of making the bank difficult to acquire, but also scuttling its offensive M&A program (they terminated their deal with the Bank of Princeton) and significantly increasing expenses to deal with the regulatory costs. ISBC has materially underperformed the regional banks since then. In November of last year, the WSJ reported ISBC had hired KBW to investigate a possible merger and about 6 weeks ago, the company ended its arrangement with the regulators following a 2.5 year period of elevated costs/compliance.
In a deal, ISBC could be worth $15-$17 p/s, equating to ~140%-160% P/TBV, a 9.5%-14% deposit premium and 13x-14x earnings with 35% cost saves.
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Valuation
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15
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16
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17
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P/TBV
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142%
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151%
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161%
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Implied deposit premium
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9.6%
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11.8%
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13.9%
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Cost Saves
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35%
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35%
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35%
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Expenses (2018)
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407
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407
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407
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savings (30% tax effected)
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0.36338
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0.36338
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0.36338
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cons EPS (2020)
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0.82
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0.82
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0.82
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new EPS (2020)
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1.18338
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1.18338
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1.18338
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12.7
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13.5
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14.4
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35% in costs saves is on the higher end of the range, but supported by the fact that both ISBC has had a relatively bloated cost base as a result of the legacy BSA/AML issues and the likely acquirers have significant branch overlap (ISBC, PBCT, VLY and STL have each also independently announced branch of subscale branches giving some indication of how marginal/bloated some of these branch networks are)
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P/TBV
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Total Assets
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Total Loans
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% of branches within 2 mi of ISBC
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VLY
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1.80
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30.8
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24.4
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50%
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NYCB
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1.50
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51.2
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39.8
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48%
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M&T
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2.46
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116.8
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86.8
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43%
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STL
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1.70
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31.2
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20.6
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22%
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PBCT
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1.86
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44.1
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32.2
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13%
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Other social/qualitative factors suggesting the likelihood of a deal are: the CEO/COO who run the show are now in their early 60s, and having built up ISBC over the last 15 years have a decent chunk of their net worth in the stock. Also, there is an activist on the board (Blue Harbour) who joined in early 2017, shortly after the company had entered into their arrangement with the regulators.
Absent a transaction, I would expect a slow grind for the stock, with capital return (TCE is still at 11%) more than offsetting slight declines in core NIM to keep slow but steady EPS/BV growth. Despite their regulatory headaches and the resulting spending, credit quality has remained strong for ISBC. In terms of credit exposure their largest exposures are multifamily (8Bn), residential (5.2Bn), C&I (2.1Bn) and Commercial RE (4.6Bn). For the last 5 years they have experienced net charge offs of $50MM (averaging 10mm/yr).
I also don’t view a dilutive M&A transaction as likely absent a better relative multiple given the company seems aware of their limitations in this respect, from the last earnings call:
“… certainly makes it difficult to try to do a transaction, Matt, if our currency is trading – our stock is trading at about 115% intangible book. So it's – again, it's difficult to use it, and we put that on a back burner at this point, I mean, while we'll always look at a potential transaction, we are most concerned with the level of dilution that may occur if we were entering to a transaction. So, right now, we see that buybacks are a pretty good deal for us.”
I view downside as relatively modest, likely around the TBV value where it was trading at the beginning of the year. Company has been an aggressive repurchaser of their stock around those levels and seemed to indicate on the last earnings call that was the most likely avenue of capital deployment.
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.
Catalyst
Sale of company/ MOE