Description

Situation Overview:

Peoples Financial Services Corp. (“Peoples”, Ticker: PFIS) and Penseco Financial Services Corporation (“Penseco”, Ticker: PFNS) announced on Friday, June 28, the signing of a definitive agreement for the two banks to merge in an all stock transaction.  As part of the deal, Peoples will issue 1.3636 shares of PFIS stock in exchange for each outstanding share of PFNS stock.

We are at the early stages of this trade and more details/analysis will follow.  The transaction is expected to close in late 2013, pending satisfaction of customary conditions and shareholder and regulatory approvals.  Assuming that the deal closes, the IRR on this trade would be ~25%.  

I believe that regulatory approval on this transaction is high given that it is a merger of two healthy community banks both headquartered in Pennsylvania that are only about 1 hour drive away from each other.  

• Peoples is a $678mm asset bank based in Hallstead, PA.  Penseco is a $930mm asset bank based in Scranton, PA.  Post close, headquarters will be based in Scranton with significant operations in Hallstead.
• Both banks are well capitalized.  Peoples has 9.9% TCE, 12.1% Tier 1, 13.4% RBC, and 9.4% Leverage ratio.  Penseco has 11.8% TCE, 16.8% Tier 1, 18.0% RBC, and 11.8% Leverage ratio. 
• Both banks have stable asset quality.  Peoples has an 18% texas ratio, 1.73% NPAs/Assets, 1.38% reserves/loans, 57% reserves/NPAs.  Penseco has a 3% texas ratio, 0.32% NPAs/Assets, 1.11% reserves/loans, 237% reserves/NPAs.
• Both franchises are very profitable.  Just look up their ROAs and ROEs on SNL
• Regulatory approval will be required from the Pennsyvlania Department of Banking and Securities and the FDIC.  The SEC will also be involved but less important.

The combined franchise is unlikely to affect the competitiveness of the marketplace. 

• There is one overlapping MSA and Federal Reserve Banking Market (Scranton-Wilkes-Barre, PA).  The 2012 market HHI post-merger score is 1,018 and 898 for MSA and Fed Banking Market, respectively.  The 2012 market HHI changes are 21 and 17, respectively. 
• There is one overlapping city (Clarks Summit, PA) that has a post-merger HHI of 1,530 and a market HHI change of 188
• These scores are below general regulatory thresholds of 1,800 for market HHI and 200 for market HHI change

Shareholder approval does not seem difficult 

• Compelling proposition for shareholders to merge two clean banks, gain scale, improve liquidity, and then list on the NASDAQ
• Merger agreement states that not more than 7% of shareholders can dissent to the transaction but this does not seem too onerous, per my discussions with management/law firm
• Directors and officers of both banks have entered into agreements to vote their shares in favor of the merger.  Per the latest proxy, this is 12.8% at Penseco and 6.6% at Peoples.

Valuation 

• PFIS stock is currently trading at 1.6x Price/TBV.  Quarterly ROEs for Peoples over the last two years have hovered around 13-15%
• Assuming PFIS’s June 26 close of $34.90, the transaction price for PFNS at announcement is $47.59 ($34.90 x 1.3636), which equates to 1.5x Price/TBV.  Quarterly ROEs for Penseco over the last two years have hovered around 7-9%

Other Notes:

• Peoples terminated SEC filings in late 2012 because it was getting too costly ($150-250k/year).  
• More information (plans, projections) will be shared in the upcoming months
• Peoples will file a registration statement within 45 days, which will contain information on both franchises as well as pro forma financials
• Peoples will survive as the holding company

Termination Rights:

• Termination fees: $3.7 million, or legal and other advisor expenses up to $600k.  This is about 2.5-3.0% of the target valuation, which does not seem overly tight.
• Penseco may terminate the merger if the closing stock price of PFIS on the date that is the later of the date of the Peoples’ shareholder meeting and the date on which all regulatory approvals have been received (i) is less than 75% of Peoples’ common stock price on the date of the Merger Agreement and (ii) has underperformed the NASDAQ Bank Index by 25% or more since the signing of the Merger Agreement

Conditions to Close:

• Shareholder approval (from both sets of shareholders)
• Regulatory approval
• Absence of legal prohibition against the merger
• Registration by Peoples of its common stock to Penseco shareholders
• Delivery of customary legal opinions as to the federal tax treatment of the merger
• Accuracy of representations and warranties
• Material performance of all covenants
• Absence of material adverse effects

Resources:

Deal Presentation:

http://www.sec.gov/Archives/edgar/data/1054508/000119312513277190/d561553d425.htm

Merger Agreement:

http://www.sec.gov/Archives/edgar/data/1054508/000119312513277177/d561553dex21.htm

Press Release: http://www.sec.gov/Archives/edgar/data/1054508/000119312513277174/d561553d8k.htm

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