Description

Disclaimer: The author personally holds an investment in securities of Peak Bancorp and may buy or sell securities at any time. IDFB is currently my biggest equity allocation at a personal level, but this may change depending on fundamentals and alternatives available in the market. The author has no responsibility to update any of the thoughts presented and readers are encouraged to do their own work before buying or selling securities.

IDFB (Peak Bancorp, ticker IDFB US), is an ~$55mn market cap bank holding company listed on the OTC Pink sheets in the US, conducting business as Idaho First Bancorp, primarily in Idaho & its adjacent areas. Shares are somewhat liquid for its size, trading ~$42k/day, so this mainly for smaller funds and personal accounts.

BAWAG Group, one of Austria’s largest banks (#4 by assets, ticker BAWG AU, good writeup on VIC by Pluto on 4/14/2023), made an all-cash-offer for all shares of IDFB for $12.05/share in Feb 2022, which is still pending regulatory approval. Initially, Bawag management had hoped to close the deal before Q1 2023, however, due to delays in regulatory approval, the deal has still not been consummated. Due to these delays in deal completion, worries around banking sector fundamentals, and fears of BAWAG walking away (like TD did from FHN), IDFB share price has widened significantly from the deal price, presenting an opportunity for those willing to do the research & invest in off-the-run securities as I believe shares are mispriced at current levels.

IDFB share price development:
Pre-deal price on 01/23/2022 of $8.01
Post-deal price on 01/30/2022 of $11.35
Price before SVB crash on 03/05/2023 of $10.94
Price before FHN-TD deal break on 04/23/2023 of $10.80
Price today on 5/17/2023 of $10.33


Shares of IDFB currently trade at $10.33 (as of 5/17/2022), which implies a gross upside of c. 16.6% to the deal price. Assuming the deal is completed in next 3 months, this is an IRR of ~85% in the “success case” of the world. Current spread is the widest since the acquisition was announced.

As of their Q1 conference call, Bawag management seems quite committed to the deal, unlike TD when asked about their intentions with FHN – see below BAWAG management response to analyst asking for an update on IDFB deal on 4/25/2023 and how fundamentals are faring post the SVB initiated regional banking crisis:

“This (the deal with IDFB) is still pending regulatory approval. Nothing out of the ordinary. It is just a prolonged process. Obviously I think the regulators have been probably busy. It is out of the San Francisco Office as well. Then, we have been in touch with the management team almost daily. This is pretty robust and static, in terms of just the deposits and divorced from some of the issues you are seeing with US regional banks. Those issues have not migrated to Idaho First Bank or Peak Bancorp.”

In contrast, TD management’s comments on the FHN acquisition before the deal broke were significantly more circumspect:

4/20/2023 – “ As previously disclosed, we've come to believe that the deal is not expected to close by the May 27 expiry date. We have opened discussions with First Horizon about a possible extension, and we will update our shareholders when we can”

“I think it's the same as my answer to the earlier question. We disclosed in March that our belief is that we will not be able to get approvals to close the transaction by the merger expiry date of May 27 of this year. And we have initiated extension negotiations with First Horizon to extend that date. That's all I can provide you at this stage”


This makes sense as FHN lost deposits, while IDFB did not - total average deposits were -4% Y-Y versus +8% Y-Y respectively in Q1 2023, and that IDFB is a smaller deal for Bawag than FHN for TD. This update gives us a few pieces of key evidence:


1) Deal is pending regulatory approval, likely at the SF Fed office which has been besieged by some of the largest banking failures in recent memory (FRC, SIVB) so it is plausible the deal has been delayed due to factors outside the control of BAWAD/IDFB rather than a signal that either party wants to walk or there will be meaningful regulatory issues with the transaction
2) BAWAG thinks fundamentals are holding up well & seems to continue to push forward with the acquisition process


There are several notable differences between IDFB/Bawag and FHN/TD which lead me to conclude that the risk of a break is overblown here. In order, these are 1) regulatory, 2) size, and 3) buyer profile.

1) Regulatory

In general, the Fed rarely blocks mergers of banks – the last deal blocked by the Fed was in 2003, with thousands of acquisitions approved in the interim years. The deal between FHN and TD was blocked not by the Fed but rather by the OCC and the DoJ for TD’s improper AML and KYC practices, which shouldn’t be a concern here as the acquirer Bawag has a good reputation for compliance and isn’t facing the same issues as TD. Bawag also doesn’t have meaningful overlap with IDFB from a business perspective, as they operate primarily in Europe and peripheral markets rather than the US. While hard to know for certain, there is no evidence to suggest that OCC/DOJ are involved here and want to block this deal from happening, nor is there reason to suspect so, unlike TD. In general, regulatory risk should be low as the banking system is highly fragmented, the merging entities have negligible share or overlap, and the acquisition of smaller regional banks like IDFB by a large well run & capitalized bank like Bawag should be positive for system stability.

2) Size

Another important consideration is size – FHN was a very large bank (80bn in assets for FHN, versus 580mn in assets for IDFB), and an all cash acquisition of this size, even by someone as big as TD leads to a significant erosion in banking system equity. This is not the case for Bawag, where the purchase price for IDFB of 65mn is only 1.7% of shareholders equity, as compared to 12.6% for FHN-TD. Not only does it mean that Bawag is less sensitive to the price paid (as they are primarily acquiring a banking license in the US/entering the market, not just book value/earnings power), but also means that the potential pool of buyers for an asset of this size is much larger for IDFB than it is for FHN. Thus not only do I think the size makes this acquisition much more likely to go through, but also that in the unlikely case that the deal breaks or whatever reason, there should be another bidder ready to buy IDFB for its geographical footprint and extract cost synergies.
The US is a significantly more attractive market than Europe for banking, but this is not the same case for Canada, where NIM spreads are high due to a more consolidated banking market, so TD has less to gain from buying into a US bank than Bawag does from buying into the US (NIMs are 3.0%, 2.7%, 3.9%, 4.1% for TD, Bawag, FHN, and IDFB i.e 90bps delta between TD-FHN and 140bps delta between Bawag-IDFB). A banking license in the US would allow Bawag to shift more of their capital from low NIM yielding loans in Europe to higher NIM business in the US, especially in light of recent banking conditions which have lead to better spreads for banks on new loan originations. This is more accretive for Bawag than it is for TD.

3) Buyer Profile

Bawag is also a serial acquirer of banks globally and would hurt their own reputation significantly by choosing to walk away from the IDFB deal, which again is not the case for TD, which although acquisitive, doesn’t see M&A as a core part of their strategy. Bawag has completed 5 acquisitions in the last 5 years, as compared to 5 for TD in the same period, despite Bawag being much smaller than TD in terms of size. A recut would hurt their reputation severely, especially given that IDFB has not seen any material deterioration in fundamentals despite the headlines but I can’t rule it out


Scenario Analysis

Given all the above, I feel fairly confident that there are high odds that the deal goes through as envisioned (c. 80% scientific wild ass guess, but readers are encouraged to come up with their own estimates).
In the case the deal breaks, there are two ways to think about the downside

1) Where IDFB would trade should deal break and no other bidder comes forward
2) Where IDFB would get bought out by another strategic should the Bawag deal fail/Bawag pushes for a recut to align with current market conditions.

I assign both of these options ~10% probability each of happening.

Standalone case:

On 1), we need to better understand IDFB fundamentals to get a sense of where this would trade standalone. Generally it seems like deposit outflows in Q1 2023 for IDFB were much lower than other regional banks, as deposits were still up Y-Y in Q1 2023, as compared to a drawdown across most other regional banks. Applying a KRE average multiple of 6.5x forward P/E on run-rate Q1 2023 earnings of $5.2m growing 5% Y-Y, we get a share price of $6.6/share.

IDFB doesn’t have meaningful exposure to problematic areas of CRE like Office, Retail, etc. and seems to have granular, mostly retail liabilities that are mostly insured by the FDIC, reducing risk of both asset quality issues and liability/deposit run issues. IDFB’s NIM is fairly interest rate responsive, so there shouldn’t be any headwinds to profitability from higher rates. Given generally higher quality of the business (lower risk of deposit or asset issues) than the average KRE bank, one could argue that IDFB deserves a premium, and more like 7-10x P/E or $7.1-10.2/share

Deal re-cut or another buyer emerging case:

On 2), we can look at what typical synergies look like for bank mergers, and assume an acquirer would be wiling to pay a price that is 5% lower than their own multiple as that would be accretive. Adding in imputed synergies of 31% of opex to run-rate earnings (McKinsey report, June 2021 – “US Midcap Banking: The Shakeout Ahead”), and tax-effecting the earnings, at a 5% discount to KRE, gets us a buyout price of $10.5/share (synergized post tax earnings of $9.1mn for an acquirer).
Putting all of this together, our different outcomes are follows:

Case/Payout/Probability (author est)

Deal close: $12.05/share, 80% chance
Deal recut: $10.5/share, 10% chance
Deal break: $6.6/share, 10% chance

Expected value = $11.35/share or 9.9% gross upside. Annualized, this is a c. 45% IRR+ depending on timing of deal close (assumed 3 month close, judging from June 2023 deadline to close acquisition which could be extended). I believe this is a very attractive return given the deal is largely uncorrelated to broader equity markets and should close imminently.

Risks:

Acquisition breaks, either because Bawag walks away or there are regulatory issues to deal completion
Deposit outflows, which not meaningful in Q1 2023 for IDFB, accelerate in Q2 2023 as banking crisis gains steam

Catalyst