So you want to buy an entire bank (or just a portion), let's talk about how

"I'm looking to buy an entire bank, have any ideas on what to do?"  That seems like a strange question doesn't it?  Yet it's a question I've been asked a number of times over the past few years, and a question that a number of investors have more than a passing interest in hearing the answer.  Seeing as there isn't much online, I thought I'd provide a bit of a primer on how to buy a bank as well as include information on how regulators and bankers value banks.  This is important because it'd be hard to purchase a bank without knowing how to pay for it.

A bank is just a business like any other except for a few simple details and it's those simple details that make banks seem unlike any other business.  And that's what makes buying a bank appear so difficult.

It wasn't that long ago when a group of business people could form a partnership, raise capital and start a bank from nothing.  The financial crisis ended that practice with only two de novo (from scratch) banks receiving regulator approval since 2008.  That leaves individuals who want to own a bank with only one choice, they need to purchase an existing bank.

The Purchase

Buying a bank seems like a daunting task.  Maybe this is because the stereotypical image of a bank is one of an imposing institution.  This is an image banks have themselves helped propagate.  Rhetorically I ask how many tiny community banks have images on their website of marble buildings with greco columns set high above the road with imposing steps when their actual branches look more like a brick rectangle with a drive through?  We imagine our money being kept in large secure vaults, not on servers stored as bits.

Bankers themselves help to create this impression that "we are different."  There is banking specific lingo, there are banking specific conferences and bank specific magazines.  These things exist in other industries, but other industries share common traits that banking doesn't.  You can have a discussion of logistics or product pricing and most executives in any industry will find information that's useful to their specific business.  When bankers talk about interest rate risk, or net interest margin compression or deposit growth there is no cross over to other industries.

There are barriers to entry for the industry, but they aren't as large as some would think they are.  A little education can go a long way.

When investors think of purchasing companies their minds naturally drift to publicly traded companies.  That's because purchasing a portion of a public company is easy, it's a few clicks, or at most a phone call to a broker.  Gaining control of a public company is much harder and visible.  This is because once investors see another investor is interested in purchasing as much as possible of a company they're less willing to sell their own shares.  This usually forces a potential acquiring investor to make an offer for the company rather than slowly accumulating shares in the open market.  Banks are no different in this regard.

But one significant difference does need to be mentioned.  There are no ownership limits on non-banking companies.  For example as an investor I can purchase 25% of a company if the shares are available for purchase.  The same isn't true for banks.  The most an investor can purchase in a bank is 9.9% of the bank's stock.  This is because at the 10% ownership threshold the FDIC and Federal Reserve consider the owner to be an owner of influence and subject to approval and regulation.  There are two ways to pass the 10% threshold, the first is to obtain an waiver from regulators, the second is if a bank is buying shares in another bank, they aren't subject to the same threshold limits.  If a fund attempts to purchase more than 10% of a bank without a waiver they could be considered a regulated bank holding company and subject to holding company disclosure and regulation.  Not something a casual investment fund wants to deal with, unless they intend to become a bank only investment fund.

At 9.9% an investor can significantly influence a bank, but they don't own it or control it.  A public investor would need to make an offer for the entire bank at this point.  While this is a feasible route, it's akin to taking the longer route to a destination.  There are quicker and better methods.

Of the ~6,000 banks in the US only about 1,000 are publicly traded, and by traded I mean they have a ticker associated with them.  This means there are 5,000 banks in the US where the owners are private individuals or groups of individuals.  These are the types of banks that an investor who wants to own a bank needs to target.  There are a number of reasons for this, the first is it's much easier to talk to a private company verses a public company about confidential or sensitive information.  A public company needs to issue press releases related to various material events.  Private companies don't have this same level of responsibility.  Secondly it's much easier to negotiate a transition plan with a private company compared to a public company.

Let's take a look at how this might work.  The first thing to consider is that banking is a very congenial industry.  Bankers are friendly and politeness and formality is appreciated.  The bull in the china shop approach that's common in the public markets isn't widely accepted or appreciated.  The first place to start would be to talk to the CEO or President of a small bank and make your intentions known.  Maybe take them to lunch and let them know you're interested in purchasing a bank and would be interested in theirs, or an introduction to any bankers they know who might be interested in selling.  This is an important point, you want to work through networks.  A formal introduction from a friendly banker is extremely valuable.  There are always banks shopping themselves formally or informally.  The banker network is aware of these banks, you as an outsider might not be.  The key is to get inside the network.

Once you find a bank that's willing to sell it's a matter of purchasing your ownership stake.  To find the owners of a private bank you need to get a hold of the bank's Y-6 regulatory filing.  I'll make a shameless plug here that we have digital versions of every bank holding company's Y-6 filing inside CompleteBankData along with the ability to search them and obtain contact information for individuals.  A Y-6 will show who the majority owners are, the number of shares they own as well as their ownership percentage.  Interested in buying their shares?  Call these shareholders, or have bank management introduce you to the owners.  Once you've figured out a way to purchase a majority ownership block you need to determine how much you'll pay for the shares, that's the next section.

The Valuation

It never fails to amuse me when I visit a financial information site that presumes banks are the same as any other business.  These sites will prominently show a bank's EV/EBITDA ratio, or other metrics that are completely irrelevant.  Banking financials are unlike other financial statements.  At the most simple level a bank earns a spread between their cost of funding and the interest earned on the loans they extend.  Out of this spread they pay salaries, pay for operating expenses and pay taxes.  What's left over is considered net income.  See banking really is simple!

Because banks work differently they're viewed differently by the market as well.  There are two short-hand metrics for valuing banks, price to earnings and price to tangible book.  The rest of the market has moved from these simplistic measures onto more sophisticated ratios such as EV/adjusted-EBITDA or price to earnings-when-my-grandkids-are-in-college.  But banking has relied on simplistic short hand measures.  Thrifts and smaller community banks are usually valued on a tangible book basis and larger banks with higher returns on capital valued on their earnings.  These are quick estimates of value for market participants.  Knowing that a bank trades for 105% of tangible book value (TBV) doesn't mean anything itself, it's a relative valuation.  Knowing that a bank trades at 105% of TBV when comparable banks trade for 165% of TBV is meaningful, but it doesn't necessarily mean a bank is cheap either.  It simply means there is a discrepancy that needs to be investigated to determine if there is value in the difference.

When a bank acquires another bank they don't rely on simple metrics.  I'd be laughable to think of a boardroom with a Director saying "our target bank is only trading or 95% of TBV, I think we should purchase it."

Banking is no different than any other industry when it comes to mergers.  A bank looks at an institution to be acquired as an opportunity to maximize scale, put idle assets to work, and save on duplicated operating costs.  What's unique about banking is that at a high level all of these institutions work the same, that means that a merger is more likely to create value compared to a merger outside of banking.  There are differences in operations and cultures, but those chasms can be crossed easily.  The fundamentals of merging bank businesses are the exact same, and that's what's important.

In almost every private market the transaction dynamics of a purchase are similar.  An acquirer is granted a detailed look at the to be acquired institution after a formal letter of interest and the acquirer makes what's considered a fair market offer.  It's rare that a purchaser pays a basement bargain price for a company in the private market deal.  This is because the dynamics of the deal are much different.  Unless the seller needs cash ASAP, or has a impaired asset bargain deals in private markets just don't exist.  This is because both parties receive access to the same financials and a deal is discussed that's agreeable to both parties.  There are no public shareholders to please or worry about.

Instead alpha is generated in the private market through operational improvement.  A buyer and seller will negotiate a fair price for a deal, but the buyer has an idea in the back of their mind on ways they can better utilize the assets they are buying.  Maybe they have better customer service, or can cut costs, or can cross-sell, or a variety of other things.  Buyers pay fair prices and make their money back through operational changes.  That's one of the benefits of being a majority owner, you can make changes as you see fit to change an entire organization.

The way to value a bank is through this lens of operational changes.  The formula we use at CompleteBankData is one made popular by Richard Lashley of P&L Capital.  While ultimate credit goes to him for putting the formula on paper I had heard the sentiments of his formula explained by those in the industry long before I heard of his specific formula.  The formula is as follows: look at the to be acquired bank's operating expenses and estimate after tax cost savings.  Add those savings to the bank's net income and apply a multiple to the projected earnings after cost savings.  The concept makes sense on an intuitive level.  A second level of valuation is to estimate additional earnings from putting excess capital to work.  Typically in a merger cost savings will provide the largest bang for the buck compared to putting capital to work.  That is unless you happen to find one of these banks with 50% of their assets sitting in cash waiting to be deployed, but even in that case my guess is there are more than a few cost synergies.

Now What?

You now know how to find a bank that's looking to sell and then how to value the bank for purchase, so what's next?  You write a big fat check and get working!  It's a fallacy to think that one could buy a bank, sit back and collect checks without doing anything else.  The money to be made from buying a bank is from putting your fingerprint on the institution.  If you do it right a lot of money can be made, if done wrong then at best you can hope there's a government backstop to help you out.

Interested in learning more about banking?  I'm in the process of writing a book on banking.  You can receive a free copy of a chapter "Are Banks Risky?" by signing up for our email updates list.  We rarely will email you, but list subscribers will receive special deals on the book when it's released and advanced notice on the release date.

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  1. Interesting write up. Especially after hearing about a local guy be approached to buy part of a bank he did a fair bit of business with. Though, it does make me wonder if anyone has set out to do a roll up of various banks. I am curious as to what topics you will be addressing with the book: will it be more geared towards operating a bank or making investments in them.

  2. Hi Nate, I have a couple questions for you. If you don't want to answer them that's fine, no offense taken. First of all, if you take your best bank ideas right now, how excited are you about them? How cheap are they in relation to some of the cheapest stocks you've seen? Are we talking outrageous valuations like we had with mexican restaurants and randall bearings? Or are these more just safe and moderately cheap things. And secondly, how much of your total portfolio is in banks these days? Thanks,

    1. Matt,

      Great questions. I'm most excited about the small banks I'm seeing right now. We just profiled Ojai Bancopr, 60% of TBV. Looked at another this week less than 30% of TBV. These are small, sure there are warts, but this is Mexican restaurants cheap.

      The nice thing is there is a spectrum to buy from. I own some egregiously cheap stuff, it has warts. Then I own other banks at 80% of book with 11% ROE's and growth. You can buy all types.

      About 30% of my portfolio is in banks and all new money is going to bank ideas. I'm working on moving my wife's IRA and allocating it 100% to banks.