Coming off of a busy year in 2015 for M&A activity in the commercial finance sector, highlighted by GE Capital’s divestitures, it was fair to wonder whether 2016 would continue to be a seller’s market – or, with volatile debt and equity markets and a cloudy economic outlook characterizing the start of the year, whether M&A activity would dwindle to a trickle. So far in 2016, activity has remained quite brisk, albeit with a heavy concentration specifically in the equipment finance and leasing market. The outlook remains favorable for continued M&A activity across the commercial finance space – specifically equipment lending and leasing, asset-based lending, accounts receivable factoring, Small Business Administration 7(a) lending, and even the still nascent marketplace lending sector.
Thus far, valuations have remained attractive for selling shareholders in 2016, but each announced deal had its own circumstances surrounding the sale and unique financial results that impacted valuation. Generally speaking, valuation metrics for healthy sellers in the commercial finance sector have averaged 12x to 15x trailing after tax earnings and 1.5x to over 2.0x tangible equity. With charge-offs and delinquencies generally remaining at or near all-time lows, loan loss provisioning has not been a major expense, resulting in good earnings. If credit quality deteriorates in the near term, valuations will suffer in the sector, which could lead to the continued momentum of M&A transactions as sellers look to seek liquidity before credit quality, and therefore earnings, start to suffer.
The Players in Today’s Market
While most headlines involving banks these days tend to highlight the overly burdensome post-recession regulatory environment, net interest margins remain within striking distance of the lowest levels of all time. Bank financial performance has in fact improved over the last few quarters, helping bank stocks rebound from both last fall’s selloff and the volatility of early 2016. And some banks remain willing to think outside the box by evaluating commercial finance company acquisitions as a way to exploit their cost of funds and leverage advantages to improve margins and fee income.
Within the last year, banks of all sizes have completed acquisitions of commercial finance companies. Aside from the large purchases involving GE Capital’s divestitures and bank buyers such as Wells Fargo, smaller community banks have been acquisitive. Berkshire Bank (Pittsfield, MA - $8 billion in assets) acquired equipment lender Firestone Financial and SBA-7(a) specialist 44 Business Capital. State Bank and Trust Company (Macon, GA - $3.5 billion in assets) acquired equipment finance provider Patriot Capital Corp.
Gulf Coast Bank & Trust Company (New Orleans, LA - $1.4 billion in assets) acquired AmeriFactors Financial Group, an accounts receivable finance company. And Sterling National Bank (Montebello, NY - $13 billion in assets) acquired NewStar Business Credit, an asset-based lender. Each of these deals involved a sub-$15 billion asset bank acquiring a non-bank commercial finance company to either enter a new line of business or further penetrate an existing line of business. These types of acquisitions should continue through the balance of 2016.
An encouraging sign relative to banks and recent acquisitions of commercial finance companies is that in several transactions, like those cited above, the bank buyer was a regional or community bank with a specific, or even narrow, geographic retail focus, yet in their acquisitions of a finance company, were willing to take on a platform with a greater geographic reach, or even a national presence. Many banks are opposed to this strategy, but if the acquisition brings a centralized credit decision-making platform, a history of good credit quality, and diversification of both loan types and geography for the bank on a pro forma basis, then this could be a highly prudent M&A model for banks to follow. As margins remain compressed and revenue growth a challenge, we expect banks in general to remain open to exploring commercial finance M&A.
With business development companies (BDCs) as a peer group continuing to trade at about 80% of book value, essentially prohibiting their ability to accretively raise equity capital, commercial finance company M&A activity has generally screeched to a halt. BDCs, however, are willing to opportunistically consider commercial finance M&A, and they continue to be an attractive option for growing specialty finance companies as a source of debt capital, particularly junior debt that can be treated as equity capital and levered with cheaper senior debt from traditional lender finance providers such as Wells Fargo and Capital One.
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