A $5.5 billion merger between two Texas-based regional bank holding companies recently highlighted the potential credit implications of such integrations between similar financial entities when Moody’s Investors Service rated the deal as credit negative for the newly combined entity.
Moody’s pointed to historical trends, suggesting that complications during the integration of the companies could have costly side effects.
“In general, we do not have a favorable view of large U.S. bank acquisitions,” Moody’s wrote.
Texas Capital Bancshares, Inc., and Independent Bank Group, Inc., reached a definitive agreement to combine all stocks in a merger of equals in December to create what the companies described in a press release as “the premier, Texas-based super regional bank.”
The bank holding company will operate under the Independent Bank Group moniker and the combined bank will be dubbed Texas Capital – the name used by the bank owned by Texas Capital Bancshares.
The top executives for both companies championed the merger, stating that it will create the potential for greater profitability through cost savings, stronger compliance and technological infrastructure, continued customer growth and expanded diversification in the marketplace.
“This combination with Texas Capital is a singular opportunity to significantly diversify our customer base, business lines and loan concentrations, enabling us to accelerate our growth and enhance our financial flexibility for continued strategic investments,” Independent Bank Group Chairman and CEO David Brooks said in the release. “At the same time, Independent Bank Group will benefit from the strength of Texas Capital’s technology, processes and systems to ensure we are even better positioned to serve and compete for clients in all lines of business while mitigating risk. With our combined scale, a deeply experienced and talented team with similar cultures and focus on superior operational execution, we believe that together we are well positioned to generate enhanced value for both companies’ shareholders through improved efficiency, strong returns on capital and earnings accretion.”
Brooks will head up the leadership team at the new company – adding the role of “president” to his title. Texas Capital President and CEO Keith Cargill will serve as special advisor to Brooks at the company. He also will assist in talent and client retention, as well as with advising on strategic initiatives.
“We have found the ideal partner in Independent Bank Group given our shared core values and strong commitment to fostering talent and delivering a premier client experience,” Cargill said in the release. “Independent Bank Group is an outstanding complement to Texas Capital with its enviable commercial branch network, small business market leadership and solid deposit funding model in combination with our strong corporate banking practice and powerful technology and compliance infrastructure. Importantly, this accretive transaction delivers significant value to our shareholders, with substantial growth drivers, an annual dividend and increased profitability run rate with meaningful synergies.”
Where Moody’s raises the possibility of negative credit implications is with regard to the merger itself.
“Specifically, transformational mergers of equals are challenging and we believe it is vital that roles, responsibilities and corporate culture are quickly defined and understood so the long path to a full integration can proceed while minimizing disruption,” Moody’s wrote. “To that end, the banks’ selection and disclosure of the executive management team and board composition on the day the deal was announced is favorable, but the time table for a full and comprehensive integration remains long.”
The analytics firm pointed out that significant challenges and due diligence missteps often associated with mergers are not always immediately apparent, with some coming to light long after the completion of a merger. Supporting its contention, Moody’s pointed to numerous bank integrations in recent decades – particularly during the financial crisis.
“History has shown that in U.S. banks’ zeal to expand, banks have often undertaken poorly timed or ill-advised acquisitions, frequently taken on too much leverage in the process and often absorbed liabilities tied to legacy issues at selling institutions,” Moody’s wrote. “Therefore, we are cautious in examining the potential effect of an acquisition on the acquirer’s credit profile when evaluating transactions announced by rated U.S. banks.”
Moody’s also acknowledged instances in which mergers have proven credit positive, including the recent large-scale integration between BB&T and SunTrust Banks, but cautioned that integrations tend to prove most beneficial in achieving goals driven by a need to increase in scale.
“Many of those firms cited the rapidly evolving U.S. banking environment, particularly the need to increase technology investments, as the key driver for their mergers,” Moody’s explained. “When it comes to technology and innovation, the benefits of scale are likely to continue spurring more regional bank consolidation in the U.S.
“Bank acquisitions, for both buyers and sellers, can be a credit-positive alternative to improving earnings than pursuing more aggressive organic loan growth, particularly since the economic cycle is in its latter stages. But consolidation only solves the dilemma if they markdown the assets of their acquired banks appropriately, integrate them well and raise sufficient compensating capital.”
The analytics company updated its ratings outlook for Texas Capital from stable to negative.
“Though the merger will result in a more diversified loan and deposit franchise and provide opportunity for cost savings that could enhance profitability, it also presents material integration risks, which was the driver of the outlook change to negative from stable,” Moody’s wrote. “Any operational missteps that would surface in the integration process could weaken the financial standing and performance of the combined entity, which may in turn incentivize management to increase the firm's risk appetite to preserve profitability or capital. Mitigating these challenges is the combined management team’s integration experience and Independent’s track record in recent years, though the current transaction is much larger than anything previously undertaken.”
Moody’s stated that the ratings could return to stable in the next 12-18 months if Texas Capital maintains funding and liquidity levels similar to those it held while under the direction of Texas Capital Bancshares and improves capitalization post-close of the transaction. Such an upgrade during that time frame would be unlikely, however, according to Moody’s.
Texas Capital could see a downgrade in its ratings if Moody’s assesses weakened internal controls or underwriting in its loan portfolio. Further downgrading also could occur if the bank’s expected capitalization improvement does not materialize, Moody’s noted.
Leaders of the new entity will not be out of the wood after the merger closes, either.
“After the close of the merger with Independent, any operational missteps in the integration process that weaken the financial standing and performance of the combined entity, or indications of an increase in risk appetite, could lead to a rating downgrade,” Moody’s wrote.
The terms of the merger agreement, which received unanimous approval from both companies’ boards of directors, stipulate that Texas Capital shareholders will receive 1.0311 shares of Independent Bank Group for each Texas Capital share they own. Former Texas Capital shareholders will own 55 percent and Independent Bank Group shareholders will own 45 percent of the combined company. Upon consummation of the transaction, the combined company expects to offer an annualized dividend on its common stock of $1 per share, subject to approval by the board of directors.
Along with Texas, the new regional bank also will serve portions of Colorado previously served by Independent Bank branches. Those branches will continue to be branded with the “Independent” name. The corporate headquarters of the combined company will be located in McKinney, Texas.