How Much Might Citizens Republic Bancorp Fetch In A Sale?

| About: Citizens Republic (CRBC)

Last Friday afternoon, Bloomberg News reported that Flint, Michigan based bank Citizens Republic Bancorp, Inc. (NASDAQ:CRBC) had engaged JP Morgan Chase (NYSE:JPM) to find a buyer and had recently approached potential buyers, citing three people "with knowledge of the matter". While I have no independent confirmation that this rumor is true, if it is true, and if a deal is consummated, it would probably be the second largest bank M&A transaction announced this year. Large bank M&A deals have been relatively rare in recent years, so this deal would be a major positive for those eager to see deal activity pick up.

Here is some overview information on CRBC and a preliminary estimate of what CRBC might fetch.

CRBC operates in Michigan, where it is ranked 8th on a deposit market share basis, Wisconsin, where it is ranked 11th, and Ohio, where it is ranked 50th. 80% of its deposits are in Michigan, 15% in Wisconsin and 5% in Ohio. Michigan's 2011 median household income of $44,734 lags the national median of $50,227; Wisconsin's $50,026 is essentially identical to the national median. Under the assumption that the attractiveness of the Michigan franchise will be what drives acquiror interest, let's drill down a bit there. As is true for many states, Michigan's population and deposits are concentrated in a relatively low number of counties. Michigan's ten most populous counties, out of a total of 83, contain 63% of the state's population and 75% of its deposits. CRBC has a presence in 43 Michigan counties, and 60% of its deposits are in the ten most populous counties. Some are more demographically attractive than others. The Michigan county with the most CRBC deposits, Genesee County, is ranked 26th in the state in terms of median household income ($41,204). The demographics of CRBC's Michigan footprint is a mixed bag.

The aforementioned Bloomberg article suggested that Huntington Bancshares (NASDAQ:HBAN) might be a potential acquiror. This makes sense, since it is ranked 6th in Michigan from a deposit market share standpoint. An acquisition of CRBC would increase HBAN's deposits by 18% and increase its rank in the state to 5th. Other potentially interested acquirors would include Comerica (NYSE:CMA), currently ranked 2nd in the state, and Fifth Third Bancorp (NASDAQ:FITB), currently ranked 5th.

Let's turn to CRBC's financial performance. Most importantly, its Q2 earnings announcement on July 26 showed a massive increase in earnings, to $297 million, compared to $18.5 million in the year ago period. The increase was primarily due to a tax benefit of $277 million related to the elimination of the valuation allowance against its deferred tax asset. As a result tangible book value per share ("TBV-PS") increased from $10.75 in Q1 2012 to $17.84 in Q2 2012. CRBC's tangible common equity/tangible assets ("TCE/TA") increased from 4.68% (lean) to 7.73% (about average). CRBC's Tier 1 Common ratio increased more modestly, from 7.49% to 8.50%. CRBC's stock did not rise materially on this announcement; investors had anticipated the large increase in TBV-PS. Over the last year, CRBC's stock price has increased by 147%, versus 12% for the KBW Bank Index and 17% for the S&P 500. CRBC's stock price has been volatile, and a disappointment for long-term shareholders. Its all-time high closing price of $397.50 occurred on April 15, 1999. The stock bounced around from then until late 2006, when it began a steady downward slide. In September 2009, it effected an exchange of certain subordinated notes and trust preferred securities for common shares, which increased shares outstanding by 213%. CRBC's low closing share price of $4.85 followed shortly thereafter, on November 12, 2009. Its steady upward climb to its August 7th closing price of $19.94 began in September 2011.

Like many banks, CRBC has struggled in recent years. It was a low growth, $7.7 billion asset institution until Q4 2006, when it closed its $1 billion acquisition of Republic Bancorp, which increased total assets to $14.0 billion. From that point, CRBC's assets gradually shrunk, down to their current level of $9.7 billion. CRBC has had net charge-offs of $1.25 billion since the beginning of 2005. With that said, quarterly net charge-offs have fallen materially from their peak of $160 million in Q1 2011; for the last five quarters, they have averaged $30 million. Overdue and non-accrual loans have also fallen considerably, and even though loan loss reserves have fallen too, they are still high enough to enable a full charge-off of all non-current loans today. CRBC's loan portfolio is broadly diversified, across C&I loans (22% of total), consumer loans (17%), 1-4 family senior mortgage loans (17%), commercial real estate (28%, about equally split between owner-occupied and non owner-occupied) and other (15%). Unfortunately, cumulative net charge offs are widely spread across these loan categories too, rather than being concentrated in a single category.

Ultimately, CRBC is a fairly straightforward bank. 76% of CRBC's Q2 2012 revenue was spread-based (came from lending activities), rather than fee-based. Its Q2 2012 loans/deposits ratio was 76%, loans/earning assets was 64%, and deposits/liabilities was 87%. Net interest margin was a respectable 3.58%. Overhead expense/average assets was 2.81%, and non-interest income/average assets was 0.95%. These numbers are generally in line with CRBC's similarly-sized peers.

Without the one-time gain CRBC had in Q2 2012, its quarterly EPS would have been $0.50, giving it a return on ending assets of 1.07% and a return on ending tangible common equity of 11.1%. Pretty good. The problem is this $0.50 isn't fully taxed. CRBC hasn't been consistently paying a normal level of taxes for awhile. CRBC's $269 million deferred tax asset will allow it to avoid paying taxes for the balance of 2012, according to comments made by CRBC CFO Lisa McNeely on the Q2 earnings conference call. I estimate CRBC's fully-taxed return on assets, assuming a normalized loan loss provision, and also that its TARP preferred remains outstanding (discussed below), to be about 0.85%, equating to annualized EPS of $1.68. CRBC's average 2013 EPS estimate is $1.27.

Where might additional earnings improvement come from? CRBC's net interest margin doesn't seem poised for a material increase. And even though CRBC's assets have declined by 31% since their peak at the end of 2006, overhead expense/average assets hasn't risen, it has fallen, from 3.47% to 2.81%. So large scale cost economies don't appear to be on the horizon.

CRBC still needs to repay $300 million of TARP funding, large relative to its current market cap of $808 million but small relative to its $9.7 billion in total assets. The TARP preferred dividend is currently 5%, and will increase to 9% in 2014. Even before 2014, it would be beneficial from an EPS standpoint to liquidate assets in order to retire it. I estimate that CRBC's $1.68 of fully-taxed EPS would increase to $1.76 if this happened. However, such a retirement would materially reduce CRBC's capital ratios. It is unclear how or when CRBC will retire the TARP preferred if it remains independent.

The TARP preferred retirement aside, material future EPS increases beyond the $1.68, either from profitability improvements or from asset growth, are likely to be modest.

Taking all of the above factors into account, my preliminary estimate of CRBC's stand-alone value is about $18 per share, assuming a redemption of the TARP preferred. As I mentioned, with a Q2 2012 overhead expense/average assets ratio of 2.81%, CRBC does run lean, but if we assume that an acquiror realizes 20% cost savings, these savings would equate to additional value of about $11 per share. That gives an aggregate preliminary value estimate of about $28 per share, a 40% premium over Tuesday night's closing share price. Aggregate deal value at this price would be about $1.1 billion.

What will determine where in the range of $18-$28 per share a deal gets struck? Acquiror access to detailed non-public information on CRBC, and superior analysis? Potentially. Haggling? Definitely. I'd expect JPM to skillfully play competing acquirors off against one another to get a full price for CRBC. As we've seen in some recently announced deals, the "winner" may end up paying more than the likely value of the target including synergies. There are two reasons. First, unless a target is large relative to the acquiror (if, for example, target assets are 30% or more of acquiror assets), no acquiror's EPS accretion would be fantastic at $26 per share (a full price, but one that leaves acquiror shareholders some upside) but abysmal at $30 per share (too high a price). Second, acquirors can always think more optimistically about synergies, and perhaps even use cash consideration in a deal; both help to boost EPS accretion. Good sell-side advisors use both points to their advantage.

If a deal is struck, I think it will be at $23 per share or higher, assuming that acquirors agree with CRBC's accounting treatment of the deferred tax asset. A $23 per share deal implies a 1.3x Q2 2012 TBV-PS multiple and a 11x multiple of estimated 2013 EPS plus synergies.

As CRBC's potential acquirors are large and sophisticated, it will be interesting to see where deal price ends up. I'll write a follow-up to this article, should a deal get announced.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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