Investors Bancorp: Modestly Favorable Risk/Reward

Summary

• Citizens to acquire Investors Bancorp at 0.297x share and $1.46/share of cash.
• Citizens’ share has since appreciated more than 20%.
• The deal just keeps getting better and better for Investors Bancorp.

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Overview

Investors Bancorp (ISBC) is a Short Hills, NJ-based traditional bank that underwrites traditional 1-4 residential mortgages, home equity loans among other loan products. The case in point is the July 28 2021 announced acquisition by Citizens Financial (NYSE:CFG). This acquisition will allow Citizens to become a top 10 bank by deposit size along the I95 corridor from Philly to NYC to Boston. We will review the detailed deal dynamics in the rest of the article.

Deal Overview

For anyone that does not know Citizens' franchise, Citizens has been on an acquisition spree over the past few years. CFG acquired Royal Bank of Scotland's (NWG) commercial loan portfolio in 2014 and has been an active lender in the middle-market lending space. In September 2021, Citizens acquired JMP securities, an SF-based middle-market investment bank that focuses on the healthcare space. Similarly, the bank acquired DH Capital, a middle-market investment bank that focuses on IT services, Internet, infrastructure in December 2021. These acquisitions of financial advisory firms as well as the acquisition of HSBC's U.S. operation bolster the bank's advisory, debt underwriting capabilities and core deposit strength. Just imagine a firm such as Houlihan Lokey (HLI) or Lazard (LAZ), for that matter, or Moelis (MC) can provide the debt underwriting services to the red-hot mergers and acquisitions market. The incremental fee generation could be highly lucrative for any M&A advisors, just by adding debt underwriting capabilities. Building out its h2 balance sheet and advisory capabilities, Citizens is an h2 competitor in the making.

I hope the above rationale explains why investors are bidding up Citizens' shares as they love the platform that Citizens' management has created. Investors Bancorp's shareholders should also enjoy the share price appreciation, as we believe there are more to come. Citizens' deposit franchise includes legacy HSBC (HSBC) in NYC and Investors Bancorp in Philly / NJ market. The expansion in relationships allows the M&A bankers to work with lots of middle-market business customers with baby-boomer founders waiting for their retirement. The deal would add ~$30 billion in deposits and 234 branches, allowing Citizens to offer incremental services to ISBC's retail customers as well. Going forward, Investors should expect cross-selling of products in the future.

The one key item that was surprising, when we first saw the deal, was that ISBC's management and shareholders agree to a fixed exchange ratio type of merger. Most oftentimes, the sellers would like to protect themselves against market volatility and would negotiate a flexible exchange deal with a collar in share exchange structure such that the amount of value captured by sellers is constant, and not subjected to the market volatility. The way it works is as follows

Fixed exchange: The exchange ratio between seller and buyer is fixed

• Risk for the buyer: Buyer share appreciates while seller share depreciates
• Risk for the seller: Buyer share depreciates while seller share appreciates

Flexible exchange: The transaction price is set in stone while the number of shares issued is subjected to change

• Risk for the buyer: buyer share depreciates such that they would have to issue more shares and dilute existing shareholders
• Risk for the seller: buyer shares appreciate such that the Pro-forma ownership is not as much as expected

Normally in a bank merger, the acquirer would cap a price for the deal. To a certain extent, our speculation is that it might be the intention of the management team, as Investors Bancorp is the only regional bank with sufficient size that is on the block. Investors Bancorp is the #7th largest in NJ by the size of the deposit and is only smaller than another regional bank, Valley National Bancorp (VLY). Valley is not for sale and is engaging in value-accretive acquisition themselves - lately the acquisition of Bank Leumi Le-Israel Corporation. If it was management's intention to take advantage of the more favorable interest rate environment by asking for a fixed rate exchange ratio, then it would be a clear manifestation of a great judgment by the seller's management team. Regardless of the management intention, the risky bet of fixed exchange ratio worked out for Investors Bancorp's management and has proven to be a decent outcome since the announcement of the deal.

Valuation

Future value drivers of ISBC's shares are largely coming from the share price appreciation of Citizens Financial Group. Citizens has an asset-sensitive balance sheet and should benefit from future rate increases. P/TBV is 1.6x while P/E is only 11.1x. Investors have not been pricing in the upside potential of the franchise and as such, we expect earnings to grow as well as share price.

CapIQ, 10K

Conclusion

The share performance of Investors Bancorp will largely be depending on the share price performance of Citizens. Citizens is in the process of building out an h2 deposit franchise in NJ, NYC, and Boston markets. Citizens has gained h2 debt underwriting capabilities and with the new acquisitions of multiple financial advisory practices, investors should expect continued momentum in both spread-driven earnings and fee income. The M&A market has been red hot during the past few quarters, as shown by the earnings beats announced by Raymond James (RJF), Stifel (SF), B. Riley (RILY), to name a few. Citizens has an asset-sensitive balance sheet and will likely benefit from future rate increases. The tricky part about ISBC's performance is the timing aspect (i.e. how long will it take for the deal to close). It is difficult to predict the short-term price movement of Citizens Financial Corp, but given the FED rate hike expectation in the near future and a relatively attractive valuation, the downside potential is somewhat limited while the upside is relatively attractive. That being said, from a risk/reward basis, ISBC presents a moderately favorable risk-reward opportunity given the momentum that the Citizens Financial Group is experiencing.

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.