Great Western Bancorp (NYSE: GWB) based in South Dakota recently surprised many investors by announcing that it had agreed to sell to First inter-state Bancsystem (NASDAQ: FIBK) Montana-based deal that will create a $ 32 billion asset institution. The sale was surprising as Great Western had only hired a new CEO in early 2020, which generally indicates that the bank is not interested in selling in the short term. But with outstanding credit issues and a tough income environment for banks, it seems management and the board believe now is the right time to sell.
With First Interstate Bancsystem adding $ 13 billion in additional assets to its operations and becoming one of the region’s largest banks, let’s take a look at how Great Western is adding to the bank and whether First Interstate is still a buy-in.
How Great Western adds to First Interstate
First Interstate has traditionally been a high performing banking stock. Prior to the acquisition announcement, the bank was trading at over 200% of tangible book value (TBV), which is a bank’s equity less goodwill and intangible assets, and is what a bank if it was immediately liquidated. It is a strong assessment. Since the acquisition was announced, however, First Interstate stock is down about 9%.
While the stock is down, I think the financial data looks pretty good for the deal, which is an all-equity trade valued at $ 2 billion. The deal will immediately raise First Interstate’s TBV, and then also increase the bank’s earnings per share by 20% in 2023, a figure that could prove to be conservative. Interstate’s first CEO, Kevin Riley, on a conference call following the acquisition announcement, noted that in their modeling, management used pre-provision net sales for Great Western which is 15% lower than Street forecasts for the bank in 2023.
First Interstate plans to cut Great Western’s spending base by 21%, a figure that analysts on the conference call appeared to view as conservative. However, Riley pointed out that there is minimal branch overlap in the deal and that Great Western already has a fairly efficient spending base. In fact, with the addition of Great Western and the 21% cost savings, First Interstate will be able to reduce its efficiency ratio, a measure of a bank’s spending expressed as a percentage of revenue (the lowest is best), down from 50s. percentile at 53%.
The deal will also give First Interstate a presence in Omaha, Nebraska and Des Moines, Iowa, while strengthening the bank’s presence in South Dakota. While revenue synergies are not modeled in the assumptions, First Interstate has identified several areas where it sees opportunities, including increased penetration of credit cards among Great Western customers, wealth management, credit card solutions. cash flow and the extension of indirect lending to the entire Great Western footprint. Riley also said that over the long term, he believes the new Western Western markets will be able to generate the same mid-to-high-digit organic loan growth that First Interstate is targeting in its own footprint.
Great Western’s credit problems
Analysts spent most of the conference call asking executives about Great Western’s credit problems. The bank had problems with the exposure of its agricultural and hotel loan portfolio once the pandemic hit and has since reduced the risk of its loan portfolio.
At the end of June of this year, Great Western still had $ 612 million in classified or unrecorded loans, meaning they were at risk of defaulting or already in arrears. Unrecognized loans represent 2.48% of total loans, which is very high, and the bank has sold part of its hotel loans at a discount. First Interstate takes a 3.75% credit rating on Great Western’s loan portfolio, which is a mark of 20% on the $ 1.2 billion Great Western loans that First Interstate purchased but whose quality deteriorates.
Riley said no one should assume the combined bank will cut all of the $ 1.2 billion in affected loans, and the good news is Great Western has been reducing risk on its loan portfolio for over a year now. and made progress. In addition, the bank appears to have taken a cautious approach to credit. On Great Western’s latest earnings call, chief credit officer Steve Yose said, “We don’t see a significant loss in our non-accounting ledger.”
Great Western CEO Mark Borrecco also noted that while unrecorded loans remain high, if there was a significant improvement and decrease in unrecorded ledger, it would likely mean losses accelerating. Management also seemed confident that they could take minimal losses on their distressed farm loans. But they added that until the money was in the bank, they planned to be very careful about how they would reserve their hotel and hospitality loan book over the next six months.
Is the first highway a purchase?
While the deal caught many off guard, the financial data behind First Interstate’s acquisition of Great Western is certainly compelling. I think there is a very high probability that this acquisition will work in the long term. However, I would probably advise waiting another quarter or two to see how Great Western’s problematic loans play out. Some bank executives recently reported a slowdown in consumer spending in the hotel, accommodation and airline industries in the third quarter due to the delta variant.
Management at First Interstate and Great Western seems to be thinking hard about the problematic loans in Great Western’s loan portfolio, but the problematic loans have yet to be addressed and the world remains full of uncertainties at this time.
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