United States: Bank Merger Outlook 2002

Market Considerations: We believe three major market factors will affect bank merger activity in 2002:

First, the continued decline in the relative value of bank stocks [P/E ratios] reduces the purchasing power of bank acquirors. Investors do not want acquirors to dilute earnings per share. As a result, market conditions continue to put downward pressure on bank acquisition premiums.

Second, we continue to expect 'more sellers than buyers' in 2002, a condition that will continue to put downward pressure on bank acquisition premiums.

As illustrated below, bank acquirors are becoming more selective - the past three years have seen a decline in both the number of transactions and merger valuations. The record year for both the number and value of bank merger transactions was 1998.

Continued consolidation has reduced the number of potential acquirors and lower stock prices reduces potential acquisition valuations.

Third, we believe the end of pooling-of-interest accounting will put pressure on acquisition premiums and make mergers of equals even more difficult to accomplish. We have illustrated the accounting differences between pooling and purchase on a separate analysis available online at www.chartwellcapital.com.

We believe that the end of pooling-of-interest accounting creates a more favorable environment for hostile acquisition activity in the banking industry. An acquiror's historical desire to avoid purchase accounting gave target banks a very strong defensive weapon. Previously, a target institution had the ability to take a number of actions that would have the effect of 'fouling' pooling-of-interest accounting treatment.

The fact that all acquisitions now utilize purchase accounting means that accounting treatment no longer provides a defense for a potential target. Purchase accounting also provides acquirors with much greater financial flexibility for acquisitions.

All things considered, the end of pooling may well open the door for selective hostile activity.

In this environment it is important that bank management and the board of directors focus on the share exchange ratio, not just the announced market value of a transaction.

If a bank has the opportunity to exchange its shares for shares in a bank that is able to grow at a faster rate, then management and the board of directors should focus on the number of shares its shareholders will receive in exchange. The following exhibit illustrates a non-dilutive share exchange ratio between two banks with different growth rates.

If we assume this Target Bank has one million shares outstanding then a delay of just two years would cost the Target Bank shareholders 77,000 shares. The sooner the Target Bank affiliates with the faster growing Acquiror the more shares its shareholders will receive in exchange. In addition, faster growth generally results in greater future market value per share.

It is clearly in the best interests of the Target Bank's shareholders to explore such an affiliation if the market value of the exchange offer is at a premium to the bank's current market price - the exchange provides shareholders with new shares in a faster growing organization.

Management's challenge is to determine if their shareholders will enjoy greater future value as shareholders of an 'independent' bank or of a 'merged' bank. Our updated Merger Q&A memo is also available at www.chartwellcapital.com.

CHARTWELL CAPITAL LTD., a private investment banking firm, provides merger & acquisition advice and other specialized advisory services to banks, corporations, institutional investors and other private clients. The American Banker, Bank Director Magazine and SNL M&A all ranked Chartwell Capital among the top 20 financial advisors nationwide for 2001.

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