Friday, July 15, 2005

Merger Fever Grips the US Northeast, Peter Moreira and Vipal Monga, 15 July 2005

As TD Banknorth Inc.'s agreement to buy Hudson United Bancorp Inc. raises the specter of Northeastern bank consolidation, shares of Philadelphia-based Sovereign Bancorp Inc. are soaring, thanks not only to the deal, but to a large, disgruntled shareholder.

Even before the unit of Toronto-Dominion Bank announced its $1.9 billion purchase on Tuesday, July 12,, Sovereign shares had been moving because Relational Investors LLC, a corporate governance hedge fund in San Diego that owns 6.5% of the bank, filed a notice with the Securities and Exchange Commission complaining about Sovereign's underperformance and its directors' high pay.

Since Relational Investors filed the papers on July 7, Sovereign's shares have risen almost 10%, accounting for almost all of its 11.5% total return in the past year. The shares Thursday afternoon were trading at $24.70, up 0.9%. Though analysts and bankers say chairman and chief executive Jay Sidhu likely won't be forced into a sale, the Northeastern bank market looks as though it is consolidating, and Sovereign could be involved either as a buyer or seller.

"I would stop short of saying the company [Relational Investors] has put Sovereign in play," said James Ackor, an analyst with RBC Capital Markets. He added, however, the Northeastern bank market does appear ripe for consolidation and Sovereign may have problems because it trades at lower multiples than neighboring banks, meaning it would have trouble using stock to pay for a profitable deal. Sovereign's share price was 11 times forecast 2006 earnings, while other community banks in the Northeast trade at average PE ratios of 13 times.

What Sovereign does have going for it is a superb market, stretching from New Hampshire to Maryland, interrupted only by an absence in New York. The bank, which has a market cap of $8.9 billion, has built a 650-branch network through 30 acquisitions dating to 1989, the most recent being the purchase of Waypoint Financial Corp. in January.

Though Sidhu has achieved an enviable footprint, the constant acquisition charges have suppressed Sovereign's earnings, which is the reason for the low multiples. Though one banker said Sovereign could probably sell for as much as $35 a share to such a bank as Royal Bank of Scotland Group plc or HSBC Holdings plc, Sidhu has consistently declined to entertain the notion of selling.

"In the current environment, we can't find any use of capital more attractive than buying back Sovereign Bank [stock]," said Sovereign spokesman Mark McCollom when asked whether the bank was planning to buy or sell in the near future.

According to a source familiar with Sovereign, Sidhu has missed opportunities to sell the bank and reward shareholders. The source notes that Summit Bancorp offered to buy Sovereign in late 1999, but Sidhu declined the $23 a share bid. Summit was then bought by FleetBoston Financial Corp. in March 2001 for $7 billion, and Fleet itself was bought by Bank of America Corp. in one of the largest bank deals in history.

"How well would shareholders have done if they had sold to Summit?" the source said.

The source said Sidhu, at least for now, has his board in his corner but must address the shareholders' concerns.

Relational Investors' main complaint, according to its proxy statement, is that the bank's nonemployee directors are overpaid, receiving an average of $313,000 in 2004. That's more than directors of any other bank, including Citigroup Inc., which is 27 times as big as Sovereign, said the statement.

McCollom said the bank instituted a 10-year share-based director compensation package in 1996, since which the shares have tripled. Now that the bank is in the 10th year of the program, it is reviewing directors' compensation, he added.

If Sovereign was to seek to do a deal, attractive targets include Brooklyn, N.Y.-based Independence Community Bank Corp. and Lake Success, N.Y.-based Astoria Financial Corp., Ackor said.

The Banknorth-Hudson "deal makes ICBC easier to buy," said one banker, noting that Banknorth CEO William Ryan is interested in moving into metropolitan New York and is originally from Brooklyn.

Bankers added, however, that ICBC chief executive Alan Fishman is also in acquiring mode and the bank could do a deal of its own soon, possibly in New Jersey, because it wants to keep growing and make itself more attractive to potential buyers.