Bank Merger Arbitrage Spreads and Pipeline Indicate Different Trends

The recently announced PacWest Bancorp (NASDAQ: PACW) and CapitalSource Inc. (NYSE: CSE) merger was called a beacon in an otherwise dim bank M&A landscape so far in 2013 as it was only a $2.3 billion deal total. So far, 2013 looks to register lower in banking M&A activity than the lean years of 2011 and 2012 at only about $9.1 billion in total so far, versus almost $17 billion for each of the past two years. There are only 13 pending transactions that exceed $100 million, and two of these are expected to close imminently.

The M&T Bank Corp. (NYSE: MTB) and Hudson City Bancorp Inc. (NASDAQ: HCBK) transaction is the only pending deal of 2012 vintage due to various regulatory concerns. MTB currently has 9% short interest outstanding and PACW 15%. Another merger covered is the deal between Provident New York Bancorp (NASDAQ: PBNY) and Sterling Bancorp (NYSE: STL), and the balance are simply too small for us to warrant effort.

Arbitrage spreads in general are currently priced around 3.4%, and this is called fairly reasonable, according to the Sterne Agee banking team. Buying the spreads on these two largest transactions would yield about 10.4% and 8.9% on an annualized basis for merger-arb investors.

Sentiment is swinging against the buyers as mergers appear to be the only viable short-term solution to meaningfully grow bank balance sheets. The short interest remains at a fairly high at 6% to 7% of outstanding shares with an average of 17 days to cover.