The market for mergers and acquisitions among financial institutions has been nearly non-existent this year. Paul Aguggia, who heads the Financial Institutions Group for Kilpatrick Townsend & Stockton in Washington, D.C., talks about why that is and how to handle the formidable challenges of dealing with regulatory and shareholder concerns when it comes to M&A.
Why have we seen so few M&A deals this past year?
First, it’s the depressed stock price for both the target and the acquirer. Emotionally, it’s very difficult to proceed when you feel as if you’re selling at the bottom. For acquirers, a lower price means less buying power. Also, the regulators are delving deeper into pro forma capital levels as well as overall risk: Is there too much concentration of risk in a particular area? Do you have the resources to handle the risk of an acquisition? Regulators can signal concern early in the process. Plus, there is due diligence. It’s difficult to get your arms around your own loans much less somebody else’s. Due diligence has become more important and more difficult. It’s more difficult to get comfortable with the risks and to price the transaction appropriately.
What advice do you have for potential acquirers and targets given these difficulties?
There is a fair amount you can do to review whether a partner is a good potential fit. You can conduct preliminary financial due diligence to see what a pro forma balance sheet and income statement might look like. You can have a discussion with regulators, usually on a no-names basis. You can get the advice of lawyers and other professionals to determine if the deal makes sense financially and is likely to obtain regulatory approval. You can do, in effect, “pre-due diligence” before you devote any material resources to a potential acquisition.
For targets, if you’re not going to get top dollar for your institution, does that matter, if you’re taking stock in what might be a better company combined? As difficult as it might be to hear, don’t get too hung up on price. It’s not going to get easier to get these deals done and, in the meantime, you may lose potential acquirers.
What effect, if any, do you see activist investors having on the M&A market?
With regard to smaller institutions, activists are going to be very concerned about bad acquisitions. They would define bad as being overly dilutive on a book value basis and not picking up enough earnings to make it worthwhile, not to mention they might consider the risks from an operational and organizational standpoint as being unacceptable. Investors want to see financial institutions stick to what they know. Many don’t think certain banks are suited for expansion through acquisition. We are hearing many of them say: “Don’t do anything silly, like an acquisition.” On the target side, we’re seeing activist investors anxious for an exit strategy, especially for smaller companies with limited stock liquidity. In short, I do think activists play some role in the M&A market.
What advice would you have for dealing with activist shareholders?
Not all activist shareholders are created equally. Some are more reasonable and patient than others. My advice is, don’t bury your head in the sand. Get advice about what you can say in a meeting or in public reports that shares elements of your strategy. Shareholders don’t like surprises. Most investors want to know management and the board are focused, understand their concerns and don’t have a buy-at-all-costs mentality when it comes to expansion and mergers.
How should you approach regulators about an acquisition?
I think it’s important to have an open dialogue with regulators about your business plan. They are not going to give you approval on the spot to engage in a transaction. If you let them know an acquisition is something you might want to do, many regulators will give you guidance. Regulators in many cases think consolidation is a good thing. But they want to see acquisitions done that reduce risk, not add risk, to the financial system.
Do you think smaller institutions are effectively precluded from being acquirers because of regulatory or compliance issues?
No, as long as they can make the expansion case with conviction and communicate effectively with their shareholders and regulators. The ability to communicate a compelling case can be tougher when you don’t have economies of scale, which are more common with companies with more than $1 billion in assets—but I do think transactions are possible for smaller banks.