Opportunities Ahead: The Outlook for M&A

This roundtable session focuses on the market for M&A in 2002 and the impact of goodwill, the current economic environment, and stock prices on M&A activity in banking. The participants were John Duffy, president and co-chief executive officer, Keefe, Bruyette & Woods, Tod Perkins, managing director, Depository Institutions Group, Credit Suisse First Boston; James M. Rockett, attorney and head of the Financial Services Practice Group, McCutchen, Doyle, Brown & Enersen; Wade Schuessler, managing director, Samco Capital Markets; Jeffrey W. Warlick, senior vice president, Hovde Financial; and Jerri Moss, associate publisher, Bank Director, moderator.

BANK DIRECTOR: What effect is the current economic environment having on bank M&A and the banking industry?

John G. DUFFY: In general, the economy has been weaker the past year than it has been in the 10 previous years, but I don’t think that’s the sole reason for the M&A slowdown. There are three or four other factors that are more important. Deals get done regardless of where you are in the economic cycle. There are probably more deals when the economy is robust and healthy, and stock prices tend to be higher because it’s easier for acquirers to hit a target’s price.

H. Wade SCHUESSLER: We’ve recently gone through some pretty dramatic changes—not only for the country, but for the economy as a whole. There are a couple of things that are going to affect bank M&A and profitability as we go forward.

One is the way housing has really driven the economy, which will cause some adverse changes, especially if the economy rebounds and interest rates rise again. You will see markets get a little softer and, for some banks, that can create earnings problems and perhaps prevent some deals from happening.

The second thing that has affected the economy is the rise in bankruptcies. The FDIC just reported on the failure rates for large companies versus small companies, and though we haven’t seen quite the rise in the number of bankruptcies in small businesses as we have in large ones. I think that’s something we need to watch very closely, specifically if there is a trickle-down effect into small business.

The last thing that will affect the way deals are done is all of the changes that will result from the Enron problems. Those issues are going to draw a great deal of scrutiny—and as investment bankers, we really need to help our clients get through those issues in transactions. At the end of the day, a good deal makes sense regardless of whether it occurs in a good economy or bad economy.

James M. ROCKETT: Following up on Wade’s comment, I think the Enron fallout has already hurt bank stocks—look at PNC’s restatement of its earnings. People will be searching under the skirts of banks’ reported earnings to see whether there are things that may create Enron-type questions about their balance sheets. So there might be a reluctance to get back into the financial sector for a while. Because of this, the currency that companies need for M&A will reflect this reluctance and valuations will be down, further slowing M&A activity.

Banks also have had serious problems with their net interest margins this past year and have experienced diminished earnings as a result. It’s going to be a while before banks can pick up the pace of earnings and get back to a point where their net interest margins create a really solid earnings base to entice the marketplace back into bank stocks. Also, you’ve got a derivative effect: the decreased interest in branch transactions as a result of the squeeze on net interest margins. Finally, we’ve got the additional cost of compliance in the industry brought about by the USA. PATRIOT Act. I don’t think this has been focused on yet, and I believe that when the costs of that are fully realized, it’s going to take quite a bit of bank earnings to overcome the cost.

Jeffrey W. WARLICK: Another factor affecting M&A and the industry is the interest rate cycle and where we are in it. This certainly has an impact on bank earnings and, therefore, on the pro forma contributions that a seller can make to a buyer’s earnings. As a result, deal values are affected. As we start back up the interest rate cycle, I think that for many banks it’s going to be “cost push,” meaning that, if recovery is slow, it will continue to put significant pressure on their interest margins.

If the stock market leads the way, as it typically does coming out of a recession, then that will potentially create more disintermediation. I also don’t think that we are going to see the savings rate increase any time soon, Investors are going to be looking for the returns they enjoyed three or four years ago. So disintermediation is likely going to be a challenge. The good news is that cash is cheap and this will mean that more buyers can participate in the marketplace. In addition, if pricing multiples settle a bit, some institutions that have not been able to use their equity as currency are going to be in a position to buy with cash. As long as we are at this point in the interest rate cycle, cash will continue to be cheap.

Tod PERKINS: On the M&A side, the economy is really the gas pedal for how fast consolidation is going to happen. Factors like excess capacity and the continued need for scale economies are still in place. When we hit economic cycles that make it more difficult for banks to do deals, it’s like taking the foot off the gas, but it doesn’t mean that the reasons for consolidation change.

On the operational side, in theory, banks shouldn’t collectively grow much more than GDP, but yet they are faced with these 8% to 15% hurdles, probably averaging out around 10%. My question is: How much can the economy really support that type of growth? I would say that as the economy lingers on like it has, we’ll see these growth rates get more and more difficult for banks to achieve. That may lead to more M&A activity as people realize they can’t hit their growth hurdle.

DUFFY: There also are some differences depending on the area of the country you are talking about. Houston has probably been one of the most robust economies in the last decade, and there is some sentiment that, at least post-Enron, it’s going to get tempered a little. Psychologically a large employer has an impact on participants in that market in terms of willingness to stretch, pay up, or grow. The same is probably true in Northern California. Silicon Valley seems to be a different market than Southern California, which doesn’t appear to be feeling much of the impact of the economy slowdown, at least in the numbers I’ve seen. There’s still a fairly healthy dose of regionalization.

SCHUESSLER: I want to expand on what John said. Government spending on homeland security and defense will have a significant impact on some regions of the country. We are probably going to see some major markets pull out very quickly from the recession because of money flowing in. The timing of it, though, is key. We are probably six to nine months from that money getting pumped in and doing some good. So we may see some hot market regions that people will want to reach into for transactions.

WARLICK: Given that consumers, who are significantly overburdened now with debt, drive two-thirds of the economy, I think that you are going to see a lot of debt reduction, instead of spending, take place in the near future. It’s hard to see this economy pulling out of this recession very quickly, and the longer it stays down at the bottom, the tougher it will be for many banks.

PERKINS: The best banks in the country—a couple of examples are M&T and Fifth Third—are in economies that have never been premium economies, yet they have really figured out how to grow despite a slower economy. To me, it really boils down to sales, and those guys can sell anything. Citigroup is another example. You can argue that the economy is going to drive a portion of your business, but at the end of the day, it’s really how well you operate and sell your products.

SCHUESSLER: There’s a well-defined group of high-performing banks that fit your category, and those banks will do very well no matter what the economy does.

ROCKETT: Picking up on John’s point about regionalization, one thing I’ve noticed that’s different about this than, say, the recession California experienced in the early 1990s, is the banks have not been hit as hard. They’ve been able to plug along. While their earnings have been impacted and the net interest margins pushed lower, they are still doing quite well. And the regulators don’t seem to be as persistent in this particular economy. They are a little more patient than they were back in the early 1990s or late 1980s when they basically just hammered banks into failure. I don’t think we will see the same kind of failure rate in banking during this recession. We won’t realize the extent of credit problems as long as it doesn’t get any worse than it has so far, and there’s no indication that it’s getting worse.

WARLICK: Also, in the late 1980s and early 1990s, we had significant credit problems in the system. In fact, you could argue that the system may have been bankrupt had it not been for the Fed “engineering” the yield curve to help bail it out. Bank managements really learned from that. Look at stock prices and P/E multiples. The Street believes that banks understand how to manage credit a lot better this time around. Reserves are stronger; capitalization levels are much, much better; institutions are much more aggressive about charging off loans and they are also much better at recovering previously charged-off loans. Even their overall credit management systems are better.

ROCKETT: Banking companies also have ready access to capital through trust-preferred securities.

DUFFY: Kmart’s recent situation offers a good example. It declared Chapter 11 and most of the banks released their exposure—maybe it was a little more than a yawn, but wasn’t a huge impact on the market. The banks have done a pretty good job of getting much of the risk off the balance sheet.

SCHUESSLER: They also do a much better job of diversifying their portfolio. They learned a hard lesson: diversify, diversify, diversify.

WARLICK: Large banks certainly have. But many smaller banks are still challenged with weak net interest margins and, for them, that’s going to be very painful for the next 12 to 18 months. There may be a slight life in the interest margin as rates bottom out and CD portfolios continue to roll along for six months or so. In addition, maybe they’ll see a nice little increase in their interest margins if they are asset sensitive as interest rates head back up again. But after the initial impact is over, it’s just going to be very challenging for smaller banks. And many banks are also going to really hurt on the funding side. They can go to the Federal Home Loan Bank, which many of them are doing these days. But it’s interesting that the larger the bank is, the smaller the reliance on net interest margins and the more diversification you see. This also makes investors more comfortable and will help improve values for them.

ROCKETT: The interesting thing about the current marketplace is that normally you would expect, in the recent economy and rate environment, to see some of these smaller banks really wanting to sell. Yet I represent some serial acquirers that can’t find anyone who wants to sell, Why? The directors of possible targets are still having fun. Back in the 1990s they were tired after being beaten up by the regulators and by the economy. We are not seeing that phenomenon now. I suppose some banks have directors who are getting tired, looking for a way out, and looking to make their problem someone else’s. They will take the acquirer’s stock and just hope for the best.

PERKINS: I also think some of them feel like they might have missed the last round. The pricing was so good, while the horizon is cloudier this time. In the past, you could operate your bank and trade at 18 times earnings, and the downside was if you didn’t do so well, you’d sell out at 21. Now you really have to make it on your own.

SCHUESSLER: I agree with John. It doesn’t matter whether the market is up or down. If a deal makes sense, it makes sense. A transaction has to make sense on a relative value standpoint. The problem is that the ownership and board are focused on wanting three times book and 20 times earnings, but it may be better to take 16 times earnings and a stock that has a great deal of upside potential. They’ll come out much better in the end.

PERKINS: Wade, you’re exactly right, the market wants to see deals where the upside is in the combined entity going forward, not in the day-one premium. Take the First Union/Wachovia/SunTrust battle for example, where SunTrust came in with a premium that was much higher on day one, but it ended up equating to about what First Union’s was the next day because of the depletion in its value. It’s clear the market is looking for transactions priced moderately with acceptable and achievable assumptions.

WARLICK: There are many CEOs who told their boards, “No, the timing is not right now,” and they can’t turn around 12 months later and say, “Well it’s right now.” So for them it may require a pleasant pause, as these institutions reconsider their strategies and justify looking at a sale again. In addition, the high multiples paid several years ago may have sounded good at the country club, but a lot of bank shareholders who took those high priced stocks and tried to sell them later found out that the deal multiples had evaporated. But if you like deal statistics, they made for great numbers, as many of the charts show. But the reality in this market is that the high multiples are often just not there. It may be better in these circumstances to take a deal at a lower value and cash in on the upside - after the deal closes.

ROCKETT: There’s a general perception that one shouldn’t sell into the down economy. Yet many institutions realize it can make sense to accept a lower valuation now, if the quality of the currency they are going to get is excellent. One other consideration is that in the prior environment, there was a real chance for the double dip. Now it’s a far riskier bet on the possibility of a double dip. So you’ve got to look at the long-term value of the potential acquirer.

WARLICK: I also think that buyers are going to be much more disciplined in terms of who they want to look at, I mean, there are sellers and then there are sellers. There are some companies that are going to look good to whoever is shopping, and there are others who may not find a partner. Their best alternative may be to enter the market early before more attractive institutions go into play.

PERKINS: With pooling eliminated, the metrics have really changed. It used to be that deals were driven toward a GAAP dilution/accretion measure. Now you’ve got to deal with capital, Capital is going to be much more valuable—capital is king, You also are going to be more focused on economic returns in the form of IRR, and cash EPS is going to be much more of a driver. So the constraints are more numerous, but whether there’s actually more flexibility or not depends on the transaction.

SCHUESSLER: That’s the nice thing about purchase accounting. When people are concerned about what’s happening with goodwill and the elimination of pooling, in my opinion, creates a whole new set of opportunities and ways to structure deals. It gives the buyers more options to make the deal work better for both them and for the seller. It’s going to take a while for people to get comfortable looking at the different ways they can structure these deals.

PERKINS: It gives the operators more flexibility. So many people were afraid to do restructurings because they were concerned it would damage their ability to pool. Now you can actually operate your bank more efficiently. You can get rid of branches, assets, or businesses that don’t make sense much more easily without quering your ability to do deals.

WARLICK: Additionally, everything is negotiable under purchase accounting. Pooling was never a cookie cutter, but it was pretty close. I think we’ll even see some new instruments used as consideration in transactions; for example we may see some tax-deferred notes pop up sooner or later.

DUFFY: Some of the smart players have already adapted. Tod mentioned M&T earlier, and in my book, it has always looked at deals the right way and wasn’t bound to do pooling deals when the stock price was high. One of the reasons its stock price got higher was because it treated its currency as if it was precious and had the courage to do some purchase deals, even when poolings were the rage. It’s had the flexibility, post-deals, to do things such as buybacks, which others didn’t. It just had the right mentality in terms of how to manage its capital in terms of optimizing the returns to the shareholders. There are similar banks that are already there. It may be a while before some of the smaller players understand the wisdom of purchase accounting,

ROCKETT: The one disadvantage of purchase accounting is the sword of Damocles that hangs over the head of the purchaser—having all of that goodwill intermittently subject to audit for impairment. At some unexpected moment, the sword may fall, and instead of having a nice, even amortization of goodwill, which is predictable, you could look like an idiot for doing a deal that now causes you to write off all that goodwill in a single swallow.

PERKINS: Even though the accounting rules have this concept of impairment—where you are going to be constantly evaluated—with banks, it isn’t going to happen because typically, acquired banks’ balance sheets aren’t kept separately. They are merged together. It’s going to be difficult for bankers to ever make the impairment argument, and I think the FASB understands that, So as a banker going into that deal, you better assume that goodwill is permanent, particularly for vanilla, bank-to-bank acquisitions.

SCHUESSLER: The realization about banking is we are buying real companies and real earnings with real products, whereas the companies that got in trouble, such as the technology and communication companies, spent billions of dollars for what they thought was a good idea, and all of the sudden had to write off $25 billion or $50 billion because the value was not there, Those companies are in big trouble regardless of what time it is in the deal cycle because they have to justify the purchase price paid for that company. Banks are much easier to look at in terms of where the tangible value in the company lies.

WARLICK: One danger is that goodwill is going to accumulate. In five years, we may look back to see that it has become a significant limiting factor for a lot of buyers—that is, the relative amount of goodwill they end up putting against their equity capital. We are going to see banks with easily 50% of their equity in intangible equity. I also think that the likelihood of a bank having impairment of goodwill is somewhat remote, because it essentially means that you gave away all of what the new FASB calls “internally generated goodwill,” which means you gave away all the value created for your shareholders to the people you acquired. That is, you basically paid premiums that were in excess of the amount that you can, over the long run, justify, unless the value of your organization goes up substantially. However, once you see the fair market value of your organization go down and you no longer have that internal goodwill, it starts collapsing on you. That’s when you end up with impairment, which will obviously be a very bad event.

PERKINS: There’s a more basic problem: How are you going to define that asset? You’re changing all the bank names; you’re merging branches. It’s not a separate entity and from a practical standpoint, you are not even going to be able to begin the argument of impairment with the accountants and the SEC.

ROCKETT: It makes goodwill valuation a cottage industry! Also, with the heightened awareness of auditing in this post-Enron era, banks may see some other things that they don’t expect.

SCHUESSLER: But there’s one big factor in our favor. Banking is a highly regulated industry, and it is accustomed to having things closely scrutinized, therefore the margin of error is going to very small compared to some other industries, and as a result banking will probably hold up very well through this process.

WARLICK: As far as disclosures go, in valuations, I think that’s probably true. But in the relationship with the accountants, we are going to see accountants start to peel that onion more than they have in the past, particularly as it relates to intangibles.

BANK DIRECTOR: In the current environment, is it better to do a cash or stock transaction?

ROCKETT: California has a new serial acquirer, Union Bank of California, and its process will be very much like that of Wells Fargo—a community-bank-targeted process. It is offering cash and stock, and then giving shareholders an election to choose which one they want. It’s a terrific opportunity to sell: the cash opportunity to get out or the stock opportunity to stay in, especially if certain shareholders don’t want the immediate recognition of tax while getting a good currency that’s very liquid. Liquidity is one of the biggest elements of any stock transaction. It’s very difficult to sell a stock deal in today’s environment with an illiquid stock.

PERKINS: That works well with the liquid stocks. The problem with an acquirer buying a target that’s relatively large is that they’ve got to use a greater percentage of stock just because of the tangible capital they’ll need to remain in the business. So size can have a great deal to do with the way deals are structured. If you are Wells Fargo or Citigroup, you can give people more flexibility because at the end of the day, Citigroup can probably do a $20 billion all-cash deal if it wants. Whereas if bank A is buying bank B and it’s half its size, there are going to be some practical limitations.

SCHUESSLER: Many of these companies are using trust-preferreds, doing secondary offerings, and building up their cash reserves in order to do transactions. That’s a positive factor for the industry as a whole. More flexibility is going to be available to do cash deals.

WARLICK: It’s a great time to build a war chest and trust preferred securities are one way to do it. That’s why I say there are probably going to be more buyers. This means if you are a $300 million to $400 million bank, you’ve got to do two or three good acquisitions in order to leverage scale and offer the products and services that your customers expect. You won’t be able to support that without a significant infrastructure.

PERKINS: There’s also a distinction between consideration and financing. Even though you may offer all stock, you can buy back a big portion of your stock to help finance the deal. So it’s going to give buyers more flexibility, but I still think capital is going to be the practical limiter. I’m not sure that anyone really knows where those lines will be, but we know from a regulatory standpoint how the regulators will view it. The limitations the Street is going to put on it are unclear.

WARLICK: It is important that sellers identify their own objectives, How are they trying to satisfy the needs of the shareholders in terms of creating value? Is it cash or stock that they want? They need to have a strategy that determines what kind of buyer they would like to pursue, You can find a lot of cash buyers, but you can also get a stock that’s undervalued with upside potential. It may not be in the deal statistics, but the added value may be there when you want it, In addition, should you defer the taxes through a stock deal? That will depend on the tax situation.

DUFFY: We’ve all seen situations where the tax motivation has been a key ingredient in terms of what path a bank decides to take. There may be a preference for a stock transaction if it has a series of large shareholders with a low-cost basis. In fact, they may insist on a stock deal, and in that case, then you start worrying more about the currency you are taking. In other instances you’ve got stock deals because the buyer can pay more that way and the sellers are more interested in the liquidity of the stocks because they are worried about diversification and don’t want to have all their eggs in one basket. So I believe the dynamics have changed a little.

BANK DIRECTOR: If a bank board decides that now is the time to sell, what should they do to prepare the bank?

SCHUESSLER: If a bank is looking to sell and the board is committed to exploring the process, then the first thing they need to understand is their own motivation to sell. Is it coming from management, the board, or the shareholders? Does the bank feel like it can’t compete effectively in the market? You’ve really got to explore those kind of issues because, given the state of the economy, there are situations where it’s just not in the best interest of the bank to sell. The board may need to fix some things, such as expense ratios or asset quality, for instance, which can really add significant value to the company.

WARLICK: Sellers should do some due diligence on themselves, They should make sure they understand exactly what is available for sale and the estimated value. And if there are “warts,” then it will be much better to resolve those or make sure they are disclosed up front. It is also a good idea to have a feeling about what is being sold in terms of pro forma earnings, that is, the bottom line an acquirer will realize in their earnings per share.

PERKINS: In this environment, nothing scares a buyer more than when it comes in for due diligence and the loan portfolio turns out to be something different than was billed, From an operational standpoint, it is useful to have a rational, defensible operating plan for the ensuing years. In this way, the buyer can use it as a compass point to do its due diligence and determine how the seller’s business will fit with its own strategy.

But I also agree that a cash sale is really a different process and concept all together than a stock sale. With a cash sale you are saying, “That’s what it’s worth, and I don’t have, in effect, a real responsibility for what the shareholder base does going forward.” It’s like pulling the ripcord. On a stock sale it’s a much different prospect.

SCHUESSLER: It’s almost as if you wake up one morning and you’re married with a stock deal. With a cash sale, it’s more like, “Good morning, I’m out of here. Bye, and good luck!”

PERKINS: You have different responsibilities for generating premium in a cash deal, where in theory, if you are “selling” the company, then you have the responsibility to go out and get the highest price. If you are taking another stock, it’s a completely different transaction. You can take a lower deal value if you can determine as a board that there is more upside in currency A than in currency B, even though B’s offer might be higher.

ROCKETT: What we are all talking about is the fact that if you are going to sell, you really need to get into a process that is multilayered. The first layer consists of understanding your business and implementing your business plan in a way that’s going to create value for your shareholders. Next, it seems to me that fooling around with your balance sheet, doing unusual things, getting into new products that you don’t understand, and these types of things can get you into trouble very, very quickly. Lower your efficiency ratio as much as possible, Do similar things to your own institution that a buyer is going to do, because that creates value for your shareholders rather than for theirs. Then you should be able to realize that value, especially in a cash deal or a stock transaction, and at least you are going to get a few extra shares for your efforts.

WARLICK: Consistency and quality of earnings is going to be a major factor, which will have its rewards even if you go with lower earnings that are stable and consistently growing. You are going to be better off with consistently growing earnings than trying to hit a homerun every other quarter. With regards to an operational plan, if I were thinking about selling my organization, I would start outsourcing where possible. I would get lean and mean and trim down as much as I could. This would allow the acquirer as much flexibility as possible in terms of realizing the value of my core organization,

DUFFY: Going back to a point that Tod made just a minute ago on a stock sale, at Keefe, Bruyette & Woods we really talk to our clients about how they are making an investment for their shareholders in the acquired company. You think you are selling your company for $100 million, but you are really making a $100 million investment in that pro forma company. Think about it that way. If you are really thinking about liquifying, then you should look at multiple forms of consideration.

Another point to touch upon is how to get both sides together. Look at selling the company now. One of the things that will make their job much easier is if both sides get senior management on the same page, and that involves the whole area of contracts and the decision about whether now is the right time to sell. Because I dare say, we’ve all seen situations where the board and management are not on the same page, and at a minimum, that makes an investment banker’s life miserable, at the maximum, it sometimes prevents deals from getting done.

SCHUESSLER: Another thing is to remind management and the board about location, location, location. If you are in a very attractive market with a high-growth opportunity, then yes, it’s probably the right time to sell it. But if you are 200 miles from a major metropolitan area, you are not going to get the same kind of interest. You won’t have a group of people beating a path to your door. You’ve got to balance those expectations. Sellers often see the most recent high-priced deal and that’s tattooed on their heads—which is what they think about. So there’s an education process that must occur as sellers begin to understand who’s going to be out there to buy their banks.

WARLICK: Also, when you think about selling, remember that your biggest assets are your customers. I’m still surprised at the number of institutions that, while they have anecdotal information on who their customers are, they really can’t give you good qualitative and quantitative information about their customers. They fail to use management tools such as customer segmentation systems or customer relationship systems. That’s where the profitability of the bank is going to be driven from, and that’s what an acquirer is going to want, other than, perhaps location. Not too many buyers will buy simply because you have pretty branches—they are going to buy your customer base and the earnings it generates. So, if you can’t describe your customer base, and if acquirers can’t validate it comfortably, then you are going to be hurting value. Therefore, I would say that as you get yourself prepared to sell, begin improving the quality of the financial and nonfinancial information about your institution.

PERKINS: One other thing that hasn’t really been addressed is the actual sale process. Identifying the institutions that you’ve gotten to know over the years or think would be a good cultural fit is certainly important. Enlisting the help of outside advisers can also be advantageous. They can tell you about how certain buyers may approach the transaction, how they’ve seen other potential buyers structure deals, what their hot buttons will be, and who may or may not be interested and why. We believe that you should almost never hold a full-blown auction, for several reasons. Most notably of which is if it fails, you end up with a great number of people aware of the failure, such as customers and employees, and your franchise can come away seriously damaged. It’s very important that going into the process you identify if the handful of players are really the right buyers to invite to the party.

WARLICK: The fact is, roughly two-thirds of deals are done using financial advisers and those sellers receive 20% or so more value than the ones who choose not to have an advisor. So it’s essentially something that pays for itself and more. You can also think of the investment banker, or financial adviser, as being able to step in and, if necessary, catch some spears. You may be negotiating the contract for the CEO, for example, and the CEO may want the advisor to bring up some sensitive issues. He’ll tell you but he may not be comfortable pushing the envelope with what could be his next boss. Additionally, the advisor is available to intermediate between the board and the CEO. There may be times when there is not complete congruency in their objectives. In the end, there are often a number of individuals with vested interests and in many cases, it can become difficult to meet everyone’s interests and objectives. In these circumstances, it can become very personal and it is often desirable to have a third party represent you.

ROCKETT: I’ve always told my clients that the first thing they should do, rather than jumping in, is think, “If I was going to take the money I have in my current bank and invest it in another bank, with whom would that investment be?” If they can identify prospective buyers whose shares would be acceptable investments, they should create a list, at the board level, of those who they think are good. Then bring the investment adviser in and go through that list to determine what synergies exist and what kind of interest level there might be from those particular institutions. That’s the point at which you start narrowing the list, as Tod suggests, to a point where you can actually think about carefully approaching them and seeing what the interest level might be.

PERKINS: The size of the buyer will have an impact. This concept of absolute versus relative premiums is very, very important, because if you are a small bank and sell to Wells Fargo or Citigroup, that’s in effect telling your shareholders to sell their stock and buy the acquirer’s stock because your contribution and impact will be negligible. If you plan to sell to a bank that’s twice your size, you’re going to have a big impact on what the combined company does going forward. In other words, relative value can be much more important than absolute value, particularly over the long term.

SCHUESSLER: I agree, because in those merger and acquisition situations, where you are a relatively large component of the deal, you’ve got a lot more responsibility than if you are selling to Wells Fargo or Regions. Depending on the size of the deal, you’re basically trading your ownership for the ownership of another company and you’re going to have a responsibility to create the long-term shareholder value.

One thing I’ve always encouraged people to do is to know the value of their bank every year. Many people wait until a potential buyer approaches them before they really determine the value of their bank. In order to make the process much smoother, build a good basis with your board and senior management about what really creates long-term value. What is going to drive this company to sell for, say, 18 times earnings? To me it’s an educational process that goes on for a long time. Unfortunately, it doesn’t usually happen that way.

WARLICK: At the end of the day, the reality is that if you are not selling your institution, then you are buying it. And if you don’t know what you are buying, then how do you know how much someone else should be expected to pay and how do you know if you are even creating value for your shareholders? That’s absolutely basic, But you have to be reasonable, as well, and I think you need to have reasonable expectations in terms of the value of your franchise. That comes back to reconciling what you think your value is with what you think it might be to somebody else. Our experience is that the institutions that go into the process well educated and prepared will receive a reward for their efforts.

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