M&A Success Stories—And What Directors Can Learn from Them

This roundtable session focuses on tracking the best deals, outside and inside influences and their effect on the outcome of the deal, and advice for boards looking to acquire in the current environment. The participants were William L. Boyan III, managing director, investment banking, Friedman Billings Ramsey; William F. Hickey, principal, investment banking, Sandler O’Neill & Partners; Ronald H. Janis, partner, Pitney, Hardin, Kipp & Szuch; Arthur L. Loomis II, president, North East Capital & Advisory; Ben Plotkin, chairman and CEO, Ryan, Beck & Co.; and Jerri Moss, associate publisher, Bank Director, moderator.

BANK DIRECTOR: We’d like to ask each of you to describe a recent deal that is notable because it was either a successful strategic or financial fit.

BEN PLOTKIN: A good example is an in-market transaction that occurred in 2000 involving two banks in Pennsylvania: Harris Financial in Harrisburg and York Financial in York. This transaction involved some branch overlap and was designed to garner around 40% in cost savings, though there was a high premium paid for York by Harris in this case. Just as important though, this was a transforming deal because it involved what’s called a “second-step transaction” on Harris’s part. In other words, there was simultaneous financing in which the combined companies were transformed into a new entity, known today as Waypoint Financial Corp.

For this deal to work, expense savings had to happen, financing had to be in place, and the new company had to be recognized and appreciated by the market. Now, a year or so later, it has been accepted—its stock is up around 60%. And while it achieved the cost savings it wanted, the integration didn’t go as easy as both sides expected. Both companies were inexperienced at acquisitions and there were some glitches in terms of the systems conversions.

The other interesting aspect of this transaction is that the seller, in this case, York, really had to understand the currency it was getting. This was a pooling transaction involving 100% stock, and the seller entered into this really quite novel transaction because it appreciated the currency. In the end, it has been rewarded: Shareholders were paid a nice premium for the company and the stock is up; that wouldn’t have happened if the cost savings weren’t realized. The deal also worked well because it was an in-market transaction.

BANK DIRECTOR: How did Harris know going into that deal that it was going to work out so well? What type of due diligence did it do?

PLOTKIN: This was a novel deal. I don’t think anyone could have predicted the outcome because of some of the regulatory wrinkles and the fact that the market also had to cooperate. The success really came because both management teams saw the potential of a new company in southeastern Pennsylvania that could fill a void. This combined company has assets of nearly $5 billion, and so far there really isn’t anything else like it in the market. But the answer is, they didn’t know. You can do all the diligence you want, but acquisitions often require a leap of faith, especially when you approach a transforming deal.

RONALD H. JANIS: If purchase accounting had been used, would the acquisition have turned out differently?

PLOTKIN: Not in this particular case. It would have worked equally well as a purchase transaction as long as it didn’t have goodwill amortization, but that was obviously part of the whole equation.

BANK DIRECTOR: Ben, you mentioned Waypoint’s goal of making 40% cost savings. Is there a range of cost savings for in-market deals that is accepted by the market without a great deal of skepticism?

PLOTKIN: It’s predictable based upon the proportion of the branches within the target company’s market area. In Waypoint’s case, the 40% really turned on the branch overlap. There were seven or eight branches, and that’s what made it work. If you don’t have branch overlap, you will not get those kinds of numbers.

William F. HICKEY: Were there any social issues on this deal, especially given that stock was the only form of currency?

PLOTKIN: In all deals, there are social issues. These companies were comparable in size—one was around $2 billion in assets and the other was just over $1 billion, so clearly one CEO had to take a back seat to the other. The unique part of this transaction was the melding of management teams: The CEO of Harris is the CEO of the combined companies, the new CFO came from York, and the new vice chairman was the CEO of York, who is still active in the company and the largest shareholder. What allowed them to get around the social obstacles was that the CEO of York owned a considerable amount of stock and obviously believed in the transaction, which is not always the case. The other thing that happened was the two former CEOs hired a new CEO who didn’t come from either company, and he was responsible for the cost saves and melding the companies.

BANK DIRECTOR: Bill, what deal do you feel has worked strategically or financially well?

HICKEY: A deal completed last year that I’ll call a “high-premium merger of equals” between Richmond County Financial Corp. of Staten Island and New York Community Bancorp Inc. of Westbury is a good example. These two companies in the New York metropolitan region had talked for years about doing a transaction, and the market finally lined up in such a way that they could. Interestingly, both companies were sitting at very high multiples, on both an earnings basis and a tangible book value basis, and when the transaction was announced, the stock price performance of both companies was pretty good, given the fact that they were already trading at high levels relative to the rest of the market. Thus, it was very difficult for anyone—shareholders or third-party interlopers—to come in and criticize the valuation of this transaction or try to upset the apple cart. The combined entity has since performed very well.

The market doesn’t embrace mergers of equals and the press never embraces them. In this situation, there was certainly a blending of management and of the board of directors; it was a unique way to structure a deal, such that they ended up with a new holding company and two individual banks. It certainly created mass for this company in the New York metropolitan region.

ARThur L. LOOMIS II: Were there any distinguishable social issues in that transaction?

HICKEY: I think the critical social issue at the end of the day is that the transaction should end up with acceptable board representation after the board split, which is probably an issue with most mergers of equals because so much centers around who is involved in the decision-making process going forward. Once that hurdle was reached, the deal seemed to move quickly.

JANIS: What happened with the CEOs’ compensation? Did that change during the course of the transaction?

HICKEY: No, the New York Community Bank CEO took the CEO’s position in the new corporate entity. Richmond County’s CEO became the chairman of the new company. So compensation per se didn’t change, nor did the contracts for the management at New York Community Bank. A significant issue in any of these deals is whether one side or the other will get paid out of their contracts or whether they’ll just roll their contracts into new ones.

LOOMIS: It seemed apparent in the transaction that compensation was an inducement to Richmond. Is that a fair statement?

HICKEY: There was a form of payout, just not a full payout on their contracts. I wouldn’t categorize it as an inducement to do the deal—it just gave Richmond’s executives value for what they had given up. They had five-year contracts and now have three-year contracts, so they were paid out on the two years that they gave up.

JANIS: There weren’t any problems with getting the necessary votes on that deal, correct? Didn’t all of the shareholders strongly support it? On an all-premium transaction, that is a real accomplishment.

HICKEY: Yes, it was an oxymoron: a low premium transaction at very high multiples.

BANK DIRECTOR: Art, what strikes you as a worthy example of a successful deal?

LOOMIS: In terms of looking at a transaction that had more modest levels of cost savings yet still appears to have been very successful, I’d zero in on Charter One Financial and St. Paul Bancorp in Chicago, which occurred in 1999. By all accounts, it looked like a high-priced transaction. The actual multiple was close to 38 times earnings and the trailing 12 months earnings at the deal’s close was 29 times earnings. The parties only anticipated 18% cost savings after tax. The proof was in the pudding, however. They’ve been able to deliver earnings growth comparable to historical earnings levels of roughly 12%.

The acquisition was a modest one for Charter One, and I have to say, I was a cynic with regard to this transaction. I thought Charter One won a limited auction but had probably paid far too much. Yet, Charter One’s price performance has exceeded its peer group by 10% in the year and a half since the transaction was consummated. The price that it paid after the cost savings were reflected anticipates a 10% earnings growth, and so far it is at or in excess of that. So I think it is an interesting market-extension transaction. Charter One paid what some might argue to be a premium multiple, but it’s working. It’s not always clear that to be successful a high price must have enormous cost savings as a corollary.

PLOTKIN: How did the market treat Charter One?

LOOMIS: Initially Charter One was punished, but over the last 18 months it has rebounded nicely.

HICKEY: Wasn’t that one categorized as a marketshare play more than anything else?

LOOMIS: Yes. Charter One has driven its efficiency ratios down to fairly handsome levels as well, from 52% to 45%. Its deposit and loan income growth are both in double digits. Charter One has taken what was traditionally regarded as a thrift and actually deployed good commercial lending expertise in the Chicago marketplace and has been very successful in growing commercial loans.

BANK DIRECTOR: Bill [Boyan], what’s your nomination for a deal we can learn something from?

BOYAN: I’d say Franklin Bancorp in Washington, D.C., selling to BB&T in Winston-Salem, N.C. It was in late 1997, and many acquirers thought that D.C. was still a place to avoid. So when Friedman, Billings, Ramsey was marketing Franklin, the first thing we did to bring a few people to the table was to show potential buyers the amount of Virginia and Maryland deposits and loans they would have as a percentage of the whole. BB&T, already established in southern Virginia, took a leapfrog approach up to D.C., and at first, we weren’t sure how it was going to connect. Franklin had about $550 million in assets and a CEO who was very hands-on, very driven, and more entrepreneurial than a traditional banker. Franklin’s long-term strategy ran out of steam pretty quick—it was reaching capacity on its existing data processing systems, it was running out of space, and its employees were crammed in offices. Franklin also was bumping up against its loan-to-one borrower limits.

One of the things that certainly helped was, in starting out, the CEO owned a large amount of stock. We perceived that he wanted to sell and potentially exit, but he was skeptical we could find a partner he would really want to work for—as being entrepreneurial and then working for someone else doesn’t come easy to certain people. So we brought in BB&T, which did its usual fantastic job, and there was a real fit. BB&T brought resources on the technology and product sides and also brought lending capacity and capital. This deal was not based on cost savings, even though there were cost savings to be had. Rather, BB&T invested in Franklin to open up a new headquarters and pump money into the system. Furthermore, for a $550 million company, we were able to negotiate 10 employment agreements for the vice president level and above in order to keep the management team intact.

LOOMIS: Was it a one-off transaction?

BOYAN: No, it was a limited auction, but the ultimate success was questionable due to the D.C. exposure. We didn’t really know where we would end up, but the match between BB&T’s ability to execute, integrate, and provide resources to Franklin, gave it the means to grow. Now, three years later, Franklin is up to $3 billion in deposits. While some of that was through additional acquisitions, I think this transaction worked because there were complementary needs. BB&T wanted big markets with great demographics and it also needed a strong management team that could bring these additional products to that market. It was a great transaction from many perspectives.

HICKEY: Is the Franklin management team still involved in the organization in the D.C. area?

BOYAN: Yes. The CEO is going to retire and stay on as chairman of the local board, but he also has incentive to produce because he is extremely active in the community. He grew up in D.C., so he has tremendous connections.

LOOMIS: In the limited auction, what were the other considerations beyond price? Did you get into those issues right away or during the offer?

BOYAN: There were two other parties we were talking to, and they were so skeptical of the D.C. presence that they couldn’t compete on price. It became very clear once we got BB&T and Franklin together in a room that the chemistry was present for a successful transaction.

HICKEY: How did BB&T’s stock perform after the deal?

BOYAN: What was really interesting is that as we were in negotiation with BB&T and hadn’t received anything in writing; we locked in a fixed exchange ratio on a handshake. Two days later, BB&T was added to the S&P 500 and the stock spiked! On our side, people were scrambling and saying, “What do we do? We’ve got to call them!” But our strategy was to wait it out, and sure enough, after a couple of days, BB&T’s representatives called. They knew the stock wasn’t going to come back down, so we had to negotiate a few things. We actually took a little more of a discount than what we originally had, but BB&T came to us and said, “We can’t give you all of that premium, because the price is going to be astronomical.” We told them that because of where they were trading compared to their peer group, we wanted at least 50% of the upside. That’s where we got a small bump on the pricing. BB&T was big enough to do the right thing and split the difference.

BANK DIRECTOR: Ron, what deals have you been involved in that you find notable in terms of strategic or cultural fit?

JANIS: I have a similar type of transaction to the one Bill just mentioned: Valley National Bancorp’s acquisition last year of Merchants Bank of New York. It was, relatively speaking, a large transaction for Valley, a supercommunity bank that had about $6 billion in assets and well over 100 branches in New Jersey. The largest bank headquartered in New Jersey, it is traded on the New York Stock Exchange but has very little institutional ownership. It also has an excellent efficiency ratio. Its business as a whole is part consumer—mortgages, car loans, home equities, and credit cards—as well as a large segment of commercial mortgage loans. It has an active trust department and has acquired two investment advisors. Merchants, on the other hand, was a fairly small institution with six branches in New York City. It had $1.4 billion in assets but only about $500 million in commercial loans, with no trust department. Although it was in New York City, it had no ATMs.

The expectation was that the deal was going to be low premium to earnings with a fairly low percentage of cost savings (i.e., 15% to 20%). Valley’s view was that it was going to remake Merchants into a full-service bank. The transaction fit Valley’s strategic view, which was to acquire other, similar institutions. In fact, I think the thing Valley found attractive at the very beginning was that the credit culture was similar to Valley’s and they liked the people who believed in a customer-oriented business the same way Valley did. There was one exception, however, as to whether they fit strategically: Valley had never been interested in acquiring a bank in New York City. Yet, in this case, Valley found the strategic fit so unique that it saw no problems with the concept of going into New York.

Once the deal was consummated, the system integration was successful, though it was not accomplished as quickly as Valley had anticipated. The integration of staff is ongoing—Valley has a record of keeping most of the people that ran the previous institution. It did end up generating new business from Merchants’ similar customer base, but it was a different type of business than expected. Instead of developing more commercial loans, it actually developed more commercial mortgage loans, both in New York City and on Long Island, than it had anticipated. It has gained some retail business, installed ATMs, and seen an interest in customer loans.

The question of whether Valley is actually better off is an interesting one. I would say there is no question that Valley’s stock is now trading at historic highs. If you look back at what it was trading on January 1, 2001, to what it’s trading at now, I think it’s up 35% or more. The real issue is the source of that share price growth. I’m sure part of it came from the new business that Valley had acquired, but another part came from Valley’s own internal growth.

PLOTKIN: Ron, Valley went into New York City—a new market for it at a time when the competitive picture in New York was changing dramatically. How did Valley decide the value of the franchise it was buying was going to be protected given those competitive threats?

JANIS: The cultures of both institutions were so similar that Jerry Lipkin, the CEO, was very attracted to the situation. Valley also knew that under various legal provisions it could move over the border from northern New Jersey to New York and then branch into other areas north of New York City. I also think Valley felt that there wasn’t a substantial risk of anyone taking the customers from this particular institution. They were loyal customers to Merchants, and Valley’s culture was very similar.

LOOMIS: What kind of cost savings was it generating?

JANIS: I think it was on the order of 20%, which wasn’t very severe, so it was a fairly easy number to reach.

LOOMIS: Is 40% the highest that anyone here is aware of?

PLOTKIN: Well, there are people who say they’ve gotten more, but whether they have actually gotten it is another thing entirely.

BANK DIRECTOR: When you hear institutions announce they intend to save more than 40%, do you discount those types of claims?

BOYAN: I don’t believe anyone would try to claim they could achieve more than 40%. Right now, most acquirers are trying to be conservative, to garner support for the deal in the market.

LOOMIS: With one exception, I would agree with you. When there is an enormous amount of branch consolidation activity that can occur, then the cost savings can obviously step up. North East Capital was recently involved in a transaction where we were looking at 80% cost savings.

BOYAN: Someone was paying a large amount of money!

LOOMIS: Right! Consequently, it’s rare when you see a number like 80%. For in-market transactions, 30% to 50% is a broad-brush figure that can be used.

JANIS: I think the higher you go with the cost savings, the more customer disruption you have in the end. I’ve done several transactions for targets that featured very high cost save numbers, and you see the result when you get disruptions: branches are closed, people are unhappy, and staff that customers have been dealing with are let go. In my mind, Valley is very good at the low end of the scale in terms of cost saves while still maintaining its efficiency. You just have to be disciplined in terms of price.

BANK DIRECTOR: What would be your best advice for a board of directors looking to acquire in the current environment?

BOYAN: The M&A markets are far more difficult today than they were in 1997 and 1998, and it’s harder to put some of these transactions together. I don’t know if I want to call it a buyer’s market, but the market is not as fluid or liquid as it once was. So there are many companies that just don’t have any acquirers for them. They will decide to sell, and then they’ll wait two or three years before they can find someone who is willing to pay the price or until they are willing to lower their expectations. There isn’t an exit possibility for every institution in this country, and most of the companies out there are probably going to have a difficult time selling unless they have reasonable size and good markets or solid performance. Many acquirers are not going to take a risk on a company that is questionable or one that doesn’t really get them into a market they want to be in.

HICKEY: It’s critical for directors to think about doing deals not as a means to get bigger but to become more valuable. They need to change their thinking from, “I’m a director of a $500 million bank” to “I’m the director of a very profitable bank, regardless of size.”

PLOTKIN: My first piece of advice is that buyers need to think like sellers, especially today. If they are going to buy a company, they need, in the same breath, to understand whether the acquisition makes them more attractive if they want to sell. That’s a simple way to understand the qualitative difference between the target companies they may look at. The other thing to recognize is that in this post-pooling world, capital planning has to go hand in hand with the acquisition strategy because acquisitions use much more capital. There will be more cash transactions. For many years companies were just doing poolings. It is a different world now, which gives acquirers some structuring alternatives, but they need to also plan their capital positions.

LOOMIS: Let’s face it, pooling also masks a large number of overpayments. Whereas with purchase accounting, it is going to be more difficult to hide egregious prices.

PLOTKIN: Do you think that is why there have been fewer deals?

LOOMIS: No, I don’t think so. But one of the things a board ought to consider is where its growth rates are coming from. In virtually all of the transactions we’ve discussed, there have been typical growth rates of 10% for the foreseeable future. When your demographics are running 3% to 5% for disposable income growth or household income growth, there is a gap that you’ve got to bridge. You are going from 5% to 10%. Are you going to steal market share? It’s doubtful. Are you going to suddenly create products or non-interest income sources? Perhaps, but that’s still a fairly extensive gap to try to overcome. So directors should remember that if the bank is acquiring more than 30% of pro forma deposits with the target, the execution risk is enormous even if it is an in-market transaction.

BOYAN: Acquirers also have to realize that most of these transactions begin and end with people. If you can’t acquire the right people, chances are you are going to have trouble integrating the company. And if you can’t integrate, then you are not going to get the EPS growth and your stock will suffer. It may not come out of the wash right after the transaction is announced, or after it has closed, but ultimately it will be reflected in your EPS growth. If you are planing to make an acquisition, you need to figure out how that transaction is going to be structured prior to signing a definitive agreement. Know the risks: What are the systems going to be and who is managing them? What is the probability of having a data processing problem or a conversion problem? Figure out how you are going to handle your resources to really integrate the acquisition properly.

JANIS: If you go back a couple of years, you will find that financial engineering was what you were trying to do—acquiring deposits so that your EPS looked better. Now, managing earnings will be more difficult under purchase accounting. We’re seeing an emphasis on management and growth from customer loyalty or acquiring new sources of strength that a target might bring to the table.

PLOTKIN: We’re also at an interesting point for acquirers from a macroeconomic standpoint. That is, for the most part, everyone feels that in a couple of quarters we may get growth back in the economy, easing some of the recession fears and, with that, the credit fears, that have kept several acquirers sitting on the sidelines. For instance, I may not buy a company because I don’t know how its portfolio will hold up. Over the next two quarters, those issues should evaporate as we see the economy pick up.

At the same time, we are at a point where long-term rates haven’t gone up yet, and obviously, if we look at the budget problems, those rates will go up, but hopefully not in 2002. That’s an opportunity for acquirers. Frankly, they must think about their cost of capital—their acquisition costs in this post-pooling world. It’s a great time to lock in long-term financing for acquisitions and yet they don’t have the recession-related fears. So you also have to advise a board of an acquirer to look at where it is in the economic cycle.

LOOMIS: Bill, in terms of going forward, you felt that targets are going to be less desirable, or that buyers may be more selective. Do the rest of you see a change in that tone? What are the near-term ramifications to the M&A marketplace? Are we looking for more hostile transactions?

HICKEY: It’s tough enough to do a friendly deal! Right now, acquirers are very hesitant to increase the size of their franchise vis-à-vis acquisitions because they are not exactly sure what they have on their own books. They certainly have less confidence in what they may be acquiring on someone else’s books. As credit quality concerns go away, I think we’ll see deal flow pick up.

LOOMIS: That goes to credit quality.

HICKEY: Absolutely. We saw some decent deal flow in the fourth quarter of last year because all those discussions were initiated prior to the events of 9/11. Since Jan. 1, we’ve seen four deals announced with deal values greater than $150 million. Clearly, 9/11 slowed deal flow, but banks have questions about credit quality, both within their own organization as well as in others.

LOOMIS: How do you juxtapose the inability to be acquired because you are not attractive to what I’ll call the “Upstate New York phenomenon,” in which everyone is writing offer letters? Do you see that trend increasing because of the scarcity of good institutions?

HICKEY: That’s a good point. There are probably a number of institutions across the country that are not acquirable.

LOOMIS: I agree.

HICKEY: So how do you fix that? Perhaps merge with someone who also isn’t acquirable, or change your business mix?

PLOTKIN: Banks that are sitting back waiting for somebody to call could be fixing their business instead.

BOYAN: Management teams are getting a little more comfortable these days because they don’t have to read the newspaper or hear from the directors, “Hey, did you hear about that 25 times earnings transaction? Wouldn’t it be great if we could do that?” Acquirers are trying to let that price expectation subside and then attempting to make cheap acquisitions.

BANK DIRECTOR: Do buyers and sellers really understand those market dynamics, and are they patient enough to wait?

BOYAN: I see acquirers waiting out willing sellers, and the more time the other party takes to move in and attempt to make a play for that bank just puts fear in the mind of the potential seller.

LOOMIS: Bank to bank I see more discipline by acquirers at sizing up targets. They are seriously looking at how it fits, how to integrate, and what price to pay, which is typically at odds with the seller’s expectations. I’ve also seen more of what are called “Gramm-Leach-Bliley transactions” as a source of non-interest income for acquirers. I think it’s important to be there strategically, so we are starting to see some of what I’ll call an “end run”—not necessarily with bank-to-bank combinations but rather other revenue source combinations.

BOYAN: Banks are also opening up branches de novo. I believe that some of this is due to waiting out sellers until the prices drop, but on the other side of the coin, acquirers are a bit afraid of having a miscue in integration, the conversion, or just in the credit quality.

JANIS: They also are more interested today, as is Hudson United Bancorp, in proving to the market that they can grow without acquisition—they don’t have to buy growth.

PLOTKIN: If we look at the numbers reflecting overall deposits of the industry, though, it is not adequate. We must have acquisitions. Over the last three to five years the core deposit growth rate at the top 30 banks was negative. At the community banks it was about 3%, and that’s without acquisitions. So ultimately, there’s got to be acquisitions to obtain core deposit growth, which is the main engine of profitability.

LOOMIS: Or there must be more of a sales culture, like Commerce Bancorp in New Jersey, that can drive the deposit growth. It can obviously grow deposits without acquisitions.

HICKEY: There has been a confluence of events since late 1998 when a number of things have been going in the banks’ direction. Rates have been going in their direction. Credit quality is as clean as it has ever been. The money flow is out of equities and into deposits. Middle-market banks are making a large amount of money. When that turns down, I think you will see some enhanced merger market activity because they’ll realize it’s a hard business to grow at double-digit rates.

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