Speaking Out About M&A and Growth

A number of bank boards are facing serious challenges driving many to consider a sale as a smart and viable strategy. Bank Director recently hosted three roundtables during its 2006 Acquire or Be Acquired conference in which leading investment banking, accounting, and legal advisers participated in the engaging discussions that make up this supplement sponsored by Grant Thornton LLP.

A pervasive sense of optimism surrounds many bankers and directors this year, which, coupled with a pent-up demand for M&A, seems likely to result in an increased number of transactions in 2006 compared to 2005.

This finding, among others, is drawn from a survey of directors and officers earlier this year at Bank Director's Acquire or Be Acquired conference in Phoenix. The questions tapped into the opinions of some 350 audience members, asking about key challenges faced by boards and executives with regard to growth and mergers and acquisitions. Responses were tabulated through an electronic audience response system sponsored by Harris Nesbitt. The results of the research and subsequent analysis are summarized in this supplement, published in association with Bingham McCutchen LLP.

M&A overview

The M&A demand has increased this year largely because many community banks admit they are struggling to meet growth targets for assets and deposits (see Figure 1). This challenge is further exacerbated by a squeeze on net-interest margins that is affecting large and small institutions alike, creating an enormous need to expand market reach themselves or find a partner to do so. Juxtaposed with the likely surging demand for acquisitions and pervasive optimism, however, are certain factors that could actually slow activity in 2006, according to Bingham McCutchen partner James M.Rockett. Chief among them, he says, are challenging regulatory hurdles and the possibility of renewed zest on the part of community activists.

“I think perhaps we underestimate the lingering impact of Bank Secrecy Act and anti-money-laundering problems that were prevalent during 2005,” says Rockett. “Also, the recent requirement to publish Home Mortgage Disclosure Act data is leading some banks to be concerned about what they may face from community groups and activists, who may use this data as significant ammunition against a bank's M&A initiative.” These issues, along with the Justice Department's renewed interest in fair-lending violations, he says, will likely mean stepped-up due diligence and a more cautious approach for institutions considering a transaction.

2006 M&A trends

Overall, 90% of executives and directors polled said they believe M&A activity will, in fact, be either higher or about the same as last year (see Figure 2). However, many banks may be taking a wait-and-see approach: 26% of those polled said their own institution has no acquisition plans for the next 12 months, compared to 19% last year who said they were sitting out. So while the bankers are generally optimistic, many aren’t ready to make a specific move just yet.

“Though they are generally bullish on the market, independent banks will have to meet significant challenges this year,” says Bank DirectorPresident TK Kerstetter. “Many have unrealistic stock-price expectations and are currently hitting the wall with regard to deposit growth, which should lead them to consider finding a partner or expanding their market area.” Indeed, 76% of bankers who said they were considering acquiring in 2006 noted the reason as increased geographic coverage and reach.

Deposit growth challenges are particularly acute at community banks. When cross-tabulated by asset size, for example, 63% of respondents under $150 million in assets reported that generating deposit growth is their number-one strategic challenge this year. “Both deposit and asset growth are significant contributors to the pent-up demand for M&A. As the survey shows, most banks are having significant problems with funding sources,and one of the solutions to that is to expand through mergers and acquisitions,” says Rockett.

When asked what type of entity CEOs and directors felt they were most likely to acquire, this year's poll depicts a slight shift in interest (see Figure 3). Forty-five percent of respondents said their most-likely acquisition would be a bank, compared to 38% last year; those who stated the likelihood of acquiring a branch dropped to 14%, compared to 20% the year before. Respondents are also less inclined to purchase an insurance brokerage–only 5%, compared to 11% the year before.

Bankers and directors surveyed also suggested the likelihood of buying and selling various entity types. Insurance (23%), private banking (19%), and investment management (17%) lead the list of business lines most likely to be acquired. Lines of business most likely to be disposed of include mortgage banking (22%), transaction processing (18%), credit card (15%),and brokerage (15%).

Successfully negotiating deals

The survey focused on certain aspects of deal negotiations to determine which areas selling directors and officers believe create impediments to a successful transaction. At 63%, pricing considerations were named as the most important negotiating point for sellers, significantly higher than in the last two years (see Figure 4). In another question, two-thirds chose unrealistic price expectations as the most significant deal impediment for buyers. Price, therefore, certainly remains top of mind for parties on both sides of the table. But beyond price, what other important negotiating issues affect the duties a board owes its shareholders?

“Clearly, getting the highest price possible is in the forefront of everybody's mind as they are looking at M&A transactions,” says Rockett, but he points out that in today's market there has been “a lot of hype” about deal multiples, leading to generally inflated pricing and a lack of relative objectivity. Other negotiation factors that are just as important, he advises, are the type and quality of the buyer’s currency.

“If you are taking stock consideration, you've got to look at whether or not the business plan of the acquirer is one that will support the combined institution and give value to that currency on a going-forward basis.You also have to think about whether the currency you are taking is overvalued by the marketplace–or perhaps even undervalued–in which case the currency becomes more important than the apparent nominal values in the transaction.”

Governance and oversight

Ensuring the bank's strategic plan objectives are met is a vital responsibility of the board of directors. Within that context, the board has several levels of involvement in M&A transactions. Bank Director’s Banker & Board Poll sought to measure this involvement during various aspects of the transaction process. In doing so, we uncovered a few unsettling findings.

Under the heading of general involvement in M&A, for instance, 15% of respondents stated that their board is not involved in reviewing or approving corporate strategy; among banks with $1 billion or more,22% answered negatively (see Figure 5). These percentages, agree Kerstetter and Rockett, are clearly in an unacceptable range.

“Directors set the overall strategic tone for a bank, and each director needs to play that role in the boardroom. As a group, board members should make sure that they are in concurrence and have a good sense of what the strategic objectives of the bank will be. Directors who are not currently doing so need to step back and realize that this is the most important aspect of what they do,” says Rockett. “It is very important for a board to make the ultimate determination on what the bank is going to do with respect to M&A.” Once they make those fundamental decisions, Rockett says, the board is free to delegate the day-to-day responsibility of that oversight to a special M&A committee that can work closely with management and act as a conduit for communications. This type of arrangement, he says, helps eliminate misunderstandings and situations that can become contentious.

“These issues can really create turmoil in the boardroom,” he notes. “Thus, if the board truly understands its role and structures a process whereby the transaction or the consideration of M&A is going to be done in an effective way, then board members will be able to comport themselves in accordance with their fiduciary duties and make sure they are acting in the best interests of the institution and its shareholders.”

Additional key findings

Lurking hostility–In light of competitive pressures in the bank market today, concern over hostile takeovers continues to mount. When asked whether their bank had received a hostile takeover bid from another institution during the last 12 months, 23% of respondents said yes, 67% said no, and 7% were not sure. Interestingly, when asked whether they would consider extending either an unsolicited bid or a hostile takeover if a target bank was deemed desirable enough to warrant such an action, 44% answered yes. Thus, we conclude that a fair amount of potential acquirers would not hesitate to proceed aggressively if the circumstances appeared to be worth it (see Figure 6).

Executive pay matters–When audience members were asked: “If you were the CEO of a bank that had made the decision to sell and now were looking for candidates, how important would your employment package be in getting the deal done?” Sixty-six percent (66%) stated it would be very important or important; 22% answered not critical; and 12% said it would be a nonissue.

Continued customer focus–Not surprisingly, 85% of respondents said they differentiate themselves from their competitors by customer relationships, and of those, 58% believe the most effective means of doing so is to hire relationship-oriented employees. Respondent profile Seventy-five percent of those surveyed are from commercial banks, and the majority (39%) are from companies in the $151 million to $500 million category. Most are located in the Midwest (37%) and Southeast (26%). Forty percent of those responding are CEOs; 26% are directors; 11% are non-CEO chairmen. Most (67%) said they were attending the conference as buyers, and 33% responded as sellers. Sixty-five percent of the audience believe they will remain independent for five or more years.

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