Speaking Out About M&A and Growth 2007

Some 350 bank executives and directors were polled at Bank Director’s recent Acquire or Be Acquired Conference on key issues they are facing in 2007.Through an electronic audience response system sponsored by BMO Capital Markets,we gathered opinions on challenges such as deposit growth, interest margins, and post-merger management integration, as well as their future plans for buying or selling.The publication features results of the survey and additional analysis by supplement sponsor Bingham McCutchen LLP.

At this year’s Acquire or Be Acquired Conference in Phoenix, Arizona, Bank Director asked some 350 audience members for their thoughts on key issues they are facing related to M&A, growth strategies, and governance. Responses were tabulated through an electronic audience response system sponsored by BMO Capital Markets. Highlights of the research and subsequent analysis are summarized in this supplement, published in association with Bingham McCutchen LLP.

2007 M&A AND INDUSTRY GROWTH FORECAST

In painting a backdrop for the banking industry in 2007, one image stands out: little if any relief is expected from the net-interest margin squeeze that has plagued U.S. banks for several years. This has led to the prediction that many banks will try to overcome their sluggish growth by acquiring ready assets of other financial institutions. Likewise, banks that have hit a brick wall with regard to their earnings may be quite motivated to consider a sale in 2007. Both dynamics point to opportunities for buyers and sellers to seek mutual benefits from each other in the months to come.

This observation was borne out by the responses our conference audience members gave when we asked about the level of M&A activity they expect to see in the next 12 months. Nearly all directors and executives polled (93%) said they believe M&A activity in the banking industry will either exceed or remain at the same level as in 2006 (Figure 1).These numbers are comparable to our 2006 poll, when 95% of the audience answered similarly.

And who will be doing the buying and selling? Interestingly, while about a third of the audience characterized themselves as sellers, only 8% of those believe they will be selling within a year; the vast majority of them indicated it will be at least two years before they strike a deal; with 63% saying a deal is five or more years away. So while there are plenty of would-be sellers in the market, buyers seeking to accomplish a deal in the next 12 months may face some serious negotiations before those transactions are completed.

Another factor leading many banks to seek M&A in 2007 is the fact that directors and executives overwhelmingly believe generating deposits is their biggest challenge in the year ahead; fully 56% of those polled said deposit growth is their number one concern, a figure that has curved upward each year since we began polling in 2004.The second most popular answer, net-interest margin squeeze, garnered a 26% response—the highest percentage reported since 2004.Worries about generating loans dropped to 8%. Concerns over fee income generation (7%) and asset quality (3%) decreased as well (Figure 2).

Looking ahead to growth strategy, many executives and directors polled (48%) said their institutions are seeking a comfortable balance of both internal growth and acquisitions during the next two years. Forty-one percent are focusing on internal growth, while 6% are concentrating almost solely on acquisitions and 5% are planning to sell. Nearly three-quarters of those polled said they would consider doing a merger of equals, which is somewhat surprising given the execution risk of these transactions and their less-than-stellar track record.

We also asked bankers to describe their physical expansion plans in 2007. Forty-two percent said they would likely seek a whole-bank acquisition in the next 12 months, compared with the 15% who plan to acquire branches, 5% who will seek specialty lenders, and the sliver (3%) who are interested in buying an insurance agency. In response to another question, nearly half of the conference audience (47%) said they would concentrate on opening de novo branches. According to 75% of those we surveyed, the clear objective for much of this physical expansion is to increase geographic coverage and reach; 22% said they are looking to increase operating efficiency and economies of scale.

Digging deeper into sellers’ motivations and perceptions, about a third said that if they considered selling, it would be because the board and management were ready to cash out. Many are looking forward to starting anew—one-fifth of the audience viewed selling as an opportunity to fund the creation of a brand-new bank. Others (17%) said they would consider selling because of the CEO’s age and the lack of a succession plan. Another 13% said they would consider selling due to a competitive environment in their marketplace.

FACTORS FOR RISK AND SUCCESS

Even with the escalating attention and pressure on directors to increase their oversight in the boardroom, most audience members (66%) believe the process of getting a deal done today doesn’t differ much from pre-Sarbanes-Oxley days. In fact, conference goers (67%) told us the most significant concern or impediment to making a transaction in the current environment is unrealistic price expectations, followed by transaction risk (18%). Participants indicated they are less concerned about market and investor scrutiny (3%), regulatory changes (2%), and the heightened focus on corporate governance (2%).

When it comes to measuring the outcome of an acquisition, it’s no surprise that the factors most likely to determine deal success are often the same ones that determine its failure. According to 47% of those polled, management integration is the most important factor for success, and 55% said it is also the biggest reason for post-acquisition failure. Similarly, 29% said employee culture integration is the most important factor in the success of an acquisition, while 27% said it is the biggest reason for postacquisition failure (Figure 3).

A significant challenge banks face when they undergo an acquisition is the risk that customers will flee to other institutions they perceive as more stable.While some level of customer attrition is expected during the transition, we sought to determine director and executive pressure points regarding attrition rates. Forty-two percent said a customer attrition rate of between 5% and 10% is acceptable. Another 40% said they would be willing to accept a customer attrition rate of 3% to 5%.

MANAGING A SUCCESSFUL DEAL

Once a buyer and target have agreed to come to the table, not surprisingly, 53% of participants in our poll said their most important negotiating point would be the price/premium. Beyond that, 17% said buyer reputation and currency value, 15% said cultural fit, and 11% said form of consideration would be the most important points for negotiation. Interestingly, this year’s emphasis on price dropped slightly to give way to small increases in importance of the buyer’s reputation, cultural fit, and form of consideration (Figure 4).

Most survey participants said that if they sold their institution, they would prefer consideration in the form of cash (47%) or a combination of cash and stock (48%). Only 5% said they would want consideration entirely in stock. However, potential sellers’ preferred methods of payment don’t quite match up with those of potential buyers:While 52% said they would be willing to make a purchase with a mix of cash and stock, only 37% said they would be willing to make a purchase in cash, and 10% said they would do so exclusively with stock.

In any deal situation, the know-how of the parties can either make or break the process. About one-third of the respondents polled consider themselves “M&A savvy;” another third have done a deal or two, but don’t consider themselves particularly knowledgeable on the subject; and 37% admit they are “interested, but just learning.”

Often, the key to a successful acquisition attempt lies in the use of trusted advisers. Advisers, such as investment bankers, attorneys, accountants, and other consultants, can offer critical expertise when mapping out a plan for growth or working through specific aspects of a deal. Audience members told us there are several M&A issues they need help with to become more prepared directors—most of which are amply covered by advisory firms in the industry.The top three issues include information on market data and trends (33%), more proficiency in negotiating tactics (25%), and knowledge of best practices for governance during M&A (13%).While many participants (44%) reported they don’t use an outside adviser when developing a business or growth strategy, those who do said their most trusted confidant is an independent consultant or consulting firm (25%), an investment banker (16%), an accountant or auditor (4%), an attorney (3%), or a technology vendor (1%).

ADDITIONAL KEY FINDINGS

Unsolicited bids remain an undercurrent—This year, 34% of bankers polled said they had received an unsolicited bid offer; 42% said they would consider such a move themselves if they wanted a target institution badly enough.

Executive pay plays a crucial role—This year’s group of participants seemed to be of the same mind as last year’s audience—66% of each group said that if they were the CEO of a selling bank, their individual deal or employment package would be either very important or important in getting the deal done (Figure 5).

Customer relationships make a difference—Cutting-edge products and operational excellence (i.e., a good efficiency ratio or low rates and fees) may be important, but 87% of our participants told us their primary strategy for differentiating themselves from their competitors rests on fostering customer intimacy and building relationships to meet individual client needs. Of the customer-centric majority, 57% act on this value by hiring relationship-oriented employees, and 25% by developing contact management systems to help with customer follow-up.

RESPONDENT PROFILE

Seventy-seven percent of those surveyed are from commercial banks, and more are from banks (31%) in the $151 million to $500 million size category than any other; however, 27% are at banks in the $501 million to $999 million range and 17% are at banks over $1 billion. Most are located in the Midwest (37%), Southwest (19%), and West (19%).Thirty-eight percent of those responding are CEOs, 29% are directors, 11% are non-CEO chairmen, and 4% are CFOs. Most (68%) said they were attending the conference as buyers; 32% as sellers. Sixty-three percent of the audience believe their company will remain independent for five or more years.

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