Whether you plan to sell your bank or are in the market to acquire one, there are several sticking points that can delay the transaction. It can be helpful for both potential buyers and sellers to think about how such items may affect their future opportunities.
Executive Compensation Arrangements
Executive compensation arrangements have derailed a number of transactions. You will need to consider what deferred compensation, salary continuation, supplemental executive retirement plans and equity incentives, among other factors, exist at your institution. Will they be triggered? Are they funded — even if a sale accelerates them? You may also need to be aware of tax implications under 409A or 280G of the Internal Revenue Code.
While these arrangements can certainly complicate a deal, a buyer may require key personnel to be bound by an employment agreement. Unless these employees are under a reasonable contract, they may leave and join a peer to compete against you. Oftentimes, a buyer is bidding on the institution and its people, so they may want reassurances that those people are under contract.
Data Processing Contracts
Your data processing service is the single largest contract you have. Early termination fees are just one consideration: typically, contracts will have some formula that accounts for the remaining months multiplied by the average monthly cost. Deconversion fees are another thing altogether. Many contracts simply state that the bank will pay the “then-current deconversion fees,” which can run well into six figures. Many executives do not appreciate the distinction between early termination and deconversion fees.
An acquiring bank’s stock is often not as attractive as it would like to believe. Potential buyers who intend to offer shares as consideration should address why their stock is, or will be, more liquid than the seller’s. They should speak to its sufficient liquidity for selling shareholders. If the buyer is not a public company, there may also be limits on which selling shareholders can receive stock in a transaction.
Unrealized Gains, Losses
The current fluctuating interest rate environment means parties will need to wrestle with how to treat unrealized gains and losses. In other words, when you are calculating bank capital at the signing of the deal and then at closing, do you take interest rate fluctuations into account? One solution is to “lock in” the amount at some point in time and agree on how fluctuations will be handled.
Sellers with a number of loan participations can create due diligence challenges. If the target bank tended to sell participations, buyers will be interested in how quickly they can pull them back. If the target bank tended to buy participations, buyers will need to consider if those participations will remain post-closing, since there are no real relationships in place with the borrower. Many buyers struggle to incorporate significant participations into their risk and pricing model.
Change in Control Filings
During the acquisition process, regulators often discover that one or more of the buyer’s shareholders have crossed the ownership thresholds that required change in control filings but failed to do so. The result is a dual application path. We recommend clients regularly review their shareholder ownership information to avoid future surprises.
Historically, we have not encountered many environmental issues in bank mergers, but that is changing. In several recent transactions, we have seen older bank branches residing on sites that once housed underground tanks or are adjacent to properties like gas stations and similar businesses. While there is additional time and expense involved, buyers can require remedial action be taken before proceeding with closing.
There is always a concern around asset quality and agreeing on the credit marks. Most parties can work through this, even if it means holding back a portion of the purchase price in loan-specific escrow accounts for a period of time. Sellers also have the option of “moving the loan” to a holding company or other entity prior to closing, if they believe it to be a quality credit.
Many deals have a portion of the consideration reserved to mitigate costs associated with misrepresentations or breaches discovered after closing. The parties will need to determine the duration and amount of such escrow, as well as the appropriate triggers.
Bank transactions can be subject to scrutiny from bank regulators if the deal results in fewer branches or deposits increase above what’s considered “normal” for the market, according to the Herfindahl-Hirschman Index (HHI). HHI proportionately increases as the number of banks in a market decreases or the disparity in size increases. The calculation currently excludes market share held by credit unions, but the regulators could choose to include credit unions in the event an application exceeds the delegation criteria in a given market.