Preparing for a successful merger or acquisition is complicated enough without the additional burden that comes from poorly managed core services and information technology (IT) contracts. Unfortunately for many banks and credit unions, an existing oligopoly enjoyed by only five major core IT vendors nationwide has led to these contracts having an unnecessarily negative impact on mergers and acquisitions (M&A) in the financial services industry. In many cases, mergers can simply fail or cost shareholders dearly as a result.
According to a recently issued annual report by the Business Performance Innovation Network (BPI Network), “continued vendor consolidation into an oligopoly within the core processing and IT services industry has made it increasingly difficult for community banks and credit unions to negotiate fair market pricing from vendors.”
Paladin fs, LLC takes it a step further, suggesting that few existing agreements are M&A ready, and when institutions attempt to negotiate their own core IT contacts alone, they’re playing a game they are very unlikely to win. There is no efficiency in contract pricing and fair market value cannot be determined hard market intelligence and pricing data. In fact, a Paladin fs survey reveals that most institutions are paying too much for these contracts, sometimes by as much as 40.2 percent. Further, the overpayment amount varies by region.
The only way to overcome this risk in advance of M&A is to be better informed before opening a negotiation with these critical vendors—positioning contracts now to help with a merger strategy later. To that end, Paladin has created the industry’s only knowledge base of core IT services contract costs and favorable business and legal terms designed to protect shareholders before and during a merger. Called the Paladin Blue Book, the company leverages this intelligence to renegotiate and restructure core IT contracts for clients, saving them, on average, between $960,000 and $1.2 million over the course of a standard five-year term—without the reputational risk that comes from having to reduce staff. Additional profit improves shareholder equity and the future merger position.
“Getting the numbers right can be exceedingly difficult for an institution,” said Aaron Silva, president of Paladin fs, LLC. “Vendor sales teams are meticulouslytrained at advancing complicated contracts and are expert at delaying the contract phase until the institution has lost most of its bargaining power. Paladin has been very successful at short-circuiting this process and putting the institution back in control.”
Silva points out that timing is critical. Most institutions should begin investigating core IT options 24 to 30 months before their contracts expire. The sweet spot for signing the best deal generally falls 18 to 24 months before the existing contract ends. With less than 18 months until the contract renews, bank and credit union leaders find that their switching leverage erodes rapidly should their negotiation fail with the incumbent provider as little time remains to find another vendor, negotiate a new contract or convert services in time.
One common scenario that Paladin’s clients face is a contract that auto-renews unknowingly, saddling the buyer with an early termination fee. These fees can range in the millions of dollars. Another problem occurs when an acquiring bank learns of hidden fees and onerous terms buried in the 150+ page contract that ambush deals at great expense. For example, one recent institution acquired another to learn later that costs to recover archived item processing images exceeded $640,000.
Vendors know that each time one financial institution is acquired by another, one of the core IT vendor contracts will be abandoned. Existing contract language in 90 percent of agreements reviewed by Paladin ensures any exit from services will be as expensive as possible for the institution and even more expensive to acquire. It’s important that banks reposition or renegotiate these contracts in advance of an acquisition with these concerns in mind.
Silva says his company offers an M&A readiness assessment for any institution contemplating a merger in the future. This process has uncovered a number of these scenarios, any one of which could have doomed an M&A transaction.
There are a number of trends currently serving to drive the financial services industry toward more M&A activity. These include market contraction, a flat economy, integration demand and historically high compliance costs. But as firms are driven together, they must first ensure that the contracts governing their most important technology platforms are not positioned to negatively impact the merger. Doing this in advance of a merger has been shown to benefit both the seller and the acquirer.