The Texas Two-Step

By all appearances, this didn’t look like a time for the board of Amegy Bancorp to consider selling. The Houston banking company had leveraged its lending savvy and strong director connections with the local business community to grow into the largest independent bank in town, and the third biggest in Texas. In September, it boasted $7.9 billion in assets and deposits of $6.4 billionu00e2u20ac”both figures about 20% more than a year earlier. Net charge-offs were just 0.16% of the loan portfolio, and per-share earnings for the first three quarters were up more than 10%, to 82 cents. Only a year earlier, management and directors were openly declaring their aspirations to be the “state champs” of Texas bankingu00e2u20ac”the locally owned entry with enough size and oomph to stand toe-to-toe with the big out-of-state banks that have invaded the Lone Star state.

So when Amegy’s board announced in July that it had agreed to a $1.7 billion sale to Salt Lake City-based Zions Bancorp, some observers were surprised. They shouldn’t have been. For all the glowing numbers, some disturbing trends had emerged that got first management, and then the board, believing that a partnership with a larger institution wouldn’t be all that bad.

Directors thought they had helped craft an “asset sensitive” balance sheet that would benefit from rate hikes. Instead, the company’s net-interest margin declined in the fourth quarter of 2004 and again at the beginning of the year. Intense price competition from big, market share-hungry national banks, such as Citigroup, Wachovia Corp., and J.P. Morgan Chase & Co., added to the spread woes. The future didn’t look much brighter: combined, those outside players are expected to add several hundred branches over the next few years.

Late in the first quarter, with Amegy’s share price saggingu00e2u20ac”it would fall to near $16 per share in April, from a high of $25 only five months earlieru00e2u20ac”Chairman Walter Johnson and CEO Paul Murphy Jr. quietly began discussing the idea of a sale with select directors. In May, they laid the idea on the table for the entire board, commencing an intense, two-month-long process in which directors first weighed the company’s future as an independent against the benefits of a sale, and then refereed a competitive, auction-style sales process.

The winner of that competition was Zions, which agreed to pay $23.88 per share, in either stock or cash, when the deal closed in December. The transaction, valued at more than four times book value and 23.3 times earnings, preserves the Amegy name, local management, and operating autonomy. It comes with the lending capacity of a $40 billion balance sheet and gives shareholders stock in a well-managed, diversified company with a footprint that extends across much of the western United States. It also holds the promise of up to $50 million in cost savings. About 400 back-office jobs are expected to be lost.

“It was a very good deal for Amegy, because it can continue to penetrate a growing market with a bigger franchise that allows it to rationalize expenses,” says Jackie Reeves, an analyst with Ryan Beck & Co. “Give the board credit. They stepped forward and said, ‘We need help managing this.’ Maybe more banks should do that.”

Board members say they’re modestly disappointed that it came to a sale. Wilhelmina “Beth” Robertson, president of Westview Development Inc., a Houston real estate firm, and one of the founders of the bank nearly 30 years ago, admits there were times when she asked, “Should we really be considering selling? … There’s a part of me that’s sad to relinquish formal control. You get used to being on the board. You enjoy the growth. You’ve been picturing us taking over the Texas market,” she explains. “But when you looked at the facts, it made good sense. We got good value for shareholders, and we have a better ability to serve our customers.”

For Johnson, the chairman, it was a simple a matter of costs and competition. “It was a hard decision for the board members when they first thought about it. We liked being independent,” he says. “But I’m a realist, and the real world is, there’s a new paradigm in the banking industry: You cannot sit here and have a 65% efficiency ratio and expect to compete with the big guys.” Amegy had an efficiency ratio of 69% in the third quarter; Zions’ was about 54%.

“Smart boards are always looking ahead, figuring out what the future holds,” he adds. For Amegy’s board, the question was, “Do you wait until your efficiency ratio gets to be 80% and your net-interest margin is getting hammered, and then go hat-in-hand in search of a deal? Or do you act now, from a position of strength?”

Amegy’s roots stretched back to 1982, when a group of local business leaders led by Robertson and founding chairman John Johnson launched Northwest Crossing National Bank. “The environment was right for de novos, and we had a good location on the northwest side of town and some directors with strong business contacts,” recalls Johnson, who serves as chairman of oil services company Permian Mud Service.

The board’s conservatism enabled Northwest to survive the mid-80s oil bust, even as big banks like Texas Commerce and Allied Bank of Texas foundered. By the early 1990s, most of the local banking industry was in ruins. Northwest was a $50 million bank looking for direction when the two Johnsons (they’re not related) were brought together. Walter, Allied’s former CEO, signed on as Northwest’s new CEO, raised $23 million in capital from 125 local investors, and renamed the institution Southwest Bank of Texas with visions of creating a new in-state powerhouse. A new board was put together, with a handful of Northwest’s directors being joined by attorneys, accountants, and investors who had public-company experience.

Growth came easy, and so did returns. Through most of the ’90s, “Texas was a lender’s market. People were starving for loans, and the big banks weren’t lending,” explains Scott Analiz, an analyst with Sandler O’Neill & Partners who follows Texas banks. “The pricing was great, and volume was strong. It was a great time to grow a community bank into a big bank.” The company regularly grew its balance sheet and earnings by 20% or more annually. It went public in 1997 at a split-adjusted price of $4.12 per-share, and by late 2004 briefly surpassed $25 per-share. The board, emboldened by its successes, rechristened the company “Amegy”u00e2u20ac”a play on “America” and “energy”u00e2u20ac”introducing the name with a $6 million marketing campaign.

Behind the scenes, however, management was growing uneasyu00e2u20ac”and with good reason. Big national players, such as Citigroup, Wachovia, and KeyCorp, and regionals such as Compass Bancshares, had either bought or de novoed their ways into the market and were competing hard for market share. The established big players, including Wells Fargo & Co., Bank of America, and J.P. Morgan, weren’t about to give it up without a fight. “In a matter of two years you went from optimal conditions, with great pricing for loans and deposits, strong margins, and great growth, to a hypercompetitive situation,” Alaniz says.

Amegy was caught in the middle. The company’s emphasis on service required “spending ahead of the curve” to generate growth, says director David Heaney, chairman of Heaney Rosenthal Inc., a private investment company, and a former CFO of publicly traded Sterling Chemicals. The competition, combined with a steady stream of Federal Reserve rate hikes, began to challenge that model. As loan and deposit pricing got tighter, Amegy’s income statement took a hit. Between September 2004 and March 2005, the company’s net-interest margin dropped to 10 basis points, to 3.87%. And while assets in the first quarter of 2005 grew 3.2% over the previous quarter, net-interest income actually declined slightly.

For Murphy, Amegy’s CEO, the scenario “was a gut check that made me think differently about the outlook for EPS growth and long-term shareholder valuation.” Larger suitors had regularly approached Amegy, only to have their offers dismissed by a board that believed its own game plan promised better returns. Now, Murphy and Walter Johnson began to think that a partnership should at least be considered. They held some informal discussions with several directors, including John Brock III, former chairman of Ocean Energy Inc., a Houston oil and gas company. “We believed in our strategy,” Brock says. “But the facts had changed, and we needed to do something about it.”

At the board’s regularly scheduled board meeting on May 4, Murphy and Walter Johnson suggested exploring a sale to the group. Reaction was mixed. Those who had discussed the idea earlier, and had had time to digest it, were amenable; others weren’t so sure. “There was definitely some hesitation,” Murphy recalls. Walter Johnson estimates that about half the directors balked. “Some of them said, ‘I won’t even think about it,’” he remembers. A lengthy discussion ensued, with talk centered mostly on the rate environment and yield curve and what the growing competition might mean to Amegy’s future. As the meeting closed, an uneasy consensus emerged that it wouldn’t hurt to take a closer look at the idea.

A nine-member special committee was formed, headed by Beth Robertson and comprised of members of the board’s executive committee, less the insiders. All had big investments in the company. “If we did something, it would be a shareholder deal. We wanted people who would think like shareholders,” Walter Johnson recalls thinking. “If someone has 10,000 shares and is getting $2,000 a month in board fees, they might be inclined to stay independent.”

To help the assessment process, the board agreed to hire Goldman Sachs Group as its financial adviser and Sullivan & Cromwell of New York as legal counsel. Murphy compares the selection of top-flight advisers to that of doctors before heart surgery: “You want people who have expertise handling difficult situations. That way, if you encounter complications, you’re covered.”

Directors also set a tight timeline for whatever deliberations were to follow. “We said, ‘We’re going to get in and get out quickly. We’re not going to spend six or nine months traipsing around the country in some long and laborious process. We’re going to hire a top-notch investment banker to find out about the price, weigh that against remaining independent, and make a decision quickly,’” Murphy says.

Five days later, on May 9, the special committee held its first meeting at the St. Regis Hotel, across the street from Amegy headquarters. The four-hour meeting opened at noon with lunch, and then Sullivan & Cromwell Chairman H. Rodgin Cohen advised directors on their duties and laid out a road map for the process. The Goldman team, headed by managing directors Kenneth Coquillette and Todd Leland, offered a preliminary view of the pricing environment. The process envisioned was straightforward: First, assess Amegy’s future as an independent company to determine if it even made sense to consider selling; then, if necessary, look at specific offers.

Management presented a review of its internal three-year projections. The going looked tough, and directors weren’t shy about asking questions: What’s happening with margins? What’s the future of liability pricing and credit quality? Will the company be able to maintain its growth? What about expense management? “They intellectually challenged the major assumptions of our plan, and had a healthy discussion about the future,” Murphy says.

Their questions for Goldman’s team centered more on pricing: How much would a “trophy franchise” in Texas fetch? And how would a deal affect customer service and staffing? Specific names came upu00e2u20ac”about 25 banks in allu00e2u20ac”and the discussion was active, but it was mostly speculation; the process had just begun.

Importantly, directors were sworn to secrecy. Rumors of Amegy being for sale were nothing new; this time, however, they might be true. Just four or five members of the management team knew of the discussions, and committee members were asked to sign forms saying they wouldn’t reveal anything about their deliberations to outsiders. To punctuate the seriousness, Walter Johnson says he “personally reminded people of several cases I knew of where people went to jail for violating confidentiality” of a sales process.

The meeting adjourned with many directors remaining skeptical that a sale was necessary. “You had some directors, who had been part of those earlier [informal] conversations, who had gotten over the shock and settled in on the idea that this was a path that should be considered,” John Johnson recalls. “But for some other directors, it was still a matter of, ‘Why?’”

Over the next few weeks, Goldman pored over the financials of potential acquirers, using publicly available information to gauge their likely interest and ability to make a deal. “Ability-to-pay analysis was key,” Murphy says. Did they have capital available for a deal? Were they involved in other transactions? How did a franchise like Amegy’s fit with their strategies? Also important: Did they have regulatory issues that would preclude them from closing a deal? “You don’t want to get deep into negotiations and then find out they have a CRA issue,” Murphy explains. “It was extensive due diligence on all potential candidates, but no contact was made.”

Murphy and Walter Johnson, meanwhile, talked fence-sitting directors through the issues. Murphy remembers a three-hour lunch meeting with one director “who was strongly opposed to the idea.” Among the chief concerns: confidentiality of the process and what would happen to employees. The two “went through a great deal of detail on the numbersu00e2u20ac”where we stood, what was happening with the competitive environment, the slope of the yield curve”u00e2u20ac”and ultimately, that board member was convinced. “He became one of the strongest advocates for pursuing a deal.”

On June 1, the special committee met againu00e2u20ac”this time in a conference room at the Westin Galleria, about a mile from Amegy headquarters. The St. Regis, Murphy explains, “was too close to the bank. We didn’t want any of our own people seeing us go in and out.” The four-hour meeting featured a revised review of management’s three-year planu00e2u20ac”the pros and cons of continued independence. The conclusion: “We had some challenges with the margin and competition, and some work to do on the expense side. But asset quality was good,” Murphy says. “We weren’t under pressure to do anything rash.”

The Goldman team followed, providing a more thorough view of valuation scenarios and likely candidates. Some on the original list of 25 were involved in other deals and probably wouldn’t be able to bid; for others, the market fit didn’t look quite right. In total, the list of possible bidders was culled to about a dozen. Directors received big packages of financials and other documents about each one to review over the next two weeks. Among those, Goldman’s bankers speculated, were some that would be willing to pay top dollar for a strong presence in the Lone Star state.

The overall mood among directors that afternoon was more accepting than it had been three weeks earlier. The idea had begun to sink in, and committee members were interested in moving forward, albeit cautiously. “There was a consensus that shareholders’ best interests might be served by a combination,” Murphy says. “But if the price and terms weren’t rightu00e2u20ac”if we weren’t convinced at the end of due diligence that we could do a better job for our stakeholdersu00e2u20ac”we might not do it.”

Near the end of the meeting, the next stage of the process was defined, with something of a unique twist. Auctions aren’t all that common in the banking space. More typical is the one-on-one deal, negotiated on friendly terms behind closed doors. But directors felt Amegy’s situation merited casting a wider net. “We had the advantage of being an asset- and deposit-gathering machine in one of the country’s most attractive markets,” Heaney recalls thinking. “And we thought people might stretch to acquire a platform of that quality.” Adds Murphy: “We believed if we created a competitive environment, people might pay more for a trophy franchise.” The process would go fast. “We said, ‘From here it’s a one-month process,’” Murphy says. “Whatever we decided, we were going to decide quick.”

The next day, Goldman began contacting banks on the list. Amegy’s name wasn’t revealed, but the script started out something like, “If something were to happen with a strong franchise in Texas, would you be interested?” Some said they weren’t interested. If they said yes, Goldman would ask them to sign a confidentiality agreement and reveal the identity.

In some cases, Murphy or Walter Johnson made the calls themselves. One of those was to Zions. Johnson and Zions CEO Harris Simmons had worked together at Allied back in the early 1980s and had kept in close contact ever since. Johnson had flown out to Utah in the past, and met Simmons’ family. And the two banks had participated in loans together. Over the years, “Harris has tossed us ideas about things they were doing that we might want to try,” Johnson says. It didn’t hurt that Simmons’ two brothers, Matt and L.E., are Houston business icons and original Amegy investors. “We were close enough where I said, ‘If you’re ever interested in a deal, please tell us,” Simmons says.

On June 16, the special committee gathered again, this time at the Westin Oaks, on the other side of the sprawling Galleria mall. Seven of the 12 would-be candidates had expressed interest and signed confidentiality agreements. Several made verbal offers that didn’t meet the board’s mid-$20s threshold. “We’d say, if that’s your price range, you don’t even need to participate,” Murphy says. That left four serious bidders, each of which prepared preliminary written proposals, based on publicly available information about Amegy. Those proposals, between three and eight pages each, included pricing information and other details, such as how Amegy and its management would fit into their existing franchises.

Seeing what the company might fetch in a sale seemed to sway some of the directors. “Until then, the go-with-a-partner option had really been speculation,” Heaney says. “Now we saw that people were willing to stretch to pay for what we had.” That helped to subtly shift discussion for the first time from whether or not to do a deal to more of an “analysis of the pros and cons of each candidateu00e2u20ac”their footprints, their product mixes, their margins, and asset quality…and how we would fit into their franchises,” Murphy recalls.

At the end of that meeting, the committee agreed to open up its books to the four remaining banks. They also gave each bank a preliminary merger contract, with a request to mark it up and send it back with their bids. “We didn’t want to wait until the 11th hour, narrow it down to one group, and then find they had a big ‘gotcha’ in their document,” Murphy explains. “And from a negotiating standpoint, you have more leverage than you would later in the process.”

In another twist, Goldman established an “online data room,” which provided password-protected electronic access to Amegy loan documents and other books. That meant the bidders “were able to do all their due diligence from their own offices, without traipsing through the bank,” Walter Johnson says.

Over the next few weeks, some directors felt a sense of nervous anticipation. They were on the cusp of selling their company, and felt both excited and a bit of foreboding about their next step. Even so, they had done a good job of keeping their deliberations secret. As they narrowed their choices, code names were assigned to individual candidatesu00e2u20ac”Zions’ was “Zeus”u00e2u20ac”to maintain confidentiality. (Zions had a code name for Amegy, as well: “Amigo.”) Even today, Amegy directors won’t say who else was on that short list, although speculation includes Birmingham, Alabama-based Compass Bancshares, Citigroup, and Wachovia.

Despite such cloak-and-dagger methods, during the last week of June the veil of secrecy was violated. In less than a week, Amegy shares jumped 28%. That a leak had occurred was frustrating. Perhaps worse were the inevitable questions. The rules of the merger game almost mandate that those “in the know” lieu00e2u20ac”or at least remain silentu00e2u20ac”about what’s going on. Robertson was at a family gathering when someone said, “What about Amegy’s stock, Beth? Should we sell or hold or what?” she recalls. “I just kind of stood there, not knowing what to do … Fortunately, someone said, ‘You know she can’t say anything about that. She’s an insider.’”

At the office, things were worse. Murphy recalls getting emails from co-workers asking what was happening, and not responding. “I’d get in the elevator and see our longtime bankers … They wanted to ask me what was going on, but they didn’t. And I couldn’t reach out and tell them,” he says. “It was a very awkward and miserable time.”

On June 28, the special committee gathered one last time to look at the four formal bids. Judging by the price, directors quickly concluded that only two of themu00e2u20ac”including Zions’ proposalu00e2u20ac”were serious enough to merit consideration. This meeting, also at the Westin Oaks, was shorter than in the past. It was all but decided that a sale would occur. Now, the focus was on choosing between two good partners.

Shareholder value was the primary consideration. Even so, it wasn’t as simple as looking at the current stock price. Management had conducted its own “reverse due diligence” on the suitors, and had some thoughts about their long-term prospects. “We looked at their budgets, their pro formas, their business models and footprints,” Murphy says. Directors also talked with analysts and other industry observers. “The goal was to estimate what their stocks would be worth in December (when the deal was expected to close) and beyond.”

The two CEOs were summoned on short notice and were asked to make hour-long presentations to the full board the following day. Directors met at the Westin Oaks, but the CEOs were put up in the Westin Galleria. “We didn’t want them to run into each other or to be chitchatting in the lobby,” Murphy says.

The CEO of the other bank went first, spending an hour or so making his pitch to the board. Then directors spent another hour discussing what they had heard.

Simmons came next. In a casual, relaxed tone, he spent the first half-hour describing Zions’ supercommunity banking strategyu00e2u20ac”local managements and decisions, centralized back officesu00e2u20ac”in “an unscripted, impromptu presentation … I talked about the investment thesis for Zions, how we approach value creation, and the trade-offs between local autonomy and parts of the business,” Simmons says. The second half was devoted to answering questions from directors about business mix and “clarifying how the company is run.”

After that, the board members spent an hour discussing what they had heard. “It occurred to many of us that this was very much like staying Amegy, but with a much larger platform,” Robertson says.

Directors emphasize that both offers were attractive. “The prices were pretty much on the table. We wanted to know which buyer could solve the competitive problems of our franchise and have it contribute most to their bottom line,” Heaney says. “And at the end, it was pretty clear both offers were good. It was really a matter of which train would we feel most comfortable getting on.”

The process wasn’t quite done yet, however. “We told both parties, ‘This is a horse race. It’s coming right down to the wire, but we need the weekend to think about it.’” Over the Fourth of July weekend, Walter Johnson, Murphy, and the investment bankers were on the phone with each bidder several times a day, trying to play the two sides off each other, as directors organized their thoughts.

The board gathered for one last time on the afternoon of July 5. Both sides had been given an 11 a.m. deadline to make a “best and final offer.” The other bidder held firm to the price it had put forward a week earlier; Zions sweetened its bid with a slightly higher exchange ratio, a little more cashu00e2u20ac”about two-thirds of the payout was in Zions’ stocku00e2u20ac”and a higher dividend for Amegy shareholders.

In the meeting, directors got another lecture on fiduciary responsibility from the lawyers, focusing on the predominance of shareholder interests. Then they reviewed the offers one last time. All of this was mere formality. Zions’ offer was 88 cents per share lower than its rival’s, based on closing prices the previous trading day. Even so, directors say they were convinced that Zions’ margin strategy, operating style, and geographic footprint presented the best long-term opportunity for shareholders.

After an hour of discussion, a director moved that the Zions offer be accepted. The motion passed unanimously, and board members broke out in applause. The deal was sealed. Simmons took a red-eye flight to Houston late that night. The next morning, the sale was announced as Simmons met with Amegy staffers. Some were “hesitant,” Murphy saysu00e2u20ac”much as the board had been; others were relieved the buyer would keep most of the franchise intact. Tellingly, Simmons received two standing ovations from managers who gathered that morning.

Shareholders approved the deal overwhelminglyu00e2u20ac”of the 70% of outstanding Amegy votes that were cast, 98% were in favor of the transaction.

Today, directors say they couldn’t be happier. Most of them will remain involved with the company, on Amegy’s local board. They’ll, in essence, be part of running a bank with one shareholder, and most say they will gladly leave behind Sarbanes-Oxley and other public company obligations. Those who felt a sense of loss have come around. “After you get over the fact that your child is getting married and moving on, you realize that you’ve added a son-in-law,” Robertson says.

Selling Amegy was much the same. “To be pleased with whom they’re betrothed to makes everything better,” Robertson concludes. The diligence of the company’s directors all but ensured it.