Confidence Returns to the Bank M&A Market

If the opinions of the leaders of the nation’s banks are any indication, the bank mergers and acquisitions market is brimming with optimism. Two-thirds of the bank executives and board members responding to Bank Director’s 2015 Bank M&A Survey, sponsored by accounting and consulting firm Crowe Horwath LLP, believe that today’s environment is more favorable for deals. Compared to a few years ago, when the industry was struggling to recover from the financial crisis and deal volume had fallen to an all-time low, the industry is both healthier and stronger.

Crowe Horwath Director Rick Childs agrees that there are positive signs to be found in today’s market, including improved credit quality and better stock currency for buyers. “When credit quality is poor, deal volume is poor as well. When credit quality is good, deal volume picks up, so we have seen an improvement from the 2010 [and] 2011 levels,” he says.

As the industry’s fortunes have improved, there has been a shift from the purchase of failed banks from the Federal Deposit Insurance Corp. (FDIC)-often with a generous amount of federal assistance thrown in as part of the deal-to the pursuit of healthy banks that will help the acquirer meet its strategic growth goals. With those bargain basement FDIC transactions, “growth, market share and overall strategic vision [were] secondary to getting a good deal on the basic economics and managing out the problems inherent in that acquired organization,” says Chad Kellar, senior manager with Crowe Horwath.

“Now that credit risk and other operational risks are less of an issue, to make the current open bank deals work at multiples of tangible book, you have to focus on the strategic vision of growing the organization [and] leveraging existing personnel,” Kellar says. In 2015 and beyond, buyers will be focusing more on strategic fit and engineering a successful integration of the acquired institution.

Happy days aren’t quite here again, perhaps, but respondents reflect optimism about the health of their own institutions. Most bank executives and board members expect that their bank will still be around in the next couple of years, and almost two-thirds expect their institutions to not only survive but thrive. Of course, as it’s often said in the industry, banks aren’t bought-they are sold. If so many banks see themselves as viable, independent entities, then where will the deals come from?

Forty-seven percent of survey respondents plan to buy a bank in 2015, and more than two-thirds have merged with or acquired another institution in the past-one-third within the past two years. But not every bank that plans to buy will find a ready partner. Just 3 percent reveal that they plan to sell their bank within the next 12 months. Last year’s survey found 52 percent anxious to buy, but just 15 percent of respondents to this year’s survey report that their bank made a healthy bank acquisition in the past 12 months.

Survey participants reveal very growth-oriented reasons to acquire, says Childs. Almost half say they would acquire another bank in order to supplement or replace organic growth, and 42 percent want to expand geographically. Half of respondents from banks with more than $1 billion in assets also want to increase market share in areas they’re already operating in.

In May, Wayne, New Jersey-based Valley National Bancorp, with $16 billion in assets, acquired Florida-based 1st United Bancorp Inc., in a $313 million all-stock transaction. Why acquire so far away from the bank’s New Jersey and New York locations? Florida is growing rapidly, and 1st United’s locations in affluent markets made it a desirable target, says Jerry Korde, a member of Valley’s board.

Fifty-one percent also cite an increase in earnings per share as a reason to buy, and 40 percent want to get bigger to rationalize operating and regulatory costs over a broader base.

If buyers are looking for strategic growth, what motivates sellers? While almost half of respondents cite the high cost of regulation as a reason to sell, 40 percent cite limited opportunities for organic growth. Organic growth can pose a greater challenge for small institutions, and participants from banks with less than $250 million in assets reveal more uncertainty about their futures. When asked about plans to sell within the next 12 months, 30 percent of respondents from these small institutions are unsure, and 8 percent plan to sell, compared to 10 percent and 3 percent, respectively, for the entire survey group.

“Bigger is actually better in this environment,” due to compressed margins and increased regulatory costs, says Russ Colombo, president and chief executive officer of $1.8-billion asset Bank of Marin Bancorp, based in Novato, California, which acquired its smaller neighbor, $272-million asset Bank of Alameda, in November 2013. The deal expanded the bank’s presence in the affluent Bay Area market.

Seventy-one percent of respondents would consider a sale if the bank received an attractive offer, and price remains a sticking point. As in last year’s survey, 63 percent cite the high price expectations of potential targets as a barrier to making an acquisition-a particular concern for respondents from banks with more than $1 billion in assets, which typically are more active acquirers. And 56 percent still feel that current pricing is too low, a roadblock to selling the bank.

While asset quality concerns on this year’s survey have lessened-a little more than one-third list this as a barrier to making an acquisition, down from 2013-51 percent from banks with between $1 billion and $5 billion in assets still worry about the asset quality of potential targets, up 19 percent. Larger banks are more apt to target organizations that, due to their size, “are getting into more complicated lending,” says Childs, which, in turn, would be inherently riskier.

Seller preference for stock continues to rise as valuations improve-and this aligns with how buyers prefer to structure the transaction. Forty-five percent of potential sellers prefer a combination of cash and stock, up by almost 20 percent from the 2013 survey. Preference for an all-stock deal has doubled, though still remains low at 12 percent. “We certainly have seen buyers with more favorable stock currencies,” says Childs. If publicly traded banks are seeing higher valuations, why do buyers and sellers continue to prefer a mix of cash and stock? Acquirers and their targets, naturally, have different motivations, with the buyer keeping an eye on its own capital goals and what it deems is an acceptable level of dilution on earnings per share, says Childs. This must balance with the needs of the acquired bank’s owners for the right mix of liquidity and diversification, also keeping in mind the tax implications for the seller.

Survey respondents remain evenly split about so-called mergers of equals, or strategic mergers as they’re often termed-with these types of deals finding the greatest favor with smaller institutions, at 64 percent. Sixty-five percent of those who would consider a merger of equals say it has a greater likelihood of creating long-term shareholder value than a standard acquisition. Seventy-two percent of participants who would not consider such a deal feel that strategic mergers always result in a winner and a loser-and no one wants to be the loser.

Sellers might be healthier, but acquirers still have to put the work in. Almost three-quarters of respondents who report buying a bank in 2013 or 2014 say that post-merger integration was the most difficult aspect of the deal. Assimilating the seller can be a tremendous challenge, including the bank’s culture, the technology used by both entities-including the bank’s core systems-and the bank’s products, services and delivery channels.

“While banks tend to offer the same types of products [and] perform the same services for their customers, we all do them [in] a different way,” says Billy Beale, CEO of Union Bankshares Corp., a Richmond, Virginia-based holding company that grew to $7.2 billion in assets following its acquisition of StellarOne Corp. “You have to be very careful…that those systems and those processes and the way you deliver services come together well.”

Yet despite the challenges posed by post-merger integration, less than half say the board discusses potential integration issues when evaluating acquisition opportunities. Post-merger integration is like the multi-headed Hydra of Greek myth-remove one head, like the core systems, and two heads will grow back in its place. Successful integration can be a challenging task for acquiring banks.

ConnectOne Bancorp Inc., headquartered in Englewood Cliffs, New Jersey, more than doubled in size, to $3.4 billion in assets, following its July 2014 merger with Center Bancorp Inc., also based in New Jersey. Frank Sorrentino III, ConnectOne’s chairman and CEO, says the organization took a rapid approach to integration. “It doesn’t matter if it’s systems challenges, people challenges, board challenges-you name it, there are challenges, and the way we looked at it, the faster we could rip the Band-Aid off, we thought the better we would be,” he says. Sorrentino knew that integrating the two entities quickly-the process was completed in about 6 months-would make the transition less painful for the bank’s clients. The entire company was rebranded on the day of the merger, including all the details that a customer would see, such as new carpet and new paint within branches, updated business cards and new signage. Within a month, the bank completed a full systems conversion.

“We were told that this is not the ordinary way to do it, but we chose to go down that road,” says Sorrentino. “Sitting here today, some 100 days after the merger closed, all the challenges and issues that were merger-related are in the rearview mirror and getting smaller every day.”

Bank of Marin focuses its acquisition strategy on growth in current and contiguous markets, and the bank has developed what Colombo terms an acquisition playbook to guide bank leadership through the task of integrating systems and culture. The playbook is constantly evolving-Colombo says they learn something new about what works and what doesn’t with each deal-but the consistent approach helps the bank meet its integration goals. Technical integration typically takes about five months for Bank of Marin, though cultural integration of new employees is more complicated. “If we want to grow, the employees from the acquired bank must have a clear understanding of how we operate,” he says. To accelerate this process, he places veteran staff members into the integrated entity to ensure that the new Bank of Marin employees better understand the bank’s business and culture.

Despite the rapid integration between the merged entities, culture was not overlooked at ConnectOne. “Communication, to me, was huge through this entire merger process,” says Sorrentino. “We were very, very transparent about what was going to happen, how it was going to happen [and] when it was going to happen.” ConnectOne also developed a class for its employees to better integrate everyone into the bank’s culture.

Of course, surviving institutions can learn a thing or two from the purchased bank, though many acquiring banks make the mistake of assuming that their way is best. “Good acquirers pick and choose from the seller [the] things that they do well, says Childs. “Thoughtful acquirers look at everything and conclude…what’s really good about the selling organization that [they] should implement.”

More than one-third cite cultural fit as the greatest challenge the board faces when considering an acquisition or merger of equals-up 10 percentage points from last year’s survey. Despite being an intangible concept, Childs says that warnings signs can be found in the due diligence process. “If you’re a button-down organization with regards to credit and they’re not as much, that means they’re probably not button-down on a variety of other topics as well,” he says.

“The biggest mistake banks make is not understanding and accommodating the culture of what they’re buying,” says John Rose, a director at Pittsburgh, Pennsylvania-based F.N.B. Corp., with $14 billion in assets. A veteran bank director, he recalls a past acquisition made by a competing bank whose cultural integration was a disaster, resulting in the departure of several officers-and their loyal clients. Rose served on a competing board at the time. “We had a field day picking up disaffected calling officers and their customer base,” he says.

Almost one-quarter of participants that report a past acquisition admit that strategic goals regarding cultural fit were not met, but those that report more recent acquisitions in 2013 or 2014 have found cultural fit to be more successful-another indicator of the shift from troubled bank deals to more strategic and growth-focused acquisitions. Strategic deals are “strategic” because the acquirer has chosen a merger partner that has positive characteristics it desires, including a compatible culture. The FDIC-assisted deals that occurred after the financial crisis involved failed banks whose cultures were often broken.

Cultural fit is important at the top of the organization, too: Three-quarters of respondents who report a past acquisition say their bank integrated members of the purchased bank’s board and/or senior executives following its most recent acquisition or merger. The cultural integration challenge increases in direct proportion to the number of board members and officers brought on from the purchased bank, and more than half of respondents report that the merged relationship is adequate at best. (For more on integrating the board, see “Building a Stronger Board After the Deal” on page 20 in this issue.)

Banks that want to be successful in today’s M&A market should make the bank’s acquisition strategy a specific and ongoing focus of the board. Yet, just 30 percent report that M&A is a regular part of the board’s agenda. Even fewer have a formal M&A policy in place-just 28 percent. These policies are becoming more valuable as banks incorporate M&A into strategic plans, says Kellar, and are more prevalent at the boards of banks with more than $1 billion in assets, according to the survey-banks that have been more active acquirers in recent years. In essence, an M&A policy outlines the bank’s strategic goals for a deal-increased market share in certain geographic areas, for example-and the impact the organization would want to see in regard to capital and book value dilution. Additionally, regulators increasingly want to know how acquisitions fit into a bank’s strategic vision, and how the institution will manage the inherent risk.

M&A policies don’t have to be restrictive, says Childs, and can serve as a valuable guide to the board and leadership. It’s no accident that these policies are more prevalent among respondents reporting acquisitions in the last two calendar years, and larger banks, which generally have strong currencies.

“There’s still a significant part of the banking population that does not treat M&A as a line of business,” says Childs.

Bank of Marin lacks a formal M&A policy, but discussion with the board focuses on the geographic footprint, culture and strategic focus of the businesses that the institution could acquire. Colombo says that the bank is attractive to potential sellers due to the performance of its stock, and he keeps an open dialogue with those banks that fit into Bank of Marin’s acquisition strategy.

M&A offers more opportunities than organic growth, and is discussed at every board meeting, says Union Bankshares CEO Beale. M&A is also part of the company’s strategic plan, and its acquisition goals are pretty specific, concentrating on institutions that are located in Virginia with a strong focus on community bank loans and core deposits. Financially, the board has guidelines around a prospective acquisition’s impact on earnings per share, tangible book value dilution, accretion and growth.

Sixty percent of survey respondents from banks with more than $1 billion in assets indicate that their bank has done an acquisition in 2013 or 2014. Almost the same percentage-59 percent-from banks with less than $500 million in assets say their bank has never participated in a bank acquisition or merger. Larger banks likely will find more opportunities in today’s marketplace-75 percent from banks with more than $1 billion in assets plan some sort of acquisition in the next 12 months, whether that’s the purchase of a bank, a branch or a non-depository line of business, such as investment management or an insurance brokerage. More than half of respondents from institutions with less than $500 million in assets have no plans to expand through acquisition in 2015.

Despite the plans of respondents from the largest institutions, 2015 is unlikely to witness a flood of deals. The smallest banks might not be active in the M&A market, but most of the respondents from institutions with less than $500 million in assets plan for their institutions to remain independent for at least the next two years. “The majority of management and members of the board don’t want to sell,” says Childs. For these potential targets, it will take one heck of an offer to give up their banks’ independence.

But those who participate in the 2015 M&A market will find that the types of banks making deals have changed-shifting from a focus on the best financial deal to the best strategic fit. “As we go more to growth acquisitions…we’re seeing acquirers that haven’t done deals,” says Kellar. But in today’s evolved marketplace, these new growth-focused deals should leave stronger, healthier banks in their wake.

About the Survey
In September, 215 independent directors, chairmen and senior executives of U.S. banks of all sizes responded to an online survey on bank M&A, conducted by Bank Director. Respondents answered questions related to the current climate for bank deals, and revealed the opportunities and challenges facing bank leadership as they strive to grow through acquisition. Almost half of the participants serve as an independent director or chairman at their bank, while one-quarter are CEOs. Sixty percent represent institutions with more than $500 million in assets, and response is almost evenly split between publicly traded and privately held banks. Full summary results of the survey are available in the research section at BankDirector.com.