Under Pressure to Get Bigger

Lakeland Bancorp Chief Executive Officer Thomas Shara believes his company has a reputation for doing M&A well, and this makes his bank an attractive acquisition partner for smaller institutions. The $3.7 billion asset holding company, based in Newfoundland, New Jersey, expects to close its acquisition of Pascack Bancorp, with $402 million in assets, in January of 2016. Its regulators, the Federal Deposit Insurance Corp. and the New Jersey Department of Banking and Insurance, have already approved the deal, along with Pascack’s board of directors.

This will be Lakeland’s second acquisition since January 2013, when it acquired Somerset Hills Bancorp, with $355 million in assets. Shara says that both Pascack and Somerset Hills faced challenges common for banks of their size. “They were both profitable and well-performing banks, but they realized that the cost of compliance [and] the cost of technology [would continue to rise], and getting bigger was going to be very, very difficult,” he says. Size matters for banks in today’s growth game-perhaps now more than ever.

Bank CEOs and their boards are feeling intense pressure to grow their institutions. Sixty-seven percent of the bank executives and directors who responded to Bank Director’s 2016 Bank M&A Survey believe their bank needs to grow significantly to compete in today’s marketplace. When asked how large their bank needs to be to compete, a slim majority-one-third-cite $1 billion in assets. Shara agrees, referencing a competitive and costly operating environment. “Scale is so important today. We all have similar regulatory and compliance costs, and you have to spread that over a bigger base,” he says.

The annual M&A survey was sponsored by Crowe Horwath LLP. It was conducted online in September of last year, and 260 current and former senior bank executives and directors responded.

Lakeland and other entities of its size may not be making the types of deals that garner headlines, such as BB&T Corp.’s August 2015 acquisition of Susquehanna Bancshares, the proposed acquisition of First Niagara Financial Corp. by KeyCorp (which is expected to close in the third quarter of 2016), or M&T Bank Corp.’s more than three-year journey to close its acquisition of Hudson City Bancorp, which finally went through in November 2015. But acquisitions of small banks are more typical of what’s going on today in the bank M&A marketplace. Of whole bank acquisitions that closed in 2014 through early November 2015, 90 percent were of FDIC-insured institutions under $1 billion in assets, according to SNL Financial. Of buyers, 49 percent had more than $1 billion in assets. Given these statistics, the perceived pressure to grow-as highlighted by the survey results-casts doubt on the long-term survival of smaller institutions.

J. Pat Hickman, the CEO of Happy Bancshares, believes his $2.7 billion asset, Canyon, Texas-based holding company is just big enough. “Once you hit the $1 billion level, the regulations increase exponentially. All of a sudden, you’re considered a big bank, for CRA purposes, for Fair Lending purposes, and it’s a whole different compliance world,” he says. “We feel relatively comfortable that we can afford top notch compliance and audit personnel to be able to stay up with the regulations, yet still compete in the marketplace.”

Not everyone agrees that only large banks have a future in the U.S. banking market. Crowe Horwath Partner Rick Childs says banks below $1 billion face challenges, but the boards of these smaller institutions don’t have to throw in the towel. “I wonder how well any director or management team has explored the concept of how profitable they can be at a size that makes sense for them,” he says. “I fear a little bit that some of the directors actually haven’t explored with management: What is the landscape for profitability?”

Fifty-one percent of survey respondents expect to purchase a healthy bank in 2016, but past Bank Director M&A surveys have revealed a wide gap between those wanting to buy and those willing to sell, which suggests it’s unlikely that most potential acquirers will find a partner for a merger or acquisition. Childs says the hopes of these potential buyers may reflect perception more than reality. “More buyers are trying to arrange deals, but at the end of the day, I don’t know that more sellers have opted to get out,” he says.

Both buyers and sellers have turned down their fair share of deals over the past three years. Thirty-nine percent of respondents say they have walked away from a potential acquisition after initiating discussions with a potential target institution. Seven percent have turned down the sale of their bank. Four percent have been turned down both prospects.

Potential buyers, at 60 percent, and sellers, at 71 percent, cite price as one of the reasons their board vetoed a deal. “When a deal comes up, either on the buy side or on the sell side, price ultimately is the deciding factor,” says Childs. “We certainly are seeing more buyers interested in negotiated deals,” while smaller institutions prefer to seek a higher price via auction.

Shara says that Lakeland has walked away from deals due to a wide gap between what it was willing to pay and the expectations of the would-be seller. “We’re just not willing to compromise or take substantial dilution for our shareholders in doing a deal,” he says. “The other reason that we’ve walked away from deals [is] credit quality. That’s something that we will not compromise on in a deal, and inherit other bank’s credit quality challenges.”

When asked about their bank’s most recent acquisition, 32 percent of respondents say credit culture was the most difficult aspect of post-deal integration. These concerns have lessened since the financial crisis: For those whose bank completed an acquisition from 2008 through 2013, 52 percent cite credit culture, compared to 24 percent of deals completed from 2014 through 2015.

Unfortunately, the industry may not have learned as much as one would hope from those challenging years. Forty-six percent of respondents are beginning to see deterioration in loan underwriting standards that could lead to future credit quality issues. “The way to compete in this market, because you can’t really compete much on rate at this point, is that you’re going to be competing on covenants, you’re going to compete by not having that personal guarantee, that’s how you’re going to compete against the guy down the street,” says Chad Kellar, senior manager at Crowe Horwath.

Comptroller of the Currency Thomas Curry voiced his concerns on future loan quality within the industry in remarks made at a conference in November 2015. “Some of the loans we see banks making today are going to customers who almost certainly would not have qualified for the same loan four or five years ago,” he said. “Many banks have made a conscious decision to increase their risk appetite and take on additional credit risk…they are also targeting less creditworthy customers and offering easier terms and conditions because they feel they must, in order to hold their own against the competition for loan growth, market share and revenue.”

Given the pressures to grow in a recovering economy, it’s understandable that many banks are furiously chasing every loan dollar out there. But the industry does so at its own peril. “We will have a rebound of oppressive regulation if we have a rebound of bad credit,” says Childs.

Declining loan underwriting standards could wring out the profitability of many deals being done now if the economy takes another downturn. “To me, the biggest financial risk in an acquisition is loan quality,” says Richard Herrington, CEO of Franklin Financial Network Inc., the $2 billion asset parent of Franklin Synergy Bank.

Almost half of potential buyers cite credit quality as one of the reasons they have walked away from a target institution.

Herrington expresses a preference for organic growth, but he keeps an eye on the marketplace. He says the Franklin, Tennessee-based bank looks for small, deposit-heavy institutions to fuel the bank’s lending initiatives, or opportunities like MidSouth Bank, which Franklin Synergy acquired in 2014. That acquisition expanded Franklin Synergy’s footprint into another growing market, doubled the bank’s size and increased its legal lending limit to $8 million.

Another potential deal breaker is culture, cited by 67 percent of potential sellers and 35 percent of potential buyers. “Any time you acquire another bank, culture is going to be an issue,” says Happy Bancshares’s Hickman. “If you don’t learn how to deal with that, you’re going to have a very difficult time in expanding your footprint.”

Thirty-one percent say that identifying and retaining key personnel who are a good fit with the acquiring bank’s culture is the most difficult aspect of integration. It’s of particular concern for banks with more than $1 billion in assets, which must integrate employees across a broader geographic footprint, says Childs.

The majority of respondents, at 72 percent, indicate that they are satisfied with the quality and quantity of retained employees following their most recent acquisition. It should be noted, however, that the happiest respondents-those whose last acquisition occurred in 2014 or 2015-haven’t really had time to assess the deal’s success, says Childs. Only 56 percent of respondents whose last acquisition occurred from 2008 through 2013 are satisfied with employee retention after the deal.

When asked if it is important for acquirers to retain key employees from the target bank following the close of the deal, 43 percent say yes-as long as the culture aligns with that of the buyer. Forty-six percent believe that key employees should always be retained, as they provide valuable knowledge and expertise.

“The success of the acquisition comes down to one thing, and that’s people,” says Herrington. Employees and customers are the keys to making the deal ultimately work.

As for customers, acquirers seem to be doing a good job of keeping losses to a minimum. The overwhelming majority of participants, at 91 percent, indicate that customer retention has been maintained at the levels projected before the close of their bank’s most recent acquisition. “I think that banks are cautiously conservative about how bad the attrition will be,” says Childs. Bank leadership may plan for the worst, but customer retention tends to be high because, frankly, it’s too darn difficult for a customer to disentangle the relationship. “Your bank would have to really offend you dramatically for you to cancel your account, because, for many, the thought of unraveling everything they’ve got connected to it is almost mind numbing,” Childs says.

Just 15 percent cite customer retention as the most difficult aspect of post-deal integration.

The survey demonstrates a shift in the use of social media to communicate with customers following an acquisition, in parallel with its growth throughout the industry. Fifty-five percent of respondents who report their most recent deal occurred in 2014 or 2015 used social media, compared to 42 percent of 2011 through 2013 deals and 14 percent of 2008 through 2010 deals. Facebook, at 26 percent, is the most commonly used channel, followed distantly by Twitter (9 percent) and LinkedIn (8 percent).

Social media use is increasingly important for Lakeland, which is active on Facebook, YouTube and LinkedIn. As branch traffic continues to decline, there’s less opportunity for face to face interactions with customers. “We’re going to have to access customers through these other channels, and we’re spending a lot of time and effort trying to make sure we’re staying in front of our customers,” says Shara.

Twenty-one percent of survey participants-comprised mostly of independent directors or chairmen-are unsure how social media was used following their institution’s last acquisition. Childs says bank directors risk being caught off guard if they don’t know what their bank is doing on Facebook, and how customers are reacting. “Facebook allows you to have commentary about an organization [that is] unfiltered, unbridled and unchecked,” he says. “You do have to be aware of what you’re doing from a social media standpoint, even if you’re not an avid user yourself.”

The majority of respondents, at 62 percent, believe that today’s environment is more favorable for deals. (A similar number said the same in last year’s survey.) Seventy-seven percent of those with a glass-half-full perspective believe that more banks want to sell which, in turn, will lead to more deals. But last year’s survey found that almost two-thirds of respondents-even those from smaller institutions-expected not only to survive, but thrive as independent entities. So, what drives a bank to sell?

Fifty-five percent of survey participants who indicate they sold a bank from 2012 through 2015 say the sale was shareholder driven. Put simply, it was time to cash out. Pascack’s stock is traded over-the-counter, and Shara says the opportunity for Pascack’s owners to trade a less liquid stock for Lakeland’s public currency made the deal attractive for the seller’s board. Lakeland will issue more than three million shares of its common stock to Pascack shareholders in a 90 percent stock deal. Lakeland also pays a 3 percent dividend. “It’s a nice return for the shareholders,” Shara says.

More than two-thirds of responding former bank executives and directors of a sold bank indicate their former institution was under $1 billion in assets.

Limited opportunities to grow are also driving banks to sell, according to 27 percent of respondents who recently sold their institution. Competitive pressures and changing consumer behavior that makes the branch less and less important can make it harder for smaller banks to survive, says Herrington. “It’s important for us to view these as opportunities to expand our footprint.” One bank’s struggle is another bank’s opportunity.

Twenty-seven percent of self-identified sellers cite regulatory costs as one the reasons they sold their institution, which is consistent with what Hickman is hearing in Texas. “The regulatory climate is killing the community banks,” he says.

When respondents who indicate they served as an executive or board member of a recently acquired bank were asked about the impact of the sale of their bank, 51 percent say the result was positive for both customers and employees. Another 11 percent indicate that customers seem satisfied, but not employees. Seventeen percent feel that both customers and employees are dissatisfied. The ex-board members and executives of banks under $1 billion in assets are more likely to see the sale of their institution as a positive for both customers and employees. Shara expects that Pascack’s former employees will find more career opportunities as they move up within the larger Lakeland. The acquired customers will have access to more products and services, and larger lending limits.

In response to regulatory demands as their banks grow, most survey respondents say that their bank has improved its infrastructure, particularly in enterprise risk management, as indicated by 76 percent, and cybersecurity, for 69 percent. Fifty-nine percent have improved stress testing, including banks with less than $10 billion in assets, which aren’t required to do so under the Dodd-Frank Act. “Bankers are really good at thinking down the road as to where they’re going to end up from a risk management perspective,” says Childs. “‘I’m not going to wait until I’m $1 billion to get my house in order. I’m going to start getting it in order before I get there.’”

A bank’s growth story doesn’t have to involve M&A, of course. Forty-one percent of survey respondents indicate that their bank has never made an acquisition, and an additional 10 percent haven’t made an acquisition since 2007 or prior. Most of these institutions are under $5 billion in assets. While the primary reasons behind their decisions to opt out of the M&A marketplace vary, a slim majority, at 32 percent, say they simply prefer to grow organically. That said, M&A offers banks the most dramatic growth path in an economic environment where many banks have found organic growth to be difficult.

Childs argues that smart growth trumps size. “We have institutions [of] all sizes that continue to make tremendous amounts of money,” he says. “It’s doesn’t tend to be the size of the institution necessarily. I think it tends to be the imagination and the passion of directors and management to look at how they can get the most out of their markets and compete effectively.”

About the Survey
In September of 2015, Bank Director surveyed 260 current and former senior executives and board members of U.S. banks about today’s bank M&A environment. The survey was conducted online. Ninety-two percent serve as a current bank board member or executive. Independent directors and chairmen account for 45 percent of respondents, and one-third are CEOs. Sixty-eight percent of respondents represent a financial institution with less than $1 billion in assets. Forty-four percent identify their bank as publicly traded, and half as private. Almost half of respondents report their bank has made at least one acquisition since the 2008 financial crisis. The complete results of the survey are available in the research section at BankDirector.com.


Emily McCormick

Vice President of Editorial & Research

Emily McCormick is Vice President of Editorial & Research for Bank Director. Emily oversees research projects, from in-depth reports to Bank Director’s annual surveys on M&A, risk, compensation, governance and technology. She also manages content for the Bank Services Program. In addition to regularly speaking and moderating discussions at Bank Director’s in-person and virtual events, Emily regularly writes and edits for Bank Director magazine and BankDirector.com. She started her career in the circulation department at the Knoxville News-Sentinel, and graduated summa cum laude from The University of Tennessee with a bachelor’s degree in Spanish and International Business.

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