The Bear Country Survival Guide

By all appearances, Prospect Bancshares Inc. had a bright future as an independent company. Launched in 1999 by a group of seasoned refugees from the old Columbus, Ohio-based State Savings Bank, which was acquired a year earlier by Fifth Third Bancorp, privately held Prospect leveraged big-bank technologies and attitude to grow from nothing to a $250 million institution with a 10.3% return on equity and an annualized profit of $1.7 million. “We never took a small-bank approach to anything,” says Harvey Glick, the Worthington, Ohio company’s CEO. “From the start, we had the staffing and infrastructure of a $300 million bank.”

Business was so strong, and its clients large enough, that Prospect regularly got other banks to participate in its loans. Then in early 2004, one of those partners approached Prospect’s board with an unsolicited offer to buy the company. The bid was initially friendly in tone. “They were selling the benefits of a combination,” Glick recalls. “They said, ‘You have the growth model, and we can supply the capital.’” The price, at $30 per-share, would have provided original shareholders, who bought in at $10, a nice payoff on their investments.

The board, a well-heeled group of local business leaders who owned a combined 50% of the institution, was tempted. And so was Glick. As directors weighed their options, he sought the advice of lawyers and investment bankers. He also talked with Columbus banking icon John McCoy, the former CEO of Bank One Corp. “John said, ‘If you’re really true to your word about this being an investment, you’re not going to get a return in the future that looks anything like what you’re going to get here,’” Glick recalls.

As directors and management got to know their suitor’s plans better, however, the mood began to sour. After some deep soul-searching, the board rejected the offer. “I didn’t feel good about how our folks might be treated,” Glick recalls. “It was like a dating process, and I began to lose the lust.”

Even so, the offeru00e2u20ac”and the strategic review that accompanied itu00e2u20ac”got directors to thinking. As Glick saw it, Prospect had benefited enormously from low rates in general, and a hot commercial real estate lending market in particular. When rates began to rise, he and the board reasoned, the party would be over. The concept of selling, once considered almost preposterous, suddenly didn’t seem far-fetched.

So four months later, when Charlie Crowley, an investment banker from the Cleveland office of Friedman Billings Ramsey Group, offered to set up a meeting with Marty Adams, CEO of fast-growing Sky Financial Corp. in nearby Bowling Green, Glick said yes. A short time later, $15 billion Sky bought Prospect, paying $35 for the same shares for which the unsolicited bidder was willing to pay $30.

Today, Glick is an executive vice president for Sky. Looking back, he says the unsolicited offer wound up being a huge moment in Prospect’s history. “It got our whole board thinking more about the future,” he explains. “Without it, I don’t know that we would have done a deal.”

Covert operations

Prospect’s situation wasn’t necessarily unique. While completed deals make the headlines, unsolicited bids are to banking what spats are to marriagesu00e2u20ac”relatively common occurrences that typically remain out of view of most outsiders. Investment bankers say even after more than a decade of consolidation, the banking industry still has a lot more shrinkage ahead of it. They also say almost any bank with a desirable franchise has gotten at least nibbles from prospective buyers, usually from a larger institution that covets its geography.

More often than not, such discussions never get past the friendly, informal overture, often pitched CEO-to-CEO over lunch or a round of golfu00e2u20ac”an “if-you-ever-think-about-selling, give-me-a-call” kind of chat. CEOs might continue those discussions in earnest if there’s a mutual attraction, keeping directors apprised of their progress, and get their boards directly involved only near the end. It’s a neat and tidy process; standard industry practice.

That’s not how it always works, however. Sometimes, representatives from a would-be acquirer can feel like they’re not getting a fair hearing from the target’s CEO, or that directors on the other side either haven’t been told about, or don’t understand, what they’ve got to offer. Other times, a larger bank might feel it’s simply the best strategy to jump over management’s head and deal directly with the board. Or it can get some encouragementu00e2u20ac”direct or indirectu00e2u20ac”from existing shareholders of the target, and think by waving a flag it can win over those investors and the board.

Occasionally, a board might even bumble its way into having to fend off an unfriendly offer. H. Rodgin Cohen, a partner with Sullivan & Cromwell in New York, says he knows of boards that inadvertently brought on bids by failing to follow through on friendly talks about a sale. “The surest way to get a bear hug is to start negotiating a sale when your heart’s not into it,” he says. Such back-pedaling “often leads to annoyance, if not anger, on the part of a potential acquirer,” inspiring more aggressive action.

When that type of formal contact occurs, perhaps in the form of a bear-hug letter or a request to make a board presentation by a suitor, the effect is to “elevate the discussion to a higher level by putting the ball in the board’s court,” says Steve Nelson, a principal with Hovde Financial LLC in Chicago.

From Teddys to grizzlies

Bear hugs are particularly threatening because they put the offer in writing. Even so, not all bear hugs are alike. Cohen separates them into three distinct groups: “Teddy bear hugs” are the most common and least threatening. They usually present the general terms of a prospective deal, but are most notable for their comforting tones and pledges not to pursue a transaction without the board’s blessing, or to go public with an offer. “There’s some pressure on the board, but it’s friendly pressure,” he explains.

The “brown bear hug” lacks the warm and fuzzy feeling, and there are no promises to respect the board’s wishes. Rather, the overall message is often part sales pitch, part veiled threat: The potential acquirer “is a great place to work, with growing earnings, and adding your bank to the mix will only make it better. We want you, as a board, to know that we’re willing to pay a premium for your company. You should view this as a compliment. But if discussions don’t occur, then we’re coming into your market and setting up a branch down the street. So it’s in everyone’s best interest if we partner up,” explains Nelson, using some typical wording. In many ways, the tone is purposely murky, leaving it to the target directors’ imaginations to determine what course might be taken by the pursuer.

And then there’s a “grizzly bear hug,” with a hostile tone and full public disclosure that an offer has been made and the prospective buyer is waiting for a response. To the best of anyone’s knowledge, the only successful grizzly bear hug in banking was Bank of New York’s 1988 acquisition of Irving Bank Corp., also of New York. Others have tried and failed, including National City Corp.’s 1991 hostile bid for another Cleveland bank u00e2u20ac” Ameritrust Corp. And just this spring, New York-based E-Trade Financial Corp.’s public bid for Omaha, Nebraska-based Ameritrade Corp., a rival online brokerage, had the apparent effect of goading Ameritrade into acquiring the U.S. online brokerage operation of Toronto-based TD Bank Financial Group.

Overall, banking is still considered a civilized sport, not amenable to unsolicited approaches. Regulators “don’t like uncertainty and disruption of deals with a hostile flavor, because they have the potential to upset the markets,” says Jeffrey Smith, a partner with Thompson Hine in Columbus, Ohio. Few investment bankers recommend them, because it’s difficult to conduct due diligence on the target’s loan portfolio and internal functions without a target’s cooperation. And an institution’s reputation can be damaged within the industryu00e2u20ac”and with prospective customers and employeesu00e2u20ac”if it’s viewed as too hostile.

Predators abound

In an industry where consolidation is an ongoing theme, there’s also usually more than one potential acquirer for any bank. The time required to get regulatory approvals can be more than enough to line up a friendly white knight willing to help fend off an instigator. “You don’t want to start something unless you think you can win,” Cohen explains. And the aggressor “is psychologically not the favored party” in a competitive bidding environment. In Prospect’s case, FBR’s Crowley says, “that first bank, whatever time and money and strategizing it invested to get the ball rolling, ultimately helped Sky, but was a loss for it.”

Even so, anecdotal evidence from attorneys and investment bankersu00e2u20ac”there are no hard numbers, given the secrecy involvedu00e2u20ac”suggests unsolicited offers occur on a fairly regular basis. Nelson, who has dealt with two in recent years, says they’re most effective when pricing is lower and a bidder can offer a greater premium.

No matter the intensity, the response to such an overture can define the board’s legacy, alter the local industry’s competitive balance and impact customers and employees for the worst. In some cases, it can potentially change the face of Main Street. And it goes without saying that shareholders have a keen interest in what ultimately happens.

Given that, you’d think directors would be well versed in the dos and don’ts of addressing an unsolicited bid. Think again. Walt Moeling, a partner with Powell Goldstein in Atlanta, says that many bank boards are woefully unprepared to confront an uninvited approach, lacking both the tools and knowledge required to proactively act onu00e2u20ac”or avoidu00e2u20ac”an offer.

Ignorance, however, is rarely bliss. When the board of Salisbury Bancorp in Lakeville, Connecticut received a not-so-friendly bear hug in 1997 from Hudson Chartered Bancorp in Lagrangeville, New York, “some of our directors panicked.

They were terrified that they were going to be sued,” recalls John Perotti, Salisbury’s CEO and a director. “And others dug in their heels and said, ‘There’s no way in the world we’re selling.’”

Both instincts are understandable, but neither is exactly prudent. First and foremost, boards have a fiduciary responsibility to weigh a bid thoughtfully, contrasting its merits against the company’s expected performance. “You have to consider, if an amount is put on the table, how it compares with the bank’s future plans,” says Moeling, who has worked on a handful of semi-hostile defenses in recent years. “As long as you conclude that the bank can perform at a level that will produce the same or better results, you don’t need to go any further.”

A written bear hug letter demands a response, even if it’s borderline silly. Nelson tells of the board of one publicly traded company that was approached by a small, private buyer with an offer that represented just a 5% premium to its share price. “The response was a groan: ‘Don’t waste my time,’” he recalls. “But you have to deal with it because of the formalized nature, the fact it’s in writing.”

That said, since what goes on behind closed doors usually stays there, boards have more latitude than many directors believe when it comes to addressing unsolicited bids. One common misperception, for instance, is that “a board must negotiate with a bidder or present the offer to shareholders,” Moeling says. Not true. “Directors operate under a representational democracy. They don’t have to take it to shareholders.”

Bear repellant

Smart boards prepare for an unsolicited approach before it happens. Poison pills, staggered board terms, and other takeover defenses won’t score points with many shareholders. They might not even scare off a determined suitor. “But they can make it much more difficult for someone to actually execute a hostile deal,” Smith says.
More important, attorneys say, is to establish some processes, relationships, and governance provisions in advance that can make fielding a bid easier and more efficient. Many bank boards regularly assess their institutions’ business plans in concert with investment bankers and attorneys. Even those that don’t should have relationships in place with professionals who can quickly help assess how a bid compares with the company’s own plan for enhancing shareholder value.

Moeling also suggests including formalized provisions in the company’s bylaws and charter that set some ground rules for how the board addresses a bid. Some of his clients have enacted a “policy regarding corporate change,” crafted specifically to address the prospect of an unsolicited bid. The policy states that all offers and discussions involving a prospective sale, no matter how innocuous, must be brought to the full board. It also bars individual directors and managers from providing information about the company to a potential suitor without the full board’s consent.

“Your corporate documents should send a message to outsiders and directors alike that any discussion about buying the bank should ultimately come to the board,” Moeling explains. They should ensure “everything is kept above board … You don’t want anyone on your board out there acting like a cowboy, rounding up offers or providing information without the full board’s knowledge.”

Some companies also employ so-called “constituency provisions” in their articles of incorporation, which permit directors to consider the impact of a sale not only on shareholders, but also on employees, customers, and the community. Not all states permit such provisions, but many do. For community banks, established specifically to provide lending services to a small town, they can be justified. “If you conclude [from a potential acquirer’s history] that your bank would be turned into a deposit-production office for a large bank” and would no longer fulfill its initial mission as a source of funding for local businesses, the existence of such provisions could allow a board to reject a deal, even if the proposed premium is attractive, Moeling says.

But some experts caution those provisions must ultimately take a backseat to the duties of care and loyalty that are central to a director’s role as fiduciary of shareholder money. “If you’re saying ‘no’ to a bid because a couple hundred jobs will be lost in your hometown, that’s not a good reason,” Crowley says. “Shareholders need to rank a strong first on your list of responsibilities, or the board members could find themselves in a tough position.”

The best defense, as the clichu00c3u00a9 goes, is a good offense, and nothing works like performance to keep an unfriendly suitor at bay. “The only nearly foolproof defense is strong financial performance,” Crowley says. “If you’re in the 30th percentile on [industry] ROE, you’re going to have a hard time arguing that you’ve earned your independence. But a company that has done well for its shareholders should be able to control its own destiny.”

Profitability alone, however, won’t prevent a determined suitor from trying to acquire a bank that management thinks could bolster its own franchise. Salisbury was a highly profitable $180 million institution when Hudson Chartered’s bear hug occurred, Perotti says, but it didn’t matter. The bidder wanted to buy its way across the Hudson River into Connecticut, and Salisbury looked digestible.

The two CEOs had discussed a deal twice, and Perotti had rejected the idea both times. Then one day, Hudson Chartered’s CEO called requesting the mailing addresses of several directors. Two weeks later, he showed up in Perotti’s office with inch-thick packets for each board member.

Perotti says he “wasn’t very happy” with the situation, and would have preferred to ignore the offer. “But our attorney said that, worst scenario, you’ve got to be able to prove you’ve exercised complete due diligence.” So the board went through an assessment with its investment bank, and even dispatched its executive committee to a daylong meeting with Hudson Chartered’s board.

“We had an eyeball-to-eyeball discussion with them,” Perotti says, during which it emerged that the bidder’s strategy was to build a franchise and sell itu00e2u20ac”an unattractive proposition for the board of then-149-year-old Salisbury. “But what really killed it was, they tried to do a lowball offer.” (Hudson Chartered is now part of $54 billion M&T Bank Corp.)
Although the bid was rejected, it also jolted the board into action. Before, Perotti says, directors thought that “as long as we had reasonable returns, that was good enough.” After strategic reviews and a near-death experience, “we realized we needed to grow.” Since then, the company has added to its trust department, expanded its geography, and even made an acquisition of its own.

It’s a common theme. While most bankers are loath to discuss unsolicited or hostile offers they’ve received, strong boards that are willing and eager to control their own destinies often find such bids reenergize them. Moeling tells of the time about a decade ago that one of his small Georgia clients received a bear-hug letter from a large Alabama institution. The board met, gave the offer thoughtful consideration, and concluded that it could “build better shareholder value with a more intense and better-structured incentive compensation plan,” he recalls.

Six years later, after implementing its plan, the same board concluded on its own terms that it was time to sell, and contacted that same buyer. This time, a friendly sale agreement was reached, which generated 13% greater returns than what the original unsolicited offer contemplated. “Most banks are sold, they’re not bought,” Moeling says. In this case, “the first offer inspired the board to make the bank better, and it fetched a greater premium as a result.” Proof that happy endings can happen, even in the world of unsolicited bids. |BD|