Considering M&A in 2009?

For banks that are considering a possible sale or merger, 2009 could be a good time to put plans and balance sheets in order. Even amid concerns about the health of the U.S. banking industry, some recent developments are pointing to a possible increase in merger activity.

Should such a rebound occur, it would follow a year in which the pace of announced U.S. bank sales fell by more than 40%. According to data compiled by SNL Financial of Charlottesville, Virginia, 225 bank mergers were announced in the United States during the first nine months of 2007, compared to only 119 announced during the same time period in 2008. Declines in earnings and coinciding reduced stock prices, which large banks usually use as currency in acquisitions, are among reasons for the slower pace of mergers.

But there have been some prominent sales, including three Spanish banks that, since 2007, have agreed to buy banks headquartered in Miami. And the pending sales of Wachovia and Washington Mutual, which have Florida’s largest and fifth largest branch networks, could spur other banks to make acquisitions in Florida-just to keep pace.

Last fall, the Financial Accounting Standards Board and Securities and Exchange Commission changed their fair value rules that require banks and other financial companies to mark assets to market values in earnings reports and upon sale of a company. Their easing of those rules will reduce the size of writedowns and other charges that buyers would be required to take in some bank mergers. This development could provide incentive for buyers, once the economy and bank stock prices begin a recovery. Pricing and other conditions also could improve for possible mergers of equals among community banks.

The Spanish banks’ interest in South Florida should remain strong, as they view the region’s large Hispanic population as an ideal starting point for building U.S. retail bank networks that have FDIC coverage. The euro’s strength has also spurred Spanish banks to consider expansion in the United States.

Despite the recent credit and confidence crisis, prospective buyers in and outside the United States are interested in banks that have strong management, consistently superior earnings, good credit quality and clean balance sheets. They also will focus on a seller’s efficiency ratio, price-to book, and price-to-earnings multiples.

Preparing for a possible sale is one reason community banks should take steps to assure they have adequate loan loss reserves and programs for monitoring problem loans and exposures.

The bank should facilitate this exercise by going through an abridged version of the type of due diligence review that an acquiring bank would perform. In this case, the self-performed review could be carried out in conjunction with preparing for the annual examination by regulators. The internal team that coordinates this review can be headed by the vice president for internal audit or the controller and should have as small a number of employees as feasible. The bank does not want customers and employees knowing it is considering a sale-especially if one doesn’t happen.

When undergoing such an exercise, the team should examine, among other issues, loan quality, terms of branch leases, and executive compensation packages. The bank should also make sure it has appropriate change of control agreements in place for its key executives.

Finally, the ability to structure the sale of the bank as a sale of assets for tax purposes-which generally commands a higher sales price due to the tax benefits derived by the buyer-is one of several reasons why some community banks might consider converting to a Subchapter S corporation. An S corporation can have up to 100 shareholders, and does not pay corporate taxes; earnings are passed through to shareholders, who pay tax on that income at their individual tax rates. When an S corporation is sold, shareholders can elect to treat it as a sale of assets rather than a sale of stock. In a sale of assets, the buyer is able to amortize the core deposit intangible and goodwill acquired in the transaction.

There are many windows of opportunity in 2009 for well-performing banks to take advantage of the current conditions and strike a deal that will reward shareholders. The key is to prepare ahead of time and be ready with a clean balance sheet and portfolio when the right deal comes along.

Emilio T. Escandon, CPA, is a partner with Morrison Brown Argiz & Farra, LLP. He may be contacted at [email protected].