Pitfalls of M&A

Ted Peters, the former chairman and chief executive officer of Bryn Mawr Bank Corp., a $3.4 billion asset banking and trust company in Bryn Mawr, Pennsylvania, who did eight bank deals in his career, remembers years ago going through loan files for a bank that was for sale. When he saw evidence that someone had been falsifying records, his lawyer-who was sitting at the table with him-said, “‘If I were you, I would get up and walk out of here right now.’”

They did, and the bank in question was sold to another buyer, which lost $35 million reselling it a few years later. “It was a total disaster for the bank that bought it,” he says. “Some of the best deals are the ones you never do. You have to make sure you are obsessive about due diligence. The old days when deals would get done on a weekend, those days are long gone.”

There are plenty of pitfalls in M&A. As Kent Ellert, the president and chief executive officer of FCB Financial Holdings, in Weston, Florida, said at a conference earlier this year, “If you acquire someone else’s cooking, you had better be ready to eat it.”

What can directors do to make sure they don’t regret any of their purchases? Here at Bank Director digital magazine, we have compiled advice from people who have done lots of deals, either as the buyer, the seller or the advisor.

OVERPAYING

It’s obvious that overpaying is a bad idea, but finding out exactly what you’re buying and how it will add value will go a long way to determining a price. Don’t just use a comparative analysis to decide what other banks are selling for these days. What matters to your bank is that the deal will add value beyond the bank’s own organic growth and resulting shareholder value, says Kamal Mustafa, chairman of Invictus Group, a consulting firm, who did numerous deals as a former managing director of merchant banking for Citibank. If you can’t achieve substantial value in a deal, why would you do it?

Do an in-depth analysis of the bank’s capital and its mix of deposits and loans. What will the purchase do to your capital? If the earnings of the target are higher than your bank’s, that’s likely because the bank is doing a different type of loan and may need more capital. How much of the deposit base is core, and therefore likely to stay with your bank even as rates rise? “Each target has a unique value to each buyer,” says Mustafa. “The tools banks are using today completely ignore that.” For instance, don’t just look at the overall loan portfolio and yields. Look at maturities for those loans and extrapolate yields into the future. All loans don’t mature in the same time frame. Given the extended period of low rates, banks have been replacing older loans in the past few years with new loans at lower rates. If you look closely, yields on the bank you are acquiring probably are declining.

Gulfport, Mississippi-based Hancock Holding Co. is one bank that investors thought had overpaid for its target, the larger, New Orleans-based Whitney Holding Corp. Hancock agreed to a $1.6 billion deal to pay 164 percent of tangible book value in December 2010 for the $11.7 billion asset Whitney, which at the time was struggling under the weight of bad loans and was not profitable.

“Not only does this transaction create significant shareholder value, I believe it is also the best course of action for our employees, customers and communities,” said Whitney’s then-Chairman and CEO John C. Hope III, in a news release.

Investors were not so sure. The earn-back period for tangible book value dilution was five years. Hancock’s stock closed at $34.58 per share, down $2.46 per share, after the deal was announced. The stock didn’t recover until March 2014.

FAILURE TO INTEGRATE WELL

Another frequent problem in bank deals are projected cost reductions. Banks either cut too much or they cut too little.

Aggressive cost cutting can also run off key customers. Banks have done deals where they planned to cut expenses in half, then saw enormous attrition of staff and customers, too.

A good rule of thumb is to communicate early on what the plan is for cost savings and job cuts and execute quickly, advises Peters. “Be upfront with people,” he says. “You can’t communicate enough.” Also, be sure to lock up the key staff people you are going to need, probably with bonuses to stay with the company or one- to three-year contracts, Peters says. He often paid $25,000 or $50,000 in a bonus to get a lender to sign a contract. That sounds like a lot, but what could it cost your company to lose important staff? “If you have senior people leaving, or if you have rank and file leaving, the question is: What did you just pay for?” says Chris Marinac, director of research at broker/dealer FIG Partners. “You paid a premium. But if you had turnover, what did you really get?”

ENCOUNTERING REGULATORY DELAYS

Another hurdle that has appeared in recent years is regulatory delay. It’s best to do thorough due diligence on your own bank before embarking on mergers and acquisitions. Do you have any compliance problems that need to be resolved? Has your bank’s management team spoken to regulators about plans to acquire, and are there plans to get regulatory feedback before pursuing a particular target? What impact will the acquisition have on regulatory expectations for your bank?

“There is a zero-tolerance attitude to compliance mishaps,” says Paul Scrivano, partner and global head of the M&A practice at the law firm Ropes & Gray. Bank Secrecy Act and anti-money laundering compliance issues are real threats that can hold up any bank deal. The Community Reinvestment Act is another area of focus, particularly causing delays when community organizers or individuals issue protests with the regulator about a pending deal, according to Chip MacDonald, a partner at the law firm Jones Day in Atlanta.

“When you’re in a deal, time is risk,” he says. “You have people who are going to be leaving the target. You have customer attrition, the longer the deal goes on. You have your competitors looking at the target’s customers as well.”

In one of the most high profile cases of regulatory delay, but certainly not the only one, regulators brought up questions about Bank Secrecy Act and anti-money laundering compliance at M&T Bank Corp., now a $123 billion institution, after it announced plans to purchase the thrift Hudson City Bancorp in a cash and stock deal in August 2012. The deal took three years to close, two years more than originally planned.

“We probably did outgrow our infrastructure,” M&T Vice Chairman Rich Gold was quoted as saying in a previous issue of Bank Director magazine. “That’s shame on us. We missed that cue and we shouldn’t have, and I think we all recognize that and readily admit that.”

That inevitably hurt the bank, says MacDonald, who calculated that the market value of the deal increased 41 percent to $5.2 billion as of closing in November 2015, primarily because of increases in the value of M&T stock.

It’s clear that there are plenty of things that can go wrong in M&A. In this case, analysts seem to have liked the M&T purchase in the end. It helped the bank grow in the New Jersey market, and was accretive to earnings and tangible book value. Other deals have not turned out so well.

“With every transaction, there are pluses and minuses,” Marinac says.

It’s just important to make sure there are more pluses than minuses.