Hazy Outlook for Bank M&A in 2023

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The bank M&A landscape in 2023 will likely be affected by several factors, including concerns about credit quality and turmoil in the stock market, says Rick Childs, partner at Crowe LLP. While sellers will naturally want to get the best price possible, rising interest rates and weak bank stock valuations will impact what buyers are willing to pay. Bankers that do engage in dealmaking will need to exercise careful due diligence to understand a seller’s core deposits and credit risk. Concern about the national economy could prompt bankers to look more closely at in-market M&A, when possible. 

Topics include: 

  • Credit Quality 
  • Customer Communication 
  • Staff Retention
  • Impact of Stock Valuations 

The 2023 Bank M&A Survey examines current growth strategies, including expectations for acquirers and what might drive a bank to sell, and provides an outlook on economic and regulatory matters. The survey results are also explored in the 1st quarter 2023 issue of Bank Director magazine.

Why Mutual Banks Won’t Sell

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Two Massachusetts banks hope to preserve their mutual status for years to come by merging their holding companies now, in an example of how M&A tends to be a different story for mutual institutions.

Newburyport Five Cents Bancorp and Pentucket Bank Holdings recently received board approval to merge into a single holding company. The combined organization, with $2.5 billion in assets, will likely get a new name, Newburyport CEO Lloyd Hamm told a local news outlet. Meanwhile, $1.5 billion Newburyport Five Cents Savings Bank and $947 million Pentucket Bank will maintain their separate brands.

“We definitely want to emphasize it’s not a merger of the banks, and we will likely select a new name for the co-branded holding company,” Hamm told The Daily News in Newburyport. The new organization also plans to change its bylaws in order to make it more difficult for a future leadership team to take the company public. “This is ensuring mutuality for decades to come,” Hamm said.

All employees of the two banks will keep their jobs, and executives intend to invest more in technology, training and talent, and increase charitable giving under the combined holding company. No branch closures are planned as part of the deal.

According to data from S&P Global Market Intelligence, there have been just three combinations of mutual banks in the past five years, including the deal between Newburyport Bank and Pentucket Bank, which was announced in December 2022.

The dearth of mutual bank M&A essentially comes down to numbers: The U.S. had just 449 mutual institutions at the end of 2021, according to the Federal Deposit Insurance Corp., out of 4,839 total banks. In some respects, mutual banks may more closely resemble credit unions than public or privately held banks, though credit unions have been more actively acquiring FDIC-insured institutions, accounting for 56 deals over the past five years. Mutual banks have no shareholders and are effectively owned by their depositors. Any profits they generate are returned to their depositors in some fashion, for example, in the form of lower rates on mortgages. Last year, the FDIC approved the first de novo mutual bank to launch in over 50 years, Walden Mutual in Concord, New Hampshire.

Because mutual banks don’t have shareholders, they don’t need to always focus on the next, most profitable move, says Stan Ragalevsky, who has worked extensively with mutual banks as a partner with K&L Gates in Boston.

“If you’ve been sitting on the board of a small [mutual] bank, you realize there’s a lot of changes going on in banking, but you also think ‘We’re making money. We may not be making 80 basis points, but we’re making 45 basis points,’” Ragalevsky says. “They feel comfortable that they’re doing the right thing.”

Some of those sentiments showed up in Bank Director’s 2023 Bank M&A Survey: 77% of mutual bank executives and directors participating in the survey say they’re open to M&A but focus primarily on organic growth. Just 12% want to be active acquirers, compared to 23% of all respondents.

Furthermore, all of the 20 mutual participants say their bank’s board and management would not be interested in selling within the next five years, compared to 52% overall. When asked why they were unlikely to sell, many refer back to their institution’s mutual status and a wish to maintain an independent banking option in their communities.

Compared with deals involving publicly held banks, mutual bank deals also tend to be driven by the board more than the management, Ragalevsky adds. While board members may be motivated to some degree by personal self interest — retaining a board seat, for example — “there’s also a sense of commitment to the community,” he says.

Additionally, many prospective mutual bank sellers may be constrained by a lack of like-minded buyers. This very reason is partly why $1.4 billion Cooperative Bank of Cape Cod, based in Hyannis, Massachusetts, is unlikely to sell anytime soon, says CEO and Chair Lisa Oliver.

“We don’t sell, because there’s nobody to buy [us]. We’re owned by our depositors in a non-stock kind of way. If anything, it would be a merger for lack of succession planning, if that were really critical,” Oliver says. “But there are plenty of potential candidates that can be hired to become CEOs of a small bank.”

Some also argue that mutuals’ independent streak is, to some degree, woven into their history. Many mutual banks, particularly in the Northeast, trace their roots back over 100 years, when they were initially founded to provide banking services for poor and working class families.

“The mutual bank movement has been one of the greatest, most successful social and business experiments,” Ragalevsky says. “Mutual banks were formed to improve people’s lives — they weren’t formed to make money. They were formed to improve people’s lives, and they’ve done that.”

Current Compliance Priorities in Bank Regulatory Exams

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Updated examination practices, published guidance and public statements from federal banking agencies can provide insights for banks into where regulators are likely to focus their efforts in coming months. Of particular focus are safety and soundness concerns and consumer protection compliance priorities.

Safety and Soundness Concerns
Although they are familiar topics to most bank leaders, several safety and soundness matters merit particular attention.

  • Bank Secrecy Act/anti-money laundering (BSA/AML) laws. After the Federal Financial Institutions Examination Council updated its BSA/AML examination manual in 2021, recent subsequent enforcement actions issued by regulators clearly indicate that BSA/AML compliance remains a high supervisory priority. Banks should expect continued pressure to modernize their compliance programs to counteract increasingly sophisticated financial crime and money laundering schemes.
  • In November 2021, banking agencies issued new rules requiring prompt reporting of cyberattacks; compliance was required by May 2022. Regulators also continue to press for multifactor authentication for online account access, increased vigilance against ransomware payments and greater attention to risk management in cloud environments.
  • Third-party risk management. The industry recently completed its first cycle of exams after regulators issued new interagency guidance last fall on how banks should conduct due diligence for fintech relationships. This remains a high supervisory priority, given the widespread use of fintechs as technology providers. Final interagency guidance on third-party risk, expected before the end of 2022, likely will ramp up regulatory activities in this area even further.
  • Commercial real estate loan concentrations. In summer 2022, the Federal Deposit Insurance Corp. observed in its “Supervisory Insights” that CRE asset quality remains high, but it cautioned that shifts in demand and the end of pandemic-related assistance could affect the segment’s performance. Executives should anticipate a continued focus on CRE concentrations in coming exams.

In addition to those perennial concerns, several other current priorities are attracting regulatory scrutiny.

  • Crypto and digital assets. The Federal Reserve, the Office of the Comptroller of the Currency, and the FDIC have each issued requirements that banks notify their primary regulator prior to engaging in any crypto and digital asset-related activities. The agencies have also indicated they plan to issue further coordinated guidance on the rapidly emerging crypto and digital asset sector.
  • Climate-related risk. After the Financial Stability Oversight Council identified climate change as an emerging threat to financial stability in October 2021, banking agencies began developing climate-related risk management standards. The OCC and FDIC have issued draft principles for public comment that would initially apply to banks over $100 billion in assets. All agencies have indicated climate financial risk will remain a supervisory priority.
  • Merger review. In response to congressional pressure and a July 2021 presidential executive order, banking agencies are expected to begin reviewing the regulatory framework governing bank mergers soon.

Consumer Protection Compliance Priorities
Banks can expect the Consumer Financial Protection Bureau (CFPB) to sharpen its focus in several high-profile consumer protection areas.

  • Fair lending and unfair, deceptive, or abusive acts and practices (UDAAP). In March 2022, the CFPB updated its UDAAP exam manual and announced supervisory changes that focus on banks’ decision-making in advertising, pricing, and other activities. Expect further scrutiny — and possible complications if fintech partners resist sharing information that might reveal proprietary underwriting and pricing models.
  • Overdraft fees. Recent public statements suggest the CFPB is intensifying its scrutiny of overdraft and other fees, with an eye toward evaluating whether they might be unlawful. Banks should be prepared for additional CFPB statements, initiatives and monitoring in this area.
  • Community Reinvestment Act (CRA) reform. In May 2022, the Fed, FDIC, and OCC announced a proposed update of CRA regulations, with the goal of expanding access to banking services in underserved communities while updating the 1970s-era rules to reflect today’s mobile and online banking models. For its part, the CFPB has proposed new Section 1071 data collection rules for lenders, with the intention of tracking and improving small businesses’ access to credit.
  • Regulation E issues. A recurring issue in recent examinations involves noncompliance with notification and provisional credit requirements when customers dispute credit or debit card transactions. The Electronic Fund Transfer Act and Regulation E rules are detailed and explicit, so banks would be wise to review their disputed transaction practices carefully to avoid inadvertently falling short.

As regulator priorities continue to evolve, boards and executive teams should monitor developments closely in order to stay informed and respond effectively as new issues arise.

Legal Protections for Acquiring Banks

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Due diligence just doesn’t tell an acquiring bank everything that should be known about a target—the process also shows that the acquirer’s team is committed to the deal. In this video, Stinson Leonard Street Partner Adam Maier explains how to protect the bank from potential losses in M&A.

  • The Roles of Due Diligence vs. Representations and Warranties
  • Addressing Risks Found in Due Diligence
  • Protecting the Buyer from Financial Loss

Redefining the Meaning of a Customer Relationship

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relationship-3-12-18.pngFor most people, brick and mortar branches have become remnants of prior generations of banking. In the digital age of mobile deposits and non-financial, non-regulated companies like PayPal there is little incentive to walk into a local branch—particularly for millennials. This presents an anomaly in the community banking model. Community banks are built upon relationships, so how can the banks survive in an era so acutely inclined towards, and defined by, technology seemingly designed to eliminate “traditional” relationships?

The solution is to redefine the term “traditional” relationship. While customers may not want to walk into a branch to deposit a check, they still want information and advice. Just because a millennial does not want to deposit a check in person does not mean that he or she will not need to sit with a representative for guidance when applying for their first home loan. Using customer segmentation and understanding where there are opportunities to build relationships provides an opportunity to overcome the imminent threat of technology.

If information and advice are the keys to building relationships, it becomes imperative that bank employees are fully trained and knowledgeable. It is crucial that community banks spend time hiring the right people for the right position and then train and promote from within. Employees must fully understand, represent and communicate a brand. That brand must be clearly defined by executive management and communicated down the chain of command. It is incumbent upon the leaders of the organization to first set an example and then ask their employees to follow suit. Some of the most successful community bank CEOs can recognize their customers by name when they walk into a branch. These are not the biggest clients of the bank, but they are probably the most loyal because of the quality of the relationship.

The focus needs to switch from products and transactions towards specific relationships with specific customer segments. Customer-centric banking strategies will improve the chances of survival for community banks. Those that are not able to adapt will be eclipsed by the recent revival of de novos or will be acquired by institutions that are embracing this customer-centric approach. A customer-centric approach is critical to drive value whether pursuing organic growth or M&A. For banks evaluating an acquisition, there are additional considerations that need to be addressed prior to entering into a transaction, in order to safeguard the customer relationships that the bank has built and ensure that the deal enhances the bank’s brand and business model, while also building value.

If you are one of the survivors and are engaged in an acquisition, what does all of this mean for you?

  1. FinPro Capital Advisors Inc. advocates having strict M&A principals and parameters when evaluating the metrics of a deal, which will vary from bank to bank. This concept extends to culture and branding as well. A good deal on paper does not necessarily translate to a successful resultant entity. If a transaction will dilute your franchise, disrupt your culture or business model, or in any way undermine the brand and customer base you have built, do not pursue it.
  2. Signing a definitive agreement is not the same thing as closing a transaction. Integration begins as soon as the ink dries on the contract. Planning should have occurred well in advance. Management needs to focus on employee, customer and investor reception of the deal, along with regulatory approvals and strategic planning. A poorly executed integration can provide an inauspicious start culturally and can increase merger costs substantially.
  3. Retain the best talent from each institution and take the time to ensure that the employees are in the right position. Roles are not set in stone and an acquisition provides the perfect opportunity to re-position the bank’s staffing structure. This includes implementing management succession and talent management plans for the new entity. Develop an organizational structure for the future, not just for today.
  4. Communicate effectively throughout the entire process. Be transparent and be honest. Bolster relationships and foster enthusiasm in the new entity from day one. Corporate culture is one of the most difficult attributes to quantify but it is palpable and can either energize every person in the company or rapidly become toxic and disruptive.

For all banks, the brand and culture that you build will directly impact your customer base and define the banking relationships you create. To build meaningful relationships with your customers, banks must first build meaningful relationships within the organization. In so doing, banks will be able to redefine their model by focusing on relationships instead of transactions, customers instead of products, and eliminate isolated divisions to create integrated organizations. The traditional banking model may be dead but banks with strong leadership and corporate culture will recognize the new paradigm and enact change to evolve accordingly.

Well Conceived and Executed Bank Acquisitions Drive Shareholder Value

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acquisition-2-21-18.pngRecent takeovers among U.S.-based banks generally have resulted in above-market returns for acquiring banks, compared to their non-acquiring peers, according to KPMG research. This finding held true for all banks analyzed except those with greater than $10 billion in assets, for which findings were not statistically significant.

Our analysis focused on 394 U.S.-domiciled bank transactions announced between January 2012 and October 2016. Our study focused on whole-bank acquisitions and excluded thrifts, acquisitions of failed banks and government-assisted transactions. The analysis yielded the following conclusions:

  • The market rewards banks for conducting successful acquisitions, as evidenced by higher market valuations post-announcement.
  • Acquiring banks’ outperformance, where observable, increased linearly throughout our measurement period, from 90 days post-announcement to two years post-announcement.
  • The positive effect was experienced throughout the date range examined.
  • Banks with less than $10 billion in assets experienced a positive market reaction.
  • Among banks with more than $10 billion in assets, acquirers did not demonstrate statistically significant differences in market returns when compared to banks that did not conduct an acquisition.

Factors Driving Value

Bank size. Acquiring banks with total assets of between $5 billion and $10 billion at the time of announcement performed the strongest in comparison with their peers during the period observed. Acquiring banks in this asset range outperformed their non-acquiring peers by 15 percentage points at two years after the transaction announcement date, representing the best improvement when compared to peers of any asset grouping and at any of the timeframes measured post-announcement.

Performance-chart.png 

Acquisitions by banks in the $5 billion to $10 billion asset range tend to result in customer expansion within the acquirer’s market or a contiguous market, without significant increases in operational costs.

We believe this finding is a significant factor driving the value of these acquisitions. Furthermore, banks that acquire and remain in the $10 billion or less asset category do not bear the expense burden associated with Dodd-Frank Act stress testing (DFAST) compliance.

Conversely, banks with nearly $10 billion in assets may decide to exceed the regulatory threshold “with a bang” in anticipation that the increased scale of a larger acquisition may serve to partially offset the higher DFAST compliance costs.

The smaller acquiring banks in our study—less than $1 billion in assets and $1 billion to $5 billion in assets—also outperformed their peers in all periods post-transaction (where statistically meaningful). Banks in these asset ranges benefited from some of the same advantages mentioned above, although they may not have received the benefits of scale and product diversification of larger banks.

As mentioned earlier, acquirers with greater than $10 billion in assets did not yield statistically meaningful results in terms of performance against peers. We believe acquisitions by larger banks were less accretive due to the relatively smaller target size, resulting in a less significant impact.

Additionally, we find that larger bank transactions can be complicated by a number of other factors. Larger banks typically have a more diverse product set, client base and geography than their smaller peers, requiring greater sophistication during due diligence. There is no substitute for thorough planning, detailed due diligence and an early and organized integration approach to mitigate the risks of a transaction. Furthermore, alignment of overall business strategy with a bank’s M&A strategy is a critical first step to executing a successful acquisition (or divestiture, for that matter).

Time since acquisition. All three acquirer groups that yielded statistically significant results demonstrated a trend of increasing returns as time elapsed from transaction announcement date. The increase in acquirers’ values compared to their peers, from the deal announcement date until two years after announcement, suggests that increases in profitability from income uplift, cost reduction and market expansion become even more accretive with time.

Positive performance pre-deal may preclude future success. Our research revealed a positive correlation between the acquirer’s history of profitability and excess performance against peers post-acquisition. We noted this trend in banks with assets of less than $1 billion, and between $1 billion and $5 billion, at the time of announcement.

This correlation suggests that banks that were more profitable before a deal were increasingly likely to achieve incremental shareholder value through an acquisition.

Bank executives should feel comfortable pursuing deals knowing that the current marketplace rewards M&A in this sector. However, our experience indicates that in order to be successful, acquirers should approach transactions with a thoughtful alignment of M&A strategy with business strategy, an organized and vigilant approach to due diligence and integration, and trusted advisers to complement internal teams and ensure seamless transaction execution.

Strengthening Your Bank’s M&A Strategy

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Bank M&A activity will likely increase in 2018, but many banks don’t have the in-house expertise and procedures to successfully navigate a deal. Phil Weaver of PwC explains the factors that will fuel deal volume and why banks need to update their M&A playbooks.

  • Why 2018 Will See More Deals
  • Beefing Up the Bank’s M&A Playbook
  • Talent Considerations in Executing a Deal

Handling the Risk of M&A

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Atlanta-based State Bank Financial Corp. is fairly unique in that it uses a corporate psychologist who helps the bank assess the personalities that are the right fit for State Bank. Steven Deaton, the executive vice president and enterprise risk officer of State Bank, talks with Bank Director digital magazine’s Naomi Snyder about how the bank approaches due diligence and the risk of M&A.

He describes:

  • the importance of assessing culture in the organization you acquire
  • how the bank uses a corporate psychologist
  • the bank’s approach to M&A strategy
This article first appeared in the Bank Director digital magazine.

Credit Unions Challenge Bank Buyers for M&A Deals

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merger-9-15-17.pngA new front has developed in the ongoing battle between banks and credit unions. While relatively unheard of in prior years, credit unions have been aggressively pursuing bank acquisitions over the last three years, winning over sellers with large cash premiums and frustrating potential bank buyers that cannot bid competitively. Given the competitive advantage that credit unions have in the bidding process, this trend is expected to continue for the foreseeable future.

Since 2011 there have been 16 acquisitions of banks by credit unions nationally, including several transactions that are currently pending. Initially starting as a trickle, the pace has been picking up steam in recent years. There were a handful of deals between 2011 and 2014, three deals announced in 2015, four in 2016, and four in 2017—and the year is not over. Many industry experts believe that several additional transactions will be announced before year-end. Much of this activity has been in the Midwest and Southeast, which traditionally have been large markets for credit unions.

Credit unions are cash buyers and have two big advantages over banks during the bidding process. First, because they have no shareholders looking over their shoulders, credit unions can more aggressively price a transaction without fear of shareholder retribution. Second, credit unions can offer a far higher premium than bank suitors since credit unions are exempt from federal and most state taxes.

What does this mean? On one hand, banks that want to cash out are able to obtain a higher premium for the institution, which ultimately is good for shareholders. However, banks that want to grow through acquisition could miss out on attractive acquisition opportunities that only a few years ago would have been within their grasp. The tax advantage enjoyed by credit unions poses a significant hurdle for traditional bank bidders. Even banks sitting on the sidelines will be affected by this trend, as local competitors are acquired by credit unions.

If the banking industry determines that bank acquisitions by credit unions are, on balance, a net negative, one solution is to advocate for an “acquisition tax” to be paid by credit unions at the state and/or federal level at the time of acquisition. Such a tax could help level the playing field and protect taxpayers (at least in part) from the loss of tax revenue generated on income of the bank going forward.

Another strategy is for banks, either individually or together with other institutions, to explore the possibility of turning the tables and acquiring a credit union. Such a transaction would eliminate a credit union competitor and also give credit union members a one-time payment, compensating them for the loss of any perceived benefits that a credit union may have with regard to more favorable customer interest rates and fees. Challenges abound with this strategy, including finding a suitably motivated credit union, navigating a very complex structuring and regulatory approval process, and retaining the credit union’s members as customers.

Regardless of the industry response to this issue, selling banks need to understand and appreciate the complexity posed by a credit union acquisition. Since a credit union cannot acquire a bank charter, the transaction needs to be structured as a purchase and assumption transaction, in which assets and liabilities need to be individually transferred and assigned. This is a costly and burdensome process and requires, among other things, consents from vendors and service providers, the preparation of mortgage assignments and allonges, and the filing of deeds and other documents related to the transfer of real estate.

Since the transaction must be structured as a cash asset sale, the transaction is taxable to the bank and shareholders. Additionally, the selling bank and, if applicable, its bank holding company, has to go through a liquidation and dissolution process, which is further complicated if there is outstanding debt at either the bank or holding company level. All of these costs need to be considered in determining the adequacy of the final bid. Finally, in our experience, the regulatory approval process is much longer than a traditional bank acquisition.

Whatever your bank’s situation, it is important to understand that credit unions and their investment bankers are actively and aggressively searching for banks to acquire, adding a new and rapidly expanding dimension to credit union competition.