An M&A Checklist for BOLI, Compensation Programs

As bank M&A activity continues to pick up, it is crucial that buyers and sellers understand the implications of any transaction on bank-owned life insurance portfolios, as well as any associated nonqualified deferred compensation (NQDC) programs, to mitigate potential negative tax consequences.

Identify and Review Target Bank’s BOLI Holdings
The first step is for buyers to identify the total cash surrender value of sellers’ BOLI portfolio and its percentage of regulatory capital. The buyer should identify the types of products held and the amount held in each of the three common BOLI product types:

  • General account
  • Hybrid separate account
  • Separate account (registered or private placement)

In addition to evaluating historical and current policy performance, the buyer should also obtain and evaluate carrier financial and credit rating information for all products, as well as underlying investment fund information for any separate account products.

Accounting and Tax Considerations
From an accounting standpoint, the buyer should ensure that the BOLI has been both properly accounted for in accordance with GAAP (ASC 325-30) and reported in the call reports, with related disclosures of product types and risk weighting. Further, if the policies are associated with a post-retirement split-dollar or survivor income plan, the buyer should ensure that the liabilities have been properly accrued for.

The structure of the transaction as a stock sale or asset sale is critical when assessing the tax implications. In general, with a stock sale, there is no taxable transaction with regard to BOLI — assets and liabilities “carry over” to the buyer. With an asset sale (or a stock sale with election to treat as asset sale), the seller will recognize the accumulated gain in the policies and the buyer will assume the policies with a stepped-up basis.

Regardless of the type of transaction, the buyer needs to evaluate and address the Transfer for Value (TFV) and Reportable Policy Sale (RPS) issues. Policies deemed “transferred for value” or a “reportable policy sale” will result in taxable death benefits. Prior to the Tax Cuts and Jobs Act, the transfer for value analysis was fairly simple: In a stock transaction, the “carryover basis” exception applies to all policies, whether or not the insured individual remained actively employed. In an asset sale, policies on insureds who will be officers or shareholders of the acquiring bank will meet an exception.

The Jobs Act enacted the notion of “reportable policy sales,” which complicated the tax analysis, especially for stock-based transactions now requiring much more detailed analysis of the type of transaction and entity types (C Corp vs S Corp). It is important to note that the RPS rules are in addition to the TFV rule.

Review Risk Management of BOLI
The Interagency Statement on the Purchase and Risk Management of BOLI (OCC 2004-56) establishes requirements for banks to properly document both their pre-purchase due diligence, as well as an annual review of their BOLI programs. The buyer will want to ensure this documentation is in good order. Significant risk considerations include carrier credit quality, policy performance, employment status of insureds, 1035 exchange restrictions or fees and the tax impact of any policy surrenders. Banks should pay particular attention to ensuring that policies are performing efficiently as well as the availability of opportunities to improve policy performance.

Identify and Review NQDC plans
Nonqualified deferred compensation plans can take several forms, including:

  • Voluntary deferred compensation programs
  • Defined benefit plans
  • Defined contributions plans
  • Director deferral or retirement plans
  • Split dollar
  • Other

All plans should be formally documented via plan documents and agreements. Buyers should ascertain that the plans comply with the requirements of Internal Revenue Code Section 409A and that the appropriate “top hat” filings have been made with the U.S. Department of Labor.

General Accounting and Tax Considerations
Liabilities associated with NQDC programs should be accounted for properly on the balance sheet. In evaluating the liabilities, banks should give consideration to the accounting method and the discount rates.

Reviewing historical payroll tax reporting related to the NQDC plans is critical to ensuring there are no hidden liabilities in the plan. Remediating improperly reported payroll taxes for NQDC plans can be both time consuming and expensive. Seek to resolve any reporting issues prior to the deal closure.

Change in Control Accounting and Tax Considerations
More often than not, NQDC plans provide for benefit acceleration in the event of a change in control (CIC), including benefit vesting and/or payments CIC. The trigger may be the CIC itself or a secondary “trigger,” such as termination of employment within a certain time period following a CIC. It is imperative that the buyer understand the financial statement impact of the CIC provisions within the programs.

In addition to the financial statement impact, C corps must also contend with what can be complicated taxation issues under Internal Revenue Code Section 280G, as well as any plan provisions addressing the tax issues of Section 280G. S corps are not subject to the provisions of Section 280G. For additional insight into the impacts of mergers on NQDC programs, see How Mergers Can Impact Deferred Compensation Plans Part I and How Mergers Can Impact Deferred Compensation Plans Part II. 

Insurance services provided through NFP Executive Benefits, LLC. (NFP EB), a subsidiary of NFP Corp. (NFP). Doing business in California as NFP Executive Benefits & Insurance Agency, LLC. (License #OH86767). Securities offered through Kestra Investment Services, LLC, member FINRA/SIPC. Kestra Investment Services, LLC is not affiliated with NFP or NFP EB.
Investor Disclosures: https://bit.ly/KF-Disclosures

How Banks Can Leverage Niche With M&A

After a year of formidable industry change, bank merger and acquisition activity is beginning to bounce back.

July’s 19 announced transactions brings this year’s total to 116 deal announcements so far, compared with 111 overall in 2020, according to data from S&P Global Market Intelligence. Financial institutions are looking to make strategic investments; post-pandemic, that means building seamless digital experiences at a lower cost remains a top priority.

This is a prime opportunity for banks to revisit the outdated traditional playbook of converting newly acquired customers. The conventional model of post-M&A communication is packed with marketing jargon like “commitment” and “service,” followed by a barrage of letters that make it difficult for customers to know what to expect from their new financial partner.

The goal of this approach has always been to reduce churn. But it has led to stagnant or low growth in wallet share and overlooked chances to build stronger relationships. One in four customers surveyed by BankingExchange took some form of action due to an acquisition: 5% closed their account, and an additional 22% eventually opened an account with another financial entity. Customers are increasingly willing to bank elsewhere if their financial needs are not being met.

Financial institutions need a new conversion playbook to keep old customers happy and new customers engaged. Banks should look beyond generic tactics and think like brands to make the M&A process smoother. This approach means the institution isn’t thinking about messaging as a box to check, focusing instead on the customer experience and brainstorming fresh and creative ways to communicate. Brand identity and emotion play a critical role in customer retention. According to a Deloitte study, over 35% of respondents who switched banks cited emotional reasons — they felt their bank was too large to care about their financial needs anymore.

Embracing a new acquisition model requires a proactive approach to post-merger communications and strategy. Framing a compelling story, integrating complex technology and bringing together multiple teams is achievable — but takes time and attention to detail.

A Fresh Approach to the M&A Playbook
Post-deal communications require a fresh approach to connecting emotionally and digitally with new customers. Forming deeper connections and reaching new opportunities for growth requires starting with an innovative model that leverages niche-focused products and services to create a greater affinity with the growing customer base.

Although a niche strategy isn’t an entirely new concept, it’s one of the most undervalued assets used by banks today. “Superior customer value occurs when a company can offer either a unique bundle of value, a comparable value at a lower cost than the competition or a combination of differentiated value and low cost,” research shows. Delivering tailored financial products to niche customer segments allows banks to build a brand that appeals to a new category of customers, creating a lasting connection and brand affinity.

Engaging a niche audience doesn’t mean your bank changes its foundation; it means focusing more deeply on an underserved segment of your newly acquired customer base to deliver a more robust and connected experience. Start by identifying these underserved markets with data to determine what opportunities exist. Maybe there’s a high concentration of gig workers who could benefit from new or newly combined digital bank offerings. As the acquiring bank, you could build an experience that meets these needs and the needs of other gig workers in your current customer base and communities.

This is a prime opportunity to jumpstart research, initiate conversations and craft meaningful marketing strategies that will delight your new audience. The standard welcome letter will not generate the same excitement as a bespoke campaign inviting gig workers to take part in building innovative products that will empower them to manage and grow their finances. This proactive approach demonstrates your dedication to providing top-notch customer services and solidifies your commitment to investing in each individual member.

Banks that take advantage of the new growth opportunities in today’s M&A landscape can move to a truly innovative approach that leverages data analytics to identify, differentiate and deliver value, leading to greater affinity and sustainable growth. Banks are poised to foster deeper trust in their new customers by building brands that deliver focused financial services for specific needs, ultimately creating lifetime value.

Motivation for Mergers Will Grow as Interest Rates, Loan Growth Stay Low

The pace of announced mergers among rated U.S. banks has accelerated and is likely to gain steam.

The limited prospect of material loan growth makes asset growth via mergers and acquisitions increasingly attractive. And as we anticipated, more banks are favoring large transformational deals. We expect the industry will continue to consolidate in the second half of 2021. Greater size and efficiency will remain primary drivers of consolidation in the face of continued low interest rates, as will the imperative to invest in new technologies at scale.

  • There was a substantial jump in transformational M&A activity during the second quarter. Four sizable deals were announced in the period, and each envisions an enlarged entity that benefits from greater diversification and economies of scale. All four transactions promise eventual benefits for creditors, but each presents significant execution risk that is an immediate credit negative.
  • The main drivers of consolidation will continue for the next 12 to 18 months. Interest rates are unlikely to rise until 2023, increasing the likelihood of a jump in M&A activity. Technology upgrades will require substantial investment, which prospective cost savings from acquisitions can help fund. And loan growth will remain subdued because of the massive deposit holdings of U.S. companies and households.
  • Difficulty forecasting business activity and loan growth, as well as rising bank share prices, may have held back some deals. The value of an acquisition target is harder to gauge in an uncertain economic and market environment, which likely helped slow overall sector consolidation in 2020 and first quarter 2021, but nonetheless did not prevent the prominent deals we highlight in this report.

Data Considerations for Successful Deal Integration

Bank M&A activity is heating up in 2021; already, a number of banks have announced deals this year. Is your bank considering a combination with another institution?

Banks initiate mergers because of synergies between institutions, and to achieve economies of scale along with anticipated cost savings. Acquiring institutions typically intend to leverage the newly acquired customer base, but this can be difficult to execute upon without a data strategy.

Whether your bank is considering are buying or selling, it has never been more important to evaluate whether your data house is in order. Unresolved acquisition data challenges can result in poor customer experiences, inaccurate reporting and significant inefficiency after the merger closes. What causes these types of data challenges?

  • Both institutions possess massive volumes of data and multiple systems, while disparate systems prevent a holistic view of the combined entity. In a merger, the acquirer does not have access to the target’s data until legal close, and data is not consolidated until the core conversion is completed.
  • Systems are often antiquated, and it is difficult to access high-value customer data. Data integrity is often an issue that impedes anticipated synergies that could promote revenue generation.
  • Absence of enterprise knowledge or insight into target’s customer portfolio. This makes it difficult to identify growth opportunities and plan the strategy for the combined institution. It also creates a barrier to pivoting in the event a key relationship manager leaves the institution.

Baltimore-based Howard Bancorp has conducted five successful acquisitions in the last eight years. Steven Poynot, Howard’s CIO, recommends looking internally first and getting your house in order prior to any merger. “If you don’t understand all of the pieces of your bank’s data and portfolio well, how are you going to overlay your information in combination with the other bank’s data for reporting?”

Five solutions to merger data challenges include:

  • Create a data governance strategy before a deal is in the works. Identify the source and location of all pertinent data. Evaluate whether customer data is clean and up to date. Stale customer information such as old land line phone numbers and inaccurate email addresses yield roadblocks for relationship managers attempting to use data effectively. If your bank does identify data issues, implement a clean-up project based on a data governance policy framework. This initiative will benefit all banks, not just those looking to merge.
  • Develop an M&A integration plan that sets expectations and goals. Involve the CIO quickly and identify tools needed for the integration. Make a strategic determination of what data fields need to be integrated for reporting purposes. Acquire tools to allow for enterprise reporting and to highlight sales opportunities. Partner with vendors who understand the specific challenges of the banking industry.
  • Unify Disparate Systems. Prioritize data integration with a seamless transition for customers as the top priority. Plan for mapping and consolidating data along with reporting for the combined institution. Take product and data mapping beyond what is needed for the system mapping required for core integration. Use the information gleaned from the data to support product analytics, risk assessment, business development and cross selling strategies. The goal is to combine and integrate systems quickly to leverage the data as an asset.
  • Discourage Data Silos. Make data available and easily accessible to all who need it to do their jobs. Banking is a relationship business, and relationship managers need current customer relationship information readily available to them.
  • Analyze. Once the data has been consolidated, analyze and leverage it to identify opportunities that will drive revenue.

In a merger, the sooner that data is combined, the earlier decisions can be made from the information. As data silos are removed and data becomes easily accessible across the organization, data becomes an enterprise-wide asset that can be used effectively in the bank’s strategy.

Navigating Four Common Post-Signing Requests for Additional Information

Consolidation in the banking industry is heating up. Regulatory compliance costs, declining economies of scale, tiny net interest margins, shareholder liquidity demands, concerns about possible changes in tax laws and succession planning continue driving acquisitions for strategic growth.

Unlike many industries, where the signing and closing of an acquisition agreement may be nearly simultaneous, the execution of a definitive acquisition agreement in the bank space is really just the beginning of the acquisition process. Once the definitive agreement is executed, the parties begin compiling the information necessary to complete the regulatory applications that must be submitted to the appropriate state and federal bank regulatory agencies. Upon receipt and a quick review of a filed application, the agencies send an acknowledgement letter and likely a request for additional information. The comprehensive review begins under the relevant statutory factors and criteria found in the Bank Merger Act, Bank Holding Company Act or other relevant statutes or regulations. Formal review generally takes 30 to 60 days after an application is “complete.”

The process specifically considers, among other things: (1) competitive factors; (2) the financial and managerial resources and future prospects of the company or companies and the banks concerned; (3) the supervisory records of the financial institutions involved; (4) the convenience and needs of the communities to be served and the banks’ Community Reinvestment Act (CRA) records; (5) the effectiveness of the banks in combating money laundering activities; and (6) the extent to which a proposal would result in greater or more concentrated risks to the stability of the United States banking or financial system.

During this process, the applicant and regulator will exchange questions, answers, and clarifications back and forth in order to satisfy the applicable statutory factors or decision criteria towards final approval of the transaction. Each of the requests for additional information and clarifications are focused on making sure that the application record is complete. Just because information or documents are shared during the course of the supervisory process does not mean that the same information or documents will not be requested during the application process. The discussions and review of materials during the supervisory process is separate from the “application record,” so it helps bank management teams to be prepared to reproduce information already shared with the supervisory teams. A best practice for banks is to document what happens during the supervisory process so they have it handy in case something specific is re-requested as part of an application.

Recently, we consistently received a number of requests for additional information that include questions not otherwise included in the standard application forms. Below, we review four of the more common requests.

1. Impact of the Covid-19 Pandemic. Regulators are requesting additional information focused on the impact of the coronavirus pandemic. Both state and federal regulators are requesting a statement on the impact of the Covid-19 pandemic that discusses the impact on capital, asset quality, earnings, liquidity and the local economy. State and federal agencies are including a request to discuss trends in delinquency loan modifications and problem loans when reviewing the impact on asset quality, and an estimate for the volume of temporary surge deposits when reviewing the impact on liquidity.

2. Additional, Specific Financial Information. Beyond the traditional pro forma balance sheets and income statements that banks are accustomed to providing as part of the application process, we are receiving rather extensive requests for additional financial information and clarifications. Two specific requests are particular noteworthy. First, a request for financial information around potential stress scenarios, which we are receiving for acquirors and transactions of all sizes.

Second, and almost as a bolt-on to the stress scenario discussion, are the requests related to capital planning. These questions focus on the acquiror’s plan where financial targets are not met or the need to raise capital arises due to a stressed environment. While not actually asking for a capital plan, the agencies have not been disappointed to receive one in response to this line of inquiry.

3. List of Shareholders. Regardless of whether the banks indicate potential changes in the ownership structure of an acquiror or whether the consideration is entirely cash from the acquiror, agencies (most commonly the Federal Reserve), are requesting a pro forma shareholder listing for the acquiror. Specifically, this shareholder listing should break out those shareholders acting in concert that will own, control, or hold with power to vote 5% or more of an acquiring BHC. Consider this an opportunity for both the acquiror and the Federal Reserve to make sure control filings related to the acquiror are up to date.

4. Integration. Finally, requests for additional information from acquirors have consistently included a request for a discussion on integration of the target, beyond the traditional due diligence line of inquiry included in the application form. The questions focus on how the acquiror will effectively oversee the integration of the target, given the increase in assets size. Acquirors are expected to include a discussion of plan’s to bolster key risk management functions, internal controls, and policies and procedures. Again, we are receiving this request regardless of the size of the acquiror, target or transaction, even in cases where the target is less than 10% of the size of the acquiror.

These are four of the more common requests for additional information that we have encountered as deal activity heats up. As consolidation advances and more banks file applications, staff at the state and federal agencies may take longer to review and respond to applications matters. We see these common requests above as an opportunity to provide more material in the initial phase of the application process, in order to shorten the review timeframe and back and forth as much as possible. In any event, acquirors should be prepared to respond to these requests as part of navigating the regulatory process post-signing.

Positive Outlook for Bank M&A as the Pandemic Subsides

Will there be an acceleration of bank merger and acquisition activity in 2021 and beyond?

The short answer is yes.

As the Covid-19 pandemic recedes, we expect bank M&A activity to rebound, both in terms of branch and whole-bank acquisitions. Banks and their advisors have evolved since the pandemic’s onset forced office closures and the implementation of a new remote working environment. In the past year, institutions and their boards of directors improved technology and online banking capabilities in response to customer needs and expectations. They also gained substantial experience providing banking products and services in a remote environment. This familiarity with technology and remote operations should cause acquirors and sellers alike to reconsider where they stand in the M&A market in 2021 and beyond.

We see a number of factors supporting an improved M&A market in 2021. First, many acquirors and potential deals were sidelined in the spring of 2020, as the pandemic’s uncertainty setting in and the markets were in turmoil. We expect a number of these deals to be rekindled in mid- to late-2021, if they haven’t already resurfaced. We also expect a robust set of acquirors to return to the market looking to add deposits, retail and commercial customers, lending teams, and additional capabilities.

Second, there remains a growing number of small banks struggling to compete that would likely consider potential merger partners with similar cultures and in similar geographic markets. Similarly, risk management and compliance costs continue to challenge bank managers amid tough competition from community banks, credit unions and other non-bank financial institutions. Some small banks have also struggled to provide the digital offerings that have become commonplace since the pandemic began. These challenges are sure to have smaller banks considering merger partners or new investors.

Third, larger banks are looking to grow deposits and market share as they look to compete with more regional players that have the necessary compliance infrastructure and digital offerings. We expect these more regional players to use acquisition partners as a way to grow core deposits and increase efficiencies. Acquiring new deposits and customers also affords these regional banks the ability to cross-sell other products that smaller banks may not have been able to offer the same customers before — increasing revenue in a sustained low-interest rate environment.

Finally, the low-interest rate environment has opened the capital markets to banks of all sizes looking to raise subordinated debt, which may support community bank M&A. Many subordinated debt offerings are priced in the 4% to 5% range, and often are oversubscribed within just a few days. Banks have found these offerings to be an attractive tool to pay off debt with higher interest rates, fund investments in digital infrastructure, provide liquidity to shareholders through buyback programs and seek branch or whole-bank acquisition targets.

We are already seeing activity pick up in bank M&A, and expect that as the economy — and life itself — begins to normalize in 2021, more transactions to be announced. The prospects for an active merger market in 2020 were cut off before spring arrived. This year, as we approach spring once again, the M&A market is not likely to return to pre-pandemic levels, but the outlook is certainly much more optimistic for bank M&A.

Five Assessments that Every Acquirer Should Make

Acquiring another bank will be one of the most important decisions that a board of directors ever makes. A well-played acquisition can be a transformational event for a bank, strengthening its market presence or expanding it into new markets, and enhancing its profitability.

But an acquisition is not without risk, and a poorly conceived or poorly executed transaction could also result in a significant setback for your bank. Failing to deliver on promises that have been made to the bank’s shareholders and other stakeholders could preclude you from making additional acquisitions in the future. Banking is a consolidating industry, and acquisitive banks earn the opportunity to participate one deal at a time.

When a board is considering a potential acquisition, there are five critical assessments of the target institution that it should make.

Talent
When you are acquiring a bank, you’re getting more than just a balance sheet and branches; you’re also acquiring talent, and it is critical that you assess the quality of that asset. If your bank has a more expansive product set than the target, or has a more aggressive sales culture, how willing and able will the target’s people be to adapt to these changes in strategy and operations? Who are the really talented people in the target’s organization you want to keep? It’s important to identify these individuals in advance and have a plan for retaining them after the deal closes. Does the target have executives at certain positions who are stronger than members of your team? Let’s say your bank’s chief financial officer is nearing retirement age and you haven’t identified a clear successor. Could the target bank’s CFO eventually take his or her place?

Technology
Making a thorough technology assessment is crucial, and it begins with the target’s core processing arrangement. If the target uses a different third-party processor, how much would it cost to get out of that contract, and how would that affect the purchase price from your perspective? Can the target’s systems easily accommodate your products if some of them are more advanced, or will significant investments have to be made to offer their customers your products?

Culture
It can be difficult to assess another bank’s culture because you’re often dealing with things that are less tangible, like attitudes and values. But cultural incompatibility between two merger partners can prevent a deal from reaching its full potential. Cultural differences can be expressed in many different ways. For example, how do the target’s compensation philosophy and practices align with yours? Does one organization place more emphasis on incentive compensation that the other? Board culture is also important if you’re planning on inviting members of the target’s board to join yours as part of the deal. How do the target’s directors see the roles of management and the board compared to yours? Unless the transaction has been structured as a merger of equals, the acquirer often assumes that its culture will have primacy going forward, but there might be aspects of the target’s culture that are superior, and the acquirer would do well to consider how to inculcate those values or practices in the new organization.

Return on Investment
A bank board may have various motivations for doing an acquisition, but usually there is only one thing most investors care about – how long before the acquisition is accretive to earnings per share? Generally, most investors expect an acquisition to begin making a positive contribution to earnings within one or two years. There are a number of factors that help determine this, beginning with the purchase price. If the acquirer is paying a significant premium, it may take longer for the transaction to become accretive. Other factors that will influence this include duplicative overhead (two CFOs, two corporate secretaries) and overlapping operations (two data centers, branches on opposite corners of the same intersection) that can be eliminated to save costs, as well as revenue enhancements (selling a new product into the target’s customer base) that can help drive earnings.

Capabilities of Your M&A Team
A well-conceived acquisition can still stumble if the integration is handled poorly. If this is your bank’s first acquisition, take the time to identify which executives in your organization will be in charge of combining the two banks into a single, smoothly functioning organization, and honestly assess whether they are equal to the task. Many successful banks find they don’t possess the necessary internal talent and need to engage third parties to ensure a successful integration. In any case, the acquiring bank’s CEO should not be in charge of the integration project. While the CEO may feel it’s imperative that they take control of the process to ensure its success, the greater danger is that it distracts them from running the wider organization to its detriment.

Any acquisition comes with a certain amount of risk. However, proactive consideration toward talent, technology, culture, ROI and a thoughtful selection of the integration team will help enable the board to evaluate the opportunity and positions the acquiring institution for a smooth and successful transition.

Cloudy M&A Expectations for 2021

Due to the Covid-19 pandemic, related economic downturn and recent presidential election, 2020 was a historic year characterized by high levels of uncertainty. These circumstances resulted in a significant drop in M&A activity in the banking sector, as stock prices dropped and bankers’ focused on serving customers and supporting their staff.

Bank Director’s 2021 Bank M&A Survey, sponsored by Crowe LLP, explores this unique environment. Rick Childs, a partner at Crowe, offers his perspective on the survey results — and what they mean for 2021 — in this video.

  • Top Deal Drivers

  • Pricing Expectations

  • Looking Ahead

Will We Ever See Three Times Book Again?

Mergers and acquisitions are examined as part of Bank Director’s Inspired By Acquire or Be Acquired. Click here to access the content on BankDirector.com.

In the late 1990s, the economy was doing well.

Bank stocks traded at such rich multiples that no one batted an eye when a management team sold their bank for two times book. That valuation meant you were a mediocre bank.

Take Fifth Third Bancorp in Cincinnati. In the ‘90s, its stock traded at more than five times book value. A well run and efficient bank, it had the currency to gobble up competitors and it did.

It announced a deal in 1999 to buy Evansville, Indiana-based CNB Bancshares for 3.6 times tangible book value and 32 times earnings. “That was not completely unheard of,” says Jeff Davis, managing director at consultancy Mercer Capital. Fifth Third announced a deal in 2000 to buy Old Kent Financial Corp for a 42% premium.

In fact, Fifth Third was a little late to the M&A premium game. The average bank M&A deal price reached a peak of 2.6 times tangible book value in 1998. The median price was 24 times earnings that year.

M&A Pricing Peaked in 1998

Source: Mercer Capital, S&P Global Market Intelligence and FDIC.

It was such a hot market for bank acquisitions, investors rushed into bank stocks in order to speculate on who would get purchased next. I remember sitting down with then-president of the Tennessee Bankers Association, Bradley Barrett, in the mid-2000s. He predicted the market would fall and many banks would suffer.

Boy, was he right. He was probably the first to school me in banking cycles.

Fast forward two decades. The industry is in a relatively depressed trough for bank valuations. Selling a bank for three times book value in the 2020s seems a remote fantasy. And it is. The pandemic and the economic uncertainty that kicked off this decade took a huge chunk out of banks’ earning potential and dragged down shares. As of Feb. 2, the KBW Nasdaq Bank Index was down 4% compared to a year ago. The S&P 500 was up 18% in the same time frame.

Granted, bank stock valuations have improved during the last six months. Investors tie bank stocks to the health of the economy: When the economy is improving, so will bank stocks, the thinking goes. As pricing improves, bankers should be more interested in doing deals in 2021, Davis says. Much of bank M&A pricing is dependent on the value of the acquirer’s stock, since most deals have a stock component.

But rising stock prices haven’t translated into higher prices for deals — at least not yet. The average price to tangible book value for a bank deal at the end of 2020 was 116%, according to Davis, presenting slides during a session of Inspired by Acquire or Be Acquired.

Improved stock valuations alone can’t alleviate the pressure holding down M&A premiums. Newer loans are pricing lower as companies and individuals refinance or take on new loans at lower rates, slimming net interest margins.

Plus, investors have also been less receptive recently to banks paying big premiums for sellers, says William Burgess, co-head of investment banking for financial institutions at Piper Sandler, during an Inspired By presentation.

There’s usually a rise of mergers of equals in times after an economic crisis, and that’s exactly what the industry is experiencing. The rollout of the vaccine and improving economic conditions could lead to more confidence on the part of buyers, higher stock prices and more bank M&A. Sellers, meanwhile, are under pressure with low interest rates, slim margins and the costs of rapidly changing technology.

“We think there’s going to be a real resurgence in M&A in late spring, early summer,” Burgess says.

To see M&A pricing rise to three times book, though, interest rates would have to rise substantially, Davis says. But higher interest rates could pose broader problems for the economy, given the heavy debt loads at so many corporations and governments. Corporations, homeowners and individuals could struggle to make debt payments if interest rates rose. So would the United States government. By the end of 2020, America’s debt reached 14.9% of gross domestic product, the highest it has been since World War II. In an environment like this, it might be hard for the Federal Reserve to raise rates substantially.

“The Fed seems to be locked into a low-rate regime for some time,” Davis says. “I don’t know how we get out of this. The system is really stuck.”

Exploring Banking’s What Ifs

What if the ball didn’t sneak through Bill Buckner’s legs in 1986?

What if you answered the call to deliver two pizzas for 10,000 bitcoins in 2010?

What if Hillary Clinton lost the popular vote but won the electoral college in 2016?

Thought exercises like these can take you down the rabbit holes that many opt to avoid. But how about asking “what if” type questions as a way to embrace change or welcome a challenge?

Mentally strong leaders do this every day.

In past years, such forward-facing deliberations took place throughout Bank Director’s annual Acquire or Be Acquired conference. This year, hosting an incredibly influential audience in Phoenix simply wasn’t in the cards.

So, we posed our own “what ifs” in order to keep sharing timely and relevant ideas.

To start, we acknowledged our collective virtual conference fatigue. We debated how to communicate key concepts, to key decision makers, at a key moment in time. Ultimately, we borrowed from the best, following Steve Jobs’ design principle by working backward from our user’s experience.

This mindset resulted in the development of a new BankDirector.com platform, which we designed to best respect our community’s time and interests.

Now, as we prepare to roll out this novel, board-level business intelligence package called Inspired By Acquire or Be Acquired, here’s an early look at what to expect.

This new offering consists of short-form videos, original content and peer-inspired research — all to provide insight from exceptionally experienced investment bankers, attorneys, consultants, accountants, fintech executives and bank CEOs. Within this new intelligence package, we spotlight leadership issues that are strategic in nature, involve real risk and bring a potential expense that attracts the board’s attention. For instance, we asked:

WHAT IF… WE MODERNIZE OUR ENTERPRISE

The largest U.S. banks continue to pour billions of dollars into technology. In addition, newer, digital-only banks boast low fees, sleek and easy-to-use digital interfaces and attractive loan and deposit rates. So I talked with Greg Carmichael, the chairman and CEO of Cincinnati-based Fifth Third Bancorp, about staying relevant and competitive in a rapidly evolving business environment. With our industry undergoing significant technological transformation, I found his views on legacy system modernization particularly compelling.

 

WHAT IF… WE TRANSFORM OUR DELIVERY EXPECTATIONS

Bank M&A was understandably slow in 2020. Many, however, anticipate merger activity to return in a meaningful way this year. For those considering acquisitions to advance their digital strategies, listen to Rodger Levenson, the chairman and CEO of Wilmington, Delaware-based WSFS Financial Corp. We talked about prioritizing digital and technology investments, the role of fintech partnerships and how branches buoy their delivery strategy. What WSFS does is in the name of delivering products and services to customers in creative ways.

 

WHAT IF… WE DELIGHT IN OTHER’S SUCCESSES

The former chairman and CEO of U.S. Bancorp now leads the Make-A-Wish Foundation of America. From our home offices, I spent time with Richard Davis to explore leading with purpose. As we talked about culture and values, Richard provided valuable insight into sharing your intelligence to build others up. He also explained how to position your successor for immediate and sustained success.

These are just three examples — and digital excerpts — from a number of the conversations filmed over the past few weeks. The full length, fifteen to twenty minute, video conversations anchor the Inspired By Acquire or Be Acquired.

Starting February 4, insight like this lives exclusively on BankDirector.com through February 19.  Accordingly, I invite you to learn more about Inspired By Acquire or Be Acquired by clicking here or downloading the online content package.