2021 Bank M&A Survey Results: Uncertainty Stalls Growth Plans

Will bank M&A activity thaw out in 2021?

Bank deals have been in deep freeze due to Covid-19 and the related economic downturn, but most of the executives and directors responding to Bank Director’s 2021 Bank M&A Survey, sponsored by Crowe LLP, say their bank remains open to doing deals.

More than one-third say their institution is likely to purchase a bank by the end of 2021; this represents a significant decline compared to last year’s survey, when 44% believed an acquisition likely in 2020. Branch and loan portfolio acquisitions also look slightly less attractive compared to a year ago.

The barriers to dealmaking may prove difficult to surmount in today’s uncertain economic and political environment.

With pressures on small businesses and the commercial real estate market exacerbated by remote work and social distancing measures, the recovery of the U.S. economy — and bank M&A — may hinge on conquering the coronavirus. In response, bank leaders are focused on credit quality: 63% point to concerns about the quality of a potential target’s loan book as a top barrier to making an acquisition, up significantly from last year’s survey (36%).

Despite concerns about credit quality and profitability, 85% say their bank is no more likely to sell due to Covid-19, and just 7% regret that they didn’t sell before the current downturn, when target banks could expect to command a higher price.

This willingness to carry on and weather these challenges may find its foundation in respondents’ long-term expectations. More than half anticipate a slow rebound for the U.S. economy. Twenty-eight percent don’t expect to return to pre-crisis levels in 2021, and 7% believe the recession will deepen.

Still, half believe that when the crisis abates, their bank will be just as strong as it was earlier this year. Forty-four percent express even greater optimism, believing they’ll emerge even stronger.

Key Findings

Loan Losses
More than half (57%) believe their bank’s loan loss allowance will be sufficient to cover expected losses over the next 12 months. Two-thirds say that less than 5% of residential mortgages will default and 64% that less than 5% of commercial loans will default.

Willing to Pay for Quality
When describing their bank’s acquisition strategy, 44% indicate that they seek strategic acquisitions, regardless of price. One-quarter look for low-priced acquisitions of historically well-run banks; 27% are comfortable paying a premium for well-managed banks.

Tech Acquisitions Rare
Just 11% believe they’ll purchase a technology company. Of these, 63% express interest in buying a business or commercial lending platform; 63% are open to acquiring a consumer deposit-gathering platform. Almost half seek data analytics capabilities.

Price Remains a Barrier
Potential acquirers’ concerns about pricing as a barrier to dealmaking have dropped significantly — from 72% last year to 60% in this year’s survey. However, more respondents express concern about their ability to use stock as currency in a deal, as well as demands on their capital should they acquire.

Effects on Capital
Most believe their bank’s capital levels are sufficient to weather the economic downturn, assuming a rapid (98%) or slow (98%) recovery in 2021, or mild recession (97%). Eighty-one percent believe they can weather a deeper recession. Just one-quarter plan to raise capital over the next six months.

High Marks for Trump
An overwhelming majority award President Trump’s administration positive marks for the rollout of Paycheck Protection Program loans (90%) and stimulus payments (91%), and its support of the U.S. economy (88%). Two-thirds believe the administration has effectively responded to the pandemic.

To view the full results of the survey, click here.

The Widening M&A Gap

The number of bank M&A transactions completed in 2020 represent a stark decline compared to those that have closed in recent years. Dory Wiley of Commerce Street Capital believes that deal activity will rebound in 2021 — but notes that buyers and sellers may find it even more difficult to come to terms on price. In this video, he provides guidance on how banks can meet their goals.

  • Predictions for 2021
  • Considerations for Acquirers
  • Advice for Prospective Sellers

Banks Have Started Recording Goodwill Impairments, Is More to Come?

A growing number of banks may need to record goodwill impairment charges once the coronavirus crisis finally shows up in their credit quality.

A handful of banks have already announced impairment charges, doing so in the first and second quarter of this year. Some have written off as much as $1 billion of goodwill, dragging down their earnings and, in some cases, dividends. Volatility in the stock market could make this worse in the second half of the year.

“It was a very hot topic for all of our financial institutions,” says Ashley Ensley, a partner in DHG’s financial services practice. “Everyone was talking about it. Everybody was looking at it. Whether you determined you did … or didn’t have a triggering event, I expect that everyone that had goodwill on their books likely took a hard look at that amount this quarter.”

Goodwill at U.S. banks totaled $342 billion in the first quarter, up from $283 billion a decade ago, according to the Federal Deposit Insurance Corp.

Goodwill is an intangible asset that reconciles the premium paid for acquired assets and liabilities to their fair value. It’s recorded after an acquisition, and can only be written down if the subsequent carrying value of the deal exceeds its book value. Although goodwill is an intangible asset excluded from tangible common equity, the non-cash charge can have tangible consequences for acquisitive banks. It immediately hits the bottom line, reducing income and, potentially, even capital.

Several banks have announced charges this year. PacWest Bancorp, a $27.4 billion bank based in Beverly Hills, California, took a charge of $1.47 billion. Great Western, a $12.9 billion bank based in Sioux Falls, South Dakota, took a charge of $741 million. And Cadence Bancorp., an $18.9 billion bank based in Houston, Texas, recorded an after-tax impairment charge of $413 million.

Boston-based Berkshire Hills Bancorp announced a $554 million charge during its second-quarter earnings that wiped out all its goodwill. The charge, combined with higher loan loss provisions, led to a loss of $10.93 a share. Without the goodwill charge, the bank would’ve reported a loss of only 13 cents a share.

The primary causes of the goodwill impairment were economic and industry conditions resulting from the COVID-19 pandemic that caused volatility and reductions in the market capitalization of the Company and its peer banks, increased loan provision estimates, increased discount rates and other changes in variables driven by the uncertain macro-environment,” the bank said in its quarterly filing.

Goodwill impairment assessments begin by evaluating qualitative factors for positive and negative evidence — both internally and in the macroeconomic environment — that could cause a bank’s fair value to diverge from its book value.

“It really is not a one-size-fits-all analysis,” says Robert Bondy, a partner in Plante Moran’s financial services group. “Just because a bank — even in the same marketplace — has an impairment, it’s hard to cast that shadow over everybody.”

One reason banks may need to consider impairing their goodwill is that bank stock prices are meaningfully down for the year. The KBW Regional Banking Index, a collection of 50 banks with between $9 billion and $63 billion in assets, is off by 33%. This is especially important given the deceleration in bank deals, which makes it hard to evaluate what premiums banks could fetch in a sale.

“[It’s been] one or two quarters and overall markets have rebounded but bank stocks haven’t,” says Jay Wilson, Jr., vice president at Mercer Capital. “You can certainly presume that the annual impairment test, when it comes up in 2020, is going to be a more robust exercise than it was previously.”

Banks could also write off more goodwill if asset quality declines. That has yet to happen, despite higher loan loss provisions — and in some cases, banks saw credit quality improve in the second quarter.

The calendar could influence this as well. Wilson says the budgeting process and cyclical cadence of accounting means that annual tests often occur near year-end — though, if a triggering event happens before then, a company can conduct an interim test.

That’s why more banks could record impairment charges if bank stocks don’t rally before the end of the year, Wilson says. In this way, goodwill accumulation and impairment mirror the broader economy.

“Whenever the cycle turns, banks are inevitably in the middle of it,” he says. “There’s no way, if you’re a bank to escape the economic or the business cycle.”

Dual Deal Accounting Challenges During a Pandemic

Bank mergers and acquisitions are not easy: balancing the standard process of due diligence to verify financial and credit information, adapting processing methods and measuring fair value assets and liabilities. The ongoing pandemic coinciding with the implementation of the current expected credit loss model, or CECL, by larger financial institutions has made bank mergers even more complex. As your financial institution weighs the benefits of a merger or acquisition, here are two important accounting impacts to consider.

Fair Value Accounting During a Pandemic

When two banks merge, the acquiring bank will categorize the loans as performing or purchase credit impaired/deteriorated and mark the assets and liabilities of the target bank to fair value.

This categorization of loans is difficult — the performance of these loans is currently masked due to the large number of loan modifications made in the second quarter. With many customers requesting loan modifications to defer payments for several months until the economy improves, it is difficult for the acquiring bank to accurately evaluate the current financial position of the target bank’s customers. Many of these customers could be struggling in the current environment; without additional information, it may be very difficult to determine how to classify them on the day of the merger. 

One of the more complex areas to assess for fair value is the loan portfolio, due to limited availability of market data for seasoned loans. As a result, banks are forced to calculate the fair value of assets while relying on subjective inputs, such as assumptions about credit quality. Pandemic-response government programs and significant bank-sponsored modification programs make it difficult to fully estimate the true impact of Covid-19 on the loan portfolio. Modifications have obscured the credit performance data that management teams will base their assumptions, complicating the process even further.  

U.S. Generally Accepted Accounting Principles (GAAP) allows for true-up adjustments to Day 1 valuations for facts that were not available at the time of the valuation to correct the fair value accounting. These adjustments are typically for a few isolated items. However, the lagging indicators of Covid-19 have added more complexity to this process. There may be more-pervasive adjustments in the coming year related to current acquisitions as facts and circumstances become available. It is critical for management teams to differentiate between the facts that existed the day the merger closed versus events that occurred subsequent to the merger, which should generally be accounted for in current operations.  

CECL Implementation

For large banks that implemented CECL in the first quarter of 2020, a significant change in the accounting for acquired loans can create a new hurdle. Under the incurred loss model, no allowance is recorded on acquired loans, as it is incorporated in the fair value of the loans. Under the new CECL accounting standard, the acquirer is required to record an allowance on the day of acquisition — in addition to the fair value accounting adjustments. While this allowance for purchase deteriorated credits is a grossing-up of the balance sheet, the performing loan portfolio allowance is recorded through the provision for loan losses in the income statement.

This so-called “double-dip” of accounting for credit risk on acquired performing loans is significant. It may also be an unexpected change for many users of the financial statements. Although CECL guidance has been available for years, this particular accounting treatment for acquired performing loans was often overlooked and may surprise investors and board members. The immediate impact on earnings can be significant, and the time period for recapturing merger costs may lengthen. As a result, bank management teams are spending more time on investor calls and expanding financial statement disclosures to educate users on the new accounting standards and its impact on their transactions.  

The two-fold accounting challenges of implementing CECL during a global pandemic can feel insurmountable. While the CECL standard was announced prior to Covid-19, management teams should take a fresh look at their financial statements as they prepare for earnings announcements. Similarly, if your bank is preparing to close an acquisition, plan on additional time and effort to determine the fair value accounting. By maintaining strong and effective communication, financial institutions will emerge stronger and prepared for future growth opportunities.

Pandemic Offers Strong Banks a Shot at Transformative Deals

It’s a rule of banking that an economic crisis always creates winners and losers. The losers are the banks that run out of capital or liquidity (or both), and either fail or are forced to sell at fire-sale prices. The winners are the strong banks that scoop them up at a discount.

And in the recent history of such deals, many of them have been transformative.

The bank M&A market through the first six months of 2020 has been moribund – just 50 deals compared to 259 last year and 254 in 2018, according to S&P Global Market Intelligence. But some banks inevitably get into trouble during a recession, and you had better believe that well-capitalized banks will be waiting to pounce when they do.

One of them could be PNC Financial Services Group. In an interview for my story in the third quarter issue of Bank Director magazine – “Surviving the Pandemic” – Chairman and CEO William Demchak said the $459 billion bank would be on the lookout for opportunistic deals during the downturn. In May, PNC sold its 22% stake in the investment management firm BlackRock for $14.4 billion. Some of that money will be used to armor the bank’s balance sheet against possible losses in the event of a deep recession, but could also fund an acquisition.

PNC has done this before. In 2008, the bank acquired National City Corp., which had suffered big losses on subprime mortgages. And three years later, PNC acquired the U.S. retail business of Royal Bank of Canada, which was slow to recover from the collapse of the subprime mortgage market.

Together, these deals were transformational: National City gave PNC more scale, while Royal Bank’s U.S. operation extended the Pittsburgh-based bank’s franchise into the southeast.

“We’re more than prepared to do it,” Demchak told me in an interview in late May. “And when you have a safety buffer of capital in your pocket, you can do so with a little more resolve than you otherwise might. The National City acquisition was not for the faint of heart in terms of where we were [in 2008] on a capital basis.”

One of the most profound examples of winners profiting at the expense of the losers occurred in Texas during the late 1980s. From 1980 through 1989, 425 Texas banks failed — including the state’s seven largest banks.

The root cause of the Texas banking crisis was the collapse of the global oil market, and later, the state’s commercial real estate market.

The first big Texas bank to go was actually Houston-based Texas Commerce, which was acquired in 1986 by Chemical Bank in New York. Texas Commerce had to seek out a merger partner after absorbing heavy loan losses from oil and commercial real estate. Through a series of acquisitions, Chemical would later become part of JPMorgan Chase & Co.

Two years later, Charlotte, North Carolina-based NCNB Corp. acquired Dallas-based First Republicbank Corp. after it failed. At the time, NCNB was an aggressive regional bank that had expanded throughout the southeast, but the Texas acquisition gave it national prominence. In 1991, CEO Hugh McColl changed NCNB’s name to NationsBank; in 1998, he acquired Bank of America Corp. and adopted that name.

And in 1989, a third failed Texas bank: Dallas-based MCorp was acquired by Bank One in Columbus, Ohio. Bank One was another regional acquirer that rose to national prominence after it broke into the Texas market. Banc One would also become part of JPMorgan through a merger in 2004.

You can bet your ten-gallon hat these Texas deals were transformative. Today, JPMorgan Chase and Bank of America, respectively, are the state’s two largest banks and control over 36% of its consumer deposit market, according to the Federal Deposit Insurance Corp. Given the size of the state’s economy, Texas is an important component in their nationwide franchises. 

Indeed, the history of banking in the United States is littered with examples of where strong banks were able to grow by acquiring weak or failed banks during an economic downturn. This phenomenon of Darwinian banking occurred again during the subprime lending crisis when JPMorgan Chase acquired Washington Mutual, Wells Fargo & Co. bought out Wachovia Corp. and Bank of America took over Merrill Lynch.

Each deal was transformative for the acquirer. Buying Washington Mutual extended JPMorgan Chase’s footprint to the West Coast. The Wachovia deal extended Wells Fargo’s footprint to the East Coast. And the Merrill Lynch acquisition gave Bank of America the country’s premier retail broker.

If the current recession becomes severe, there’s a good chance we’ll see more transformative deals where the winners profit at the expense of the losers.

Revisiting the Post-Pandemic Strategic Plan

The coronavirus pandemic has tossed any strategic plans for 2020 — which bank management teams created in late 2019 — out the window.

The banking industry has been directly affected by unprecedented challenges stemming from the Covid-19 crisis, and have quickly addressed emerging issues and adapted their procedures and operations. Revisiting the strategic plan will require executives to holistically reassess risks, challenges, potential opportunities and future goals. While banks will need to re-examine their strategic plans for operational initiatives, it is prudent to also reassess their plans for capital adequacy and approach to M&A.

Capital Planning for Defense and Offense
When reassessing the strategic plan and the impact of Covid-19, banks should consider if current capital ratios provide enough flexibility to both play defense by protecting the balance sheet in a prolonged adverse scenario, and play offense with enough capital to execute on growth opportunities. We believe it is prudent to evaluate multiple scenarios and raise capital when you can — not when you need to.

The capital markets are open today, and many banks have proactively raised subordinated debt in the second quarter. Sub-debt is an attractive form of capital due to its regulatory treatment, no dilution to ownership and relatively low cost in the current rate environment. From a regulatory perspective, sub-debt can qualify as Tier 2 capital at the holding company; proceeds can be down streamed to the bank subsidiary, which qualifies as Tier 1 capital at the bank level, strengthening regulatory capital ratios. The interest expense is tax-deductible, which reduces the effective cost.

The market appetite for sub-debt has been robust: since the beginning of April, commercial banks have raised over $3.5 billion at an average interest rate of approximately 5.50%. Historically, institutional investors were the most active buyers of sub-debt, but the buyer mix has shifted to rely on community and regional banks, insurance companies and asset managers — all looking for attractive yields.

Mergers and Acquisitions        
M&A activity has come to a screeching halt as banks prioritized an internal focus to assess risk. Only nine whole-bank M&A transactions were announced in the second quarter, compared to 67 transactions during the same timeframe in 2019. It seems reasonable to expect valuation multiples will trend lower and deal activity will be subdued until acquirers’ currencies rebound and parties have more visibility and confidence with credit quality and earnings.

On a more positive note, we expect banks to warm to the idea of mergers as strategic partnerships to strengthen the combined company with operational scale and synergies. Of course, these transactions can be challenging to complete and dependent upon similar cultures and management compatibility; however, suppressed M&A valuations provide a window of opportunity since the usual bank buyers aren’t paying rich premiums in the current environment. Economic consideration in a strategic partnership is typically majority stock, not cash, so both parties are reinvesting and have potential to increase the combined company’s value for a more-advantageous positioning when the market recovers.

If you were planning on being a buyer in the next 12 to 18 months, it is important to evaluate how your M&A strategy and priorities may have changed. Buyers with a strong public currency or excess capital will maintain their competitive advantage, but need to be highly selective and strategic for their next deal. Among other things, acquirers will need to bolster the due diligence process to address new challenges and risks.

If you were planning on being a seller in the next 12 to 18 months, focus on identifying your potential buyers, how your valuation may have changed and how you can position the bank to improve the valuation. It is prudent to engage with external advisors in this process, including an investment banker and legal counsel to evaluate these scenarios in detail, even if there is no urgency for a transaction.

These are unprecedented times, and every day seems to bring a new challenge. While it is impossible to predict what will transpire in the next six to 12 months, it is important to update the strategic plan to position your bank to protect shareholder value and take advantage of opportunities.

Information contained herein has been obtained by sources we consider reliable, but is not guaranteed and we are not soliciting any action based upon it. Any opinions expressed are based on our interpretation of data available to us at the time of the original publication of the report. These opinions are subject to change at any time without notice.

Realities Beyond the Balance Sheet Facing Bank Buyers

Financial leaders face new and unique challenges as the navigate the remainder of this year and well into 2021.

The early reads on credit quality, credit access, operational and execution risk, regulatory oversight impacts and dimming growth prospects paint a bleak picture. Underlying this environment is an ongoing consideration for consolidation forcing institutions to assess their long-term viability. A closer examination of tangible book values clearly demonstrates who could be the buyers and potential sellers.

So, what is so different for M&A now? I have always believed that no two deals are the same —and that remains true. In the past, we may have looked solely at regulatory good standing, loan concentration, deposit pricing and distribution like geography and branches. While these remain fundamentally most important at the core, we now fully expect to see a heightened focus in due diligence around key layers of bank leadership, corporate culture and values, ability to deliver digital offerings to key customer segments, financial literacy programs and community investment.

A recent study by Deloitte noted that more than ever, bank M&A strategies need the right tools, teams and processes — from diligence through integrations — to pull off successful mergers. Additionally, buyers need to consider the compatibility and integration of any digital tools and how they will meet customer expectations. Can your bank deliver what these customers expect?

Most institutions looking to acquire or be acquired need to address several non-financial topics when considering how to proceed. Five in particular are consistently under-communicated by acquirers and will be even more impactful moving forward. These items speak to the fit of the merger partners — the intangible elements that cause the difference between a high customer retention rate with a platform for organic growth or a tepid retention rate with little sign of future organic growth.

1. Strategic Leadership
How an institution’s leaders navigated the recent Covid-19 pandemic says a lot about what investors, employees, customers and communities can expect if it merges with another bank. For example, the Small Business Administration’s Paycheck Protection Program may have given some banks lessons and plans that may make them potential partners worth exploring. No one knows what lies ahead, but strategic leaders must be able to think, clarify and execute during these new M&A conditions.

2. Bank Culture and Values
Most banks have a mission, vision and values statements. Until the current environment, how leaders must lead to make employees feel included and valued had not been challenged. But in almost every M&A engagement, there are significant segments of impacted employees and customers that experience uncertainty and fear. Demonstrated values can go a long way to secure trust and help the execution of these transactions succeed.

3. Digitization Expectations for Employees and Customers
Many institutions were not prepared for what occurred earlier this spring. Disaster recovery and business resumption plans were a solid start, but many were insufficient for this type of event, requiring operations and services to move off-site in a matter of days.

But aside from the initial challenges of the PPP, most banks appear to have done an outstanding job of helping employees work from home without too much customer disruption. This operating model will be the new way forward in banking. When banks merge, it is important to understand how each institution’s plan worked, and how much or little displacement that model could be for employees and customers going forward.

4. Financial Literacy and Inclusion
The reality of how our country has operated over decades has come into focus during the pandemic. One issue that many banks have identified is access to capital and providing banking services in a service-blind manner going forward. Financial literacy and inclusion must be a tenet in creating a more-effective banking system. Aligning how these programs can work, collaboration and inclusiveness can create a platform for capital distribution that works with any institutional strategy and grows exponentially after a merger.

5. Community Investment
Many institutions have invested significantly in community programs over the years. In a merger, these groups need to understand what the plan for that support will be going forward. The pandemic has made it even more important to discuss and support these investments in communities, given the struggle of many organizations these days. While these five items are not exhaustive, we know that they are among the top issues of executives, employees and customers at prospective selling institutions.

Pandemic Challenges, Strengthens Bank’s Deal Integration

One bank found that the Covid-19 pandemic actually accelerated its deal integration, creating a stronger pro-forma institution to serve clients after overcoming a number of unexpected hurdles.

The coronavirus crisis has thrown a wrench in bank mergers and acquisitions, challenging everything from due diligence to pricing to regulatory and shareholder approvals. Only two bank deals were announced in May, according to S&P Global Market Intelligence; potential buyers and sellers seem to be focusing on assisting customers while they wait for a normalized environment. But Sandy Spring Bancorp found itself with no choice but to adapt its deal integration with Rockville, Maryland-based Revere Bank, even as both banks shifted to a remote work environment.

For us, it’s very important to understand that not just the successful integration, but a successful acquisition is centered around finding the right partner to begin with,” says Sandy Spring President and CEO Daniel Schrider. “And it’s really important … to find an organization that either complements what we do or provides access to a different market that maybe we’re not in, but has a shared vision around client relationships.”

The Revere team was well-known to Sandy Spring, with executives serving on their state bank association as well as competing against each other for local deals. After talking for about 18 months, they announced their merger agreement in September 2019; the deal pushed the Olney, Maryland-based bank above $10 billion in assets.

For months, deal integration proceeded as expected. The banks kicked off internal communication campaigns to keep both groups informed of the timeline, process and upcoming changes, and increase comradery before merger close. They formed 20 cross-functional teams of employees from both companies that tackled specific integration-related tasks or objectives, which met through mid-February.

“Both companies had tremendous first quarters. We were very excited about bringing the two organizations in a new structure and pulling the trigger on a number of things, based upon our ability to be together,” he says. “Then obviously, things came to a screeching halt.”

Once the pandemic closed physical offices, Sandy Spring used video and electronic communication to continue integration work. The pro-forma executive team created welcome videos featuring Schrider, along with digital and virtual orientations, instead of the usual face-to-face interactions.

But the integration encountered yet another unexpected challenge: the Paycheck Protection Program. The Small Business Administration loan program began accepting applications on April 3, two days after the Revere acquisition closed.

All of a sudden, two companies were faced with trying to solve the problems that many of their clients are having,” Schrider says. “That actually accelerated our integration.”

The newly combined teams, which pride themselves on being relationship focused, worked together to fulfill the unsolicited loan demand. They hosted daily PPP calls and involved more than 200 employees to process applications from customers at both banks. The undertaking combatted any inertia they may have felt about actually combining and functioning as one company.

“In a strange way, we’re probably in a better place today than we would have been, absent a pandemic, from the standpoint of being together,” he says. “Even though we’re not physically together.”

Sandy Spring believes picking a bank partner with similar values and staying focused on its strategy helped the pro-forma institution navigate deal-specific challenges. For instance, the all-stock deal for Revere originally carried a price tag of $460.7 million when it was announced in September; at close, it was valued at $287 million based on Sandy Spring’s quarter-end stock price, according to S&P Global Market Intelligence. Schrider says potential buyers and sellers should avoid fixating on absolute deal price, and instead consider the relative value and potential upside of the combined entity’s shares.

So far, the only integration activities that the pandemic has paused are reorganization efforts the bank believes are best done in person, including the planned appointment of Revere co-CEO Ken Cook as executive vice president. The systems conversion and branch consolidation are still on track for the third quarter. Until then, the pro-forma institution will continue to integrate while serving clients during the pandemic.

“It’s been a wild ride but a good one,” Schrider says.

Pending, Future Bank M&A Challenged by Coronavirus Crisis

The coronavirus pandemic has complicated bank M&A, throwing prospective buyers and sellers into limbo.

The crisis and economic fallout have made mergers and acquisitions an even-more tenuous proposition for banks that find themselves in the middle of a uniquely challenging operating environment. Industry experts believe that activity may come to a standstill for the time being but see opportunity for patient buyers once it thaws.

“I think it’s kind of high drama in every situation, if you put yourself on the board of either side of these transactions,” says Curtis Carpenter, principal and head of investment banking at Sheshunoff & Co. Investment Banking. “I’m really surprised that more deals have not fallen apart, quite frankly.”

Deals that have held together so far are most likely situations where both parties have been equally impacted by the economic shutdown and believe that the transaction’s merits will remain unchanged once the pandemic subsides, he says.

But the selloff in the equity markets has weighed on valuations for stock-based deals, making them untenable for some parties. Increasing credit risk, low interest rates, net interest margin compression and high unemployment are all headwinds for bank earnings, creating a potential ceiling on stock valuations. The average share price of an acquirer with an outstanding transaction has dropped about 20% in the last three months, says Crowe partner Rick Childs. If a transaction was all stock, the discount is fully included in the price; a split between cash and stock dilutes the selloff discount.

Half of the eight deals that have been terminated since the start of the year were impacted by the coronavirus crisis, Childs says. The largest of the terminated deals was the proposed $3.3 billion merger between the $36 billion Texas Capital Bancshares, based in Dallas, and Independent Bank Group, which is based in McKinney, Texas, and has $16 billion in assets. Several more have been postponed or renegotiated.

Buyers may try to argue that stock declines are temporary, though some are choosing to renegotiate. San Diego-based Southern California Bancorp, which has $852 million in assets, disclosed in April that it had renegotiated its October 2019 merger agreement with CalWest Bancorp. It lowered its all-cash offer by 19% for the Rancho Santa Margarita, California-based bank, to $25.9 million. The acquisition of the $226 million bank closed June 1.

But there is still risk for cash buyers and other parties committing to closing a deal. For years, credit had been so clean that buyers risked “giving lip service” to doing due diligence on a seller, Childs says. Now, acquirers must take pains to understand the potential risks they might be buying, especially as banks process deferrals and loan forgiveness applications for the Small Business Administration’s Paycheck Protection Program.

Deals may also take longer to close during the pandemic because regulators have limited capacity, though not in every case. Childs is involved in some delayed deals because regulators have shifted their attention away from applications to assisting banks with changing policies and emerging issues or questions. Banks that have announced delays are adding an average of two additional months, he says.

However, some banks have managed to receive timely, or early, approvals. CenterState Bank Corp., which has $19 billion in assets and is based in Winter Haven, Florida, disclosed that it had received all regulatory approvals ahead of schedule for its merger with South State Corp., which has $17 billion in assets and is based in Columbia, South Carolina.

While the environment may be challenging for pending deals, it could be productive for prospective ones. Childs says cash buyers may find management teams with an increased interest in selling because of crisis fatigue and the anticipation of a long road to economic recovery, which could lead to compelling valuations. Carpenter counters that sellers may not want to accept a cash deal because it would be a permanent discounted valuation. Accepting equity gives the seller’s shareholders a way to ride out the recovery and could make a lower initial valuation more palpable. Both Childs and Carpenter are working on deals that have yet to be announced.

Buyers that have stock may want to include struggling fintechs in their search for potential targets, Childs says. Fintechs may have superior technology or capabilities that could add a business line or increase a buyer’s capabilities, but face funding or capital challenges because of the economic crisis.

“Either taking a significant ownership stake or buying it outright might be a heck of a deal for you, and your stock is probably going to be better than their stock,” he says.

In the meantime, Childs advises banks to trim the fat from their financial statements. If a bank has been on the fence about assets, business lines or portfolios it owns, now is an opportunistic time to sell them and raise cash. It is also a good time for cash buyers to establish credit lines or loan arrangements they may use to finance a deal, but cautioned stock buyers against raising equity capital until prices recover.

“I think we’ll have a few more deals called off between now and their expected closing dates, but probably what we’ll see is very few announced deals unless we come back in a big way,” Childs says. “We may end up having a great fourth quarter because of pent-up demand, but there will probably be a dip in the middle part of the year.”

The Biggest Priorities for Banks in Normal Times

Banks are caught in the midst of the COVID-19 pandemic sweeping across the United States.

As they care for hurting customers in a dynamic and rapidly evolving environment, they cannot forget the fundamentals needed to steer any successful bank: maintaining discipline in a competitive lending market, attracting and retaining high-quality talent and improving their digital distribution channels.

Uncovering bankers’ biggest long-term priorities was one of the purposes of a roundtable conversation between executives and officers from a half dozen banks with between $10 billion and $30 billion in assets. The roundtable was sponsored by Deloitte LLP and took place at Bank Director’s annual Acquire or Be Acquired conference at the end of January, before the brunt of the new coronavirus pandemic took hold.

Kevin Riley, CEO of First Interstate BancSystem, noted that customers throughout the $14.6 billion bank’s western footprint were generally optimistic prior to the disruption caused by the coronavirus outbreak. Washington, Oregon and Idaho at the time were doing best. With trade tensions and fear of an inverted yield curve easing, and with interest rates reversing course, businesses entered 2020 with more confidence than they entered 2019.

The growth efforts reflect a broader trend. “In our 2020 M&A Trends survey, corporate respondents cited ‘efficiency and effectiveness in change management’ and ‘aligning cultures’ as the top concerns for new acquisitions,” says Liz Fennessey, M&A principal at Deloitte Consulting.

A major benefit that flows from an acquisition is talent. “More and more, we’re seeing M&A used as a lever to access talent, which presents a new set of cultural challenges,” Fennessey continues. “In the very early stages of the deal, the acquirer should consider the aspects core to the culture that will help drive long-term retention in order to preserve deal value.”

One benefit of the benign credit environment that banks enjoyed at the end of last year is that it enabled them to focus on core issues like talent and culture. Tacoma, Washington-based Columbia Banking System has been particularly aggressive in this regard, said CEO Clint Stein.

The $14.1 billion bank added three new people to its executive committee this year, with a heavy emphasis on technology. The first is the bank’s chief digital and technology officer, who focuses on innovation, information security and digital expansion. The second is the bank’s chief marketing and experience officer, who oversees marketing efforts and leads both a new employee experience team and a new client experience team. The third is the director of retail banking and digital integration, whose responsibilities include oversight of retail branches and digital services.

Riley at First Interstate has employed similar tactics, realigning the bank’s executive team at the beginning of 2020 to add a chief strategy officer. The position includes leading the digital and product teams, data and analytics, as well as overseeing marketing, communications and the client contact center.

The key challenge when it comes to growth, particularly through M&A, is making sure that it improves, as opposed to impairs, the combined institution’s culture. “It is important to be deliberate and thoughtful when aligning cultures,” says Matt Hutton, a partner at Deloitte. “It matters as soon as the deal is announced. Don’t miss the opportunity to build culture momentum by reinforcing the behaviors you expect before the deal is complete.”

Related to the focus on growth and talent is an increasingly sharp focus on environmental, social and governance issues. For decades, corporations were operated primarily for the benefit of their shareholders — a doctrine known as shareholder primacy. But this emphasis has begun to change and may accelerate alongside the unfolding health crisis. Over the past few years, large institutional investors have started promoting a more inclusive approach known as stakeholder capitalism, requiring companies to optimize returns across all their stakeholders, not just the owners of their stock.

The banks at the roundtable have embraced this call to action. First National Bank of Omaha, in Omaha, Nebraska, publishes an annual community impact report, detailing metrics that capture the positive impact it has in the communities it serves. Columbia promotes the link between corporate social responsibility and performance. And First Interstate, in addition to issuing an annual environmental, social and governance report, has taken multiple steps in recent years to improve employee compensation and engagement.

Despite the diversity of business lines and geographies of different banks, these regional lenders shared multiple common priorities and fundamental focuses going into this year. The coronavirus crisis has certainly caused banks to change course, but there will be a time in the not-too-distant future when they and others are able to return to these core focuses.