Preparing for the New Reality of Bank Activism

activism-4-8-16.pngFrom 2000 to 2014, activist hedge fund assets under management are reported to have swelled from less than $5 billion to nearly $140 billion. This sharp rise in assets under management is reflected in a 57 percent increase in activist campaign activity over the last five years. And while performance can vary greatly by fund, reports are that activist hedge funds have generally outperformed other alternative investment strategies in recent years. The upshot for the banking industry is clear: as more activist investors with more dry powder are looking for investment opportunities, activists have moved beyond the “low-hanging fruit” into regulated industries, including financial services, which had previously been considered too complex.

Banks historically were viewed as unlikely targets for activist investors. The burdens are significant on an investor deemed to “control” the bank (from a bank regulatory perspective). The investor must be concerned with an intrusive Change in Bank Control Act filing and fundamental changes may be mandated by the Bank Holding Company Act if the investor’s voting, director and activist activities result in it crossing often less than well-defined “control” thresholds. However, today’s activists have learned that even small holdings of a bank’s stock—for example less than 5 percent of voting stock—often suffice to generate the desired change and provide the desired return. Many activists thus have successfully achieved their objectives without triggering bank regulatory consequences.

As activist investors sharpen their focus on the banking sector, their criteria for which entities to target remain the same. Target companies generally share several key characteristics: underperforming (on a relative basis), broadly held ownership structures and/or easily exercisable shareholder rights. An underperforming business presents the potential for economic upside, while a dispersed ownership structure and easily exercisable shareholder rights provide access to the boardroom, or at least the ability to make demands. Activist stakes are often small as a percentage of overall capital and many activist campaigns rely on winning over institutional and other investors on measures to improve the performance of the business and, ultimately, the stock price. These measures can range from those intended to result in a sale of the bank, such as changing directors, to less disruptive, but nonetheless material changes, such as enhancing clawback features in executive compensation plans.

While no two activist campaigns are alike, activist engagement generally begins with a private approach to the board of directors or management. If the activist does not succeed in private conversations, more public disclosure of the activist’s campaign can take the form of public letters to the board of directors or management, public letters to stockholders, white papers laying out the activist proposal, or filings with the Securities and Exchange Commission related to ownership of the target’s stock. Finally, and at greater cost to the activist and target alike, activists can commence a proxy contest or litigation.

So how is a bank to know whether an activist has taken a position in its stock? For smaller, privately held banks, it is more important than ever to maintain close oversight of investor rolls. Publicly traded banks need to monitor Schedule 13D and Form 13F filings. An investor that accumulates beneficial ownership of more than 5 percent of a voting class of a company’s equity securities must file a Schedule 13D within 10 days. In an activist campaign, however, 10 days can represent a very long time and an activist can build up meaningful economic exposure through derivatives without triggering a Schedule 13D filing obligation. 13F filings are made quarterly by institutional investment managers. On the antitrust front, and likely more relevant to midsize and larger banks, an investor that intends to accumulate more than $78.2 million of a company’s equity securities must generally make a Hart-Scott-Rodino (HSR) filing with the Federal Trade Commission and notify the issuer of the securities. As with Schedule 13D filings, an activist can use derivative investments to avoid triggering an HSR filing. Given the limits of these regulatory filings, many publicly traded companies turn to proxy solicitors and other advisors who offer additional data analytics services to track a company’s shareholder base.

Boards must proactively prepare for such events. Any activist response plan will address a handful of key issues, including an assessment of the bank’s vulnerabilities, an analysis of the bank’s shareholder rights profile, engagement with shareholders on strategic priorities generally, identification of the proper team to respond to an activist approach, and ongoing analysis and monitoring of the shareholder base. No plan will address all potential activist approaches, but the planning exercise alone, done well in advance without pressures of an activist campaign, can position a bank to minimize exposure to activist pressures and to respond quickly, proactively and effectively to activist approaches.

Fighting Off the Activists

3-2-15-CommerceSt.pngShareholder activism is on the rise and has become an increasingly relevant topic in boardrooms throughout the country. The regional and community banking sectors have also seen an increase in activist investors submitting shareholder proposals. The adage is true: The best defense is a good offense. With activist investors, the best defense is maintaining an extremely efficient, profitable bank with performance metrics and key operating ratios in the top quartile of a realistic peer group.  If this does not describe your situation, then your bank may prove an ideal target for an activist. An honest, objective assessment of a bank’s susceptibility to an activist, as well as strategic preparation about the bank board’s initial response will largely dictate the outcome of an activist’s approach. 

Regulatory structures, such as passivity agreements and certain requirements of the Bank Holding Company Act of 1956 (i.e. acting in concert), offer management advantages that are not available to non-banks. However, regulatory impediments generally do not provide much of a deterrent to activists who support their cases with empirical evidence designed to gather the support of other shareholders. More importantly, the playbook for an activist defense too often results in some form of capitulation to an activist. It is not uncommon for an activist to be awarded a board seat or for the target to be forced into announcing a review of its strategic alternatives. While arguably a compromise, too often those concessions are akin to letting the fox in the henhouse and simply put, things are never the same.

Accordingly, even with regulatory protections or other structural impediments that a company may have to slow down an activist, if a board has concerns about its vulnerability to an activist, it would be wise to seek the advice of experienced investment bankers.  Even if the board does not have concerns, it is wise to consult with an investment bank that has not been involved in the business activities of the bank or its holding companies, and is experienced in activism. The investment bankers can provide an independent assessment of the bank along with the available strategies and appropriate tactics to respond to the activist. The investment banker should be prepared to provide underperforming banks with strategic advice on the steps to be taken to increase the profitability of the bank and simultaneously prepare a strategic plan to fend off the unwanted advances of an activist. The plans need to be anticipatory in nature. If the board begins to plan only after an attack, its actions are reactive and the activist is in control of the situation.

When an activist calls, it is often the temptation for management to recommend that the board reject or stonewall the initial foray against the target or as described above, quickly compromise. The circle-the- wagons approach provides the activist just the type of unreasonable response that may garner support for the activist cause.  Failure by management to communicate with the activist shareholder is usually the response that motivates other shareholders to immediately align with the activist. 

Activists do not initiate contact without specific reasoning to put forward valid shareholder proposals. The typical activist is looking for ways to maximize the value of its investment rather than run the bank or remove mangers.The failure to recognize this point causes most targets to act unreasonably and cause the activist to pursue that very strategy of removal. Rather than an out-of-hand rejection, the board should give the activists’ recommendations serious consideration. In some situations, compromise or embracing the viable ideas of an activist may actually have some merit and show that the board is reasonable and confident that it has a plan to address shareholders’ concerns. Whatever the initial reaction by the target, it should not be based on a hasty decision-making process. 

Although it may be wise to give studied consideration to shareholder proposals, this is a far cry from acceptance. In the initial phases of a discussion, the board should consider the ultimate objective of the activist. Is this activist a long-term investor interested in a strategic acquisition? Is he a short-term investor interested in receiving a higher price in the near term? Or, regardless of the investment holding period, is he interested in putting the bank in play in order to precipitate a takeover and obtain a higher price for all shareholders? The ultimate objective of an activist, which can evolve as circumstances change, will often dictate the appropriate corporate response. The board needs to demonstrate it is acting in the best interests of all shareholders and exercising is its fiduciary duties in good faith.