Are Regulatory Delays Overblown?

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Nicolet Bankshares bought three banks during the last two years that doubled the size of the now $8.8 billion Green Bay, Wisconsin-based banking company. How hard was it to get regulatory approval? Well, if you ask CEO Mike Daniels, it was a breeze.

Despite all the talk of the tough regulatory environment for deal-making, not all banks experience problems, let alone delays. Nicolet’s latest acquisition, the purchase of $1.1 billion Charter Bankshares in Eau Claire, Wisconsin, took all of five months from announcement to conversion, including core conversion and changing branch signage.

“I hear deals are getting delayed, and you never know what the reason is,” says Daniels, who is speaking about mergers and acquisitions as part of a panel at Bank Director’s Acquire or Be Acquired conference in Phoenix this week. He attributes Nicolet’s ease of deal-making to lots of experience with conversions, good communications with its primary regulator, the Office of the Comptroller of the Currency, and an “outstanding” Community Reinvestment Act score. “We spend a lot of time with our primary regulator, the OCC, so they know what we’re thinking about,” he says. “We’re having those conversations before [deals] are announced.”

Are regulators taking longer to approve deals? “I’m in the mid-sized and smaller deal [market], and I’m not seeing that,” says Gary Bronstein, a partner in the law firm Kilpatrick Townsend in Washington, D.C. In fact, an S&P Global Market Intelligence analysis of all whole bank deals through August of 2022 found that the median time from announcement to close was 141 days from 2016 to 2019, ticking up to 145 days from 2020 through Aug. 22, 2022.

Attorneys say regulators are scrutinizing some bank M&A deals more than others, particularly for large banks. The median time to deal close for consolidating banks with less than $5 billion in combined assets was 136 days during the 2020-22 time period, compared to a median 168 days for consolidated banks with $10 billion to $100 billion in assets, according to S&P. Bronstein says in part, there’s pressure from Washington politicians to scrutinize such deals more carefully, including from U.S. Sen. Elizabeth Warren, D-Mass., who has tweeted that the growing size of the biggest banks is “putting our entire financial system at risk.” The biggest deals, exceeding $100 billion in assets, took 198 days to close in 2020-22.

President Joe Biden issued an executive order in June 2021 directing agencies to crack down on industry consolidation across the economy, including in banking, under the theory that consolidation and branch closures raise costs for consumers and small businesses, and harm access to credit.

Regulatory agencies haven’t proposed any specific rules yet, says Rob Azarow, a partner at the law firm Arnold & Porter, in part because Biden has been slow to nominate and then get Senate approval for permanent appointments to the heads of agencies.

Regulators scrutinize larger deals, especially deals creating institutions above $100 billion in assets, because of their heightened risk profiles. “It does take time to swallow those deals and to have regulators happy that you’ve done all the right things on integration and risk management,” Azarow says.

Smaller, plain vanilla transactions are less likely to draw as much scrutiny, says Abdul Mitha, a partner at the law firm Barack Ferrazzano Kirschbaum & Nagelberg in Chicago. Some issues will raise more concerns, however. Regulators are interested in the backgrounds of investor groups that want to buy banks, especially if they have a background in crypto or digital assets. Regulators are also looking for compliance weaknesses such as consumer complaints, fair lending problems or asset quality issues, so buyers will have to be thorough in their due diligence. “Regulators have asked for due diligence memos,” Mitha says. “They’re deep diving into due diligence more recently due to factors such as the economic environment.”

Bronstein concurs that regulators are asking more questions about fair lending in deals. The Consumer Financial Protection Bureau, which regulates banks above $10 billion in assets, is very much focused on consumer regulation and underserved communities, Bronstein says. So is the OCC and Federal Deposit Insurance Corp., which have traditionally focused on safety and soundness issues. They still do that as well, but fair lending has become a hot topic.

In the fall of 2022, the Fed signed off on a merger between two Texas banks, $6.7 billion Allegiance Bancshares and $4.3 billion CBTX, noting that the FDIC required the two institutions to come up with a plan to increase mortgage applications and lending to African American communities.

Still, the regulatory environment isn’t a major factor pulling down deal volume, the attorneys agreed. The economic environment, buyers’ worries about credit quality and low bank valuations have far greater impact. Buyers’ stock prices took a tumble in 2022, which makes it harder to come up with the currency to make a successful acquisition. Also, with bond prices falling, the FDIC reported that banks in aggregate took almost $690 billion in unrealized losses in their securities portfolio in the third quarter of 2022, which impacts tangible book values. Banks are wary of selling when they don’t think credit marks reflect the true value of their franchise, says Piper Sandler & Co.’s Mark Fitzgibbon, the head of financial institutions research.

An analysis by Piper Sandler & Co. shows deal volume dropped off a cliff in 2022, with 169 bank M&A transactions, compared to 205 the year before. But as a percentage of all banks, the drop looks less dramatic. The banks that sold or merged last year equated to 3.6% of total FDIC-insured institutions, close to the 15-year average of 3.4%.

“I would expect M&A activity to look more like 2022 in 2023, maybe a little lower if we were to go into a hard recession,” Fitzgibbon says. “You’d expect to see a lot of activity when we were coming out of that downturn.”

The Bumpy Road Ahead

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Banks are in the risk business, and 2023 is shaping up to be a risk-on environment that will keep management teams busy. 

The transformation of last year’s tailwinds into this year’s headwinds is stunning. Slowing economic growth, driven by monetary policy aimed at halting inflation, could translate into weaker loan growth. Piper Sandler & Co. analysts expect net interest margins to peak in the first quarter, before being eroded by higher deposit costs. Credit costs that cannot go any lower may start to rise. Banks may see little boost from fee income and may grapple with controlling expenses. Piper Sandler expects that financial service firms will have a “bumpy” 2023. 

The environment is so novel that Moody’s Analytics Chief Economist Mark Zandi made headlines by describing a new phenomenon: not a recession but a coming “slowcession — growth that comes to a near standstill but that never slips into reverse.” The research firm is baking a slowcession into its baseline economic forecast, citing “generally solid” economic fundamentals and well-capitalized banks, according to a January analysis.

This great uncertainty — and the number of ways banks can respond to it — is on my mind as I get ready for Bank Director’s 2023 Acquire or Be Acquired conference, which will run from Jan. 29-31 in Phoenix. Is growth in the cards this year for banks, and what would it look like? 

Historically, growth has been a necessity for banks. As long as banks can generate growth that outpaces the costs of that growth, they can generate increased earnings. Banks grow their asset base organically, or through mergers and acquisitions, have been two popular ways to generate growth. In a slowdown, some banks may encounter attractive opportunities to buy other franchises at a discount. But growth won’t be in the cards for all — and maybe that’s a blessing in disguise.

“[W]ith the threat of a recession and dramatically increasing cost of funds, there is a solid argument to be made that banks should be shrinking rather than growing,” wrote Chris Nichols in a recent article. Nichols is the director of capital markets at the $45 billion banking company known as SouthState Corp., in Winter Haven, Florida. Growth can exacerbate issues for banks that are operating below their cost of capital, which can push them toward a sale faster. Instead, he’s focused on operational efficiency.

“Financial pressure will be greater, and bank margins will be higher. This combination means that banks will need to focus on the quality of their earnings,” he wrote. Instead of growth, he argued bankers should focus on making their operations efficient, which will direct more profits toward their bottom line.

It makes sense. In a bumpy slowcession, banks aren’t able to control the climb of interest rates and the subsequent changes in economic activity. They may not encounter growth opportunities that set them up for long-term success in this type of environment. But they can control their operational efficiency, innovation and execution — and we’ll talk about that at #AOBA23.

Issues in Selling to a Non-Traditional Buyer

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We have seen a surge in the number of sales of smaller banks to non-traditional buyers, primarily financial technology companies and investor groups without an existing bank.

This has been driven by outside increased interest in obtaining a bank charter, the lack of natural bank buyers for smaller charters and, of course, money. Non-traditional buyers are typically willing to pay a substantially higher premium than banks and including them in an auction process may also generate pricing competition, resulting in a higher price for the seller even if it decides to sell to another bank. Additionally, buyers and sellers can structure these transactions as a purchase of equity, as opposed to the clunky and complicated purchase and assumption structure used by credit unions.

But there are also many challenges to completing a deal with a non-traditional buyer, including a longer regulatory approval process and less deal certainty. Before going down the road of entertaining a sale to a buyer like this, there are a few proactive steps you can take to increase your chances for success.

The Regulatory Approval Process
It is important to work with your legal counsel at the outset to understand the regulatory approval process and timing. They will have insights on which regulators are the toughest and how long the approval process may take.

If the potential buyer is a fintech company, it will need to file an application with the Federal Reserve to become a bank holding company. In our recent experience, applications filed with the Federal Reserve have taken longer, in part because of the increased oversight of the Board in Washington, but also because the Federal Reserve conducts a pre-transaction on-site examination of the fintech company to determine whether it has the policies and procedures in place to be a bank holding company. Spoiler alert: most of them don’t.

If the potential buyer is an individual, the individual will need to file a change in control application with the primary federal regulator for the bank. The statutory factors that regulators need to consider for this type of application are generally less rigorous than those for a bank holding company application. We have seen the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp. show more openness to next-generation business plans, as they understand the need for banks to innovate.

Conduct “Reverse” Due Diligence
Find out more about the buyer. You would be surprised at what a simple internet search will uncover and you can bet that the regulators will do this when they receive an application. We have encouraged sellers take a step further and conduct background checks on individual buyers.

Ask the buyer what steps have been taken to prepare for the transaction. Has the investor had any preliminary meetings with the regulators? What advisors has the buyer hired, and do they have a strong track record in bank M&A? Does the buyer have adequate financial resources?

Understand the key aspects of the buyer’s proposed business plan. Is it approvable? Are the new products and services to be offered permissible banking services? A business plan that adds banking as a service is more likely to be approved than one that adds international payments or digital assets. Does the buyer have a strong management team with community bank experience? What impact will the business plan have on the community? Regulators will not approve an application if they think the charter is being stripped and a community is at risk of being abandoned. We have seen buyers offer donations to local charities and engage in community outreach to show the regulators their good intentions.

Negotiate Deal Protections in the Agreement
Additional provisions can be included in the definitive agreement to protect the selling bank. For example, request a deposit of earnest money upon signing that is forfeitable if the buyer does not obtain regulatory approval. Choose an appropriate drop-dead date for the transaction. Although this date should be realistic, it should also incentivize the buyer to move quickly. We have seen sellers offer buyers options to pay for extensions. The contract should also require the buyer to file the regulatory application promptly following signing and to keep the selling bank well informed about the regulatory approval process.

While a transaction with a non-traditional buyer may be more challenging, under the right circumstances it can present an appealing alternative for a bank looking to maximize its sale price in a cash transaction.

Pandemic Offers Strong Banks a Shot at Transformative Deals

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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.

Does Market Volatility Impact Bank M&A?

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While the volatility in the stock market garners the attention of investors, it is also a worrisome topic for bank boards. As the Federal Reserve considers its first rate increase in close to 10 years—and China’s growth outlook continues to wane and impact economies around the world—bank boards have to consider the impact on their growth strategies, including any planned capital raises, IPOs or mergers and acquisitions.

Certainly, unexpectedly large swings in daily share prices make it difficult to price a potential M&A deal. This comes in an environment where bank M&A volume has not increased much, if at all, depending on how you look at the numbers. As you can see in the chart below, we have had just 34 deals with a value of more than $50 million year to date through Sept 7, 2015, which puts us slightly below the rate of 2014, according to Mark Fitzgibbon, a principal and the director of research at investment bank Sandler O’Neill + Partners.

Most bank deals are smaller than $50 million in value, however. In an upcoming article for BankDirector.com, Crowe Horwath LLP, a consulting and accounting firm, looked at all deal volume through June 30, 2015, and found 140 deals, slightly above last year’s volume in the same time frame of 130 deals.

Clearly, the lion’s share of the transactions has been small bank deals, and we have not seen many large transactions this year. Fitzgibbon is of the opinion that there are three dynamics that have slowed the pace of consolidation: (a) recent market volatility makes it tough to price deals, (b) large banks have generally been more internally focused than M&A focused, and (c) regulators have been slow to approve some deals, giving pause to some buyers.

This complements the perspectives of Fred Cannon, executive vice president and global director of research at Keefe, Bruyette & Woods, who reminded me that the pace of M&A “is simply a lot slower than it was prior to the crisis, and those of us who remember pre-crisis M&A, it will likely never be the same. We don’t have national consolidators buying up banks, and regulation does not allow the same speed of consolidation we previously had.”  In Cannon’s words, “volatility certainly slows deals a bit, but it postponed deals rather than stopped them.”

Contrast that with initial public offerings, which can really take a beating in a volatile market. Depending on the market and the individual bank’s potential value, it may no longer make sense to price an IPO, or it may make sense to delay it.

Here, I agree with Cannon’s assertion that a weak market is “more detrimental to IPOs than M&A. With M&A, the relative value of the buyers’ currency is often more important than the absolute level.” So if values fall for both the buyer and seller, the deal may still make sense for both of them. For potential deal making, market volatility is rarely good news, but it may not be as bad as it seems.

2015 L. William Seidman CEO Panel

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During Bank Director’s 2015 Acquire or Be Acquired conference in January, a panel of four community bank CEOs, all of whom are publicly traded, above $5 billion in asset size and are active acquirers discuss their different strategies for the future with our president, Al Dominick. This session is named after the former FDIC Chairman and Bank Director’s Publisher, the late L. William Seidman, who was a huge advocate of a strong and healthy community bank system.

Video length: 46 minutes

About the speakers

David Brooks – Chairman & CEO at Independent Bank Group
David Brooks is chairman and CEO of McKinney-headquartered Independent Bank Group, which currently operates 35 Independent Bank locations spanning across Texas. He has been active in community banking since the early 1980s and founded this company in 1988.

Daryl Byrd – President & CEO at IBERIABANK Corporation
Daryl Byrd is president and CEO of IBERIABANK Corporation. He serves on the boards of directors for both IBERIABANK Corporation and IBERIABANK, where he joined in 1999. Headquartered in Lafayette, LA, IBERIABANK is the 126-year-old subsidiary of IBERIABANK Corporation operating 187 branch offices throughout Louisiana, Arkansas, Alabama, Florida, Texas and Tennessee. With $15.5 billion in assets (as of October 31, 2014) and over 2,700 associates, IBERIABANK Corporation is the largest and oldest bank holding company headquartered in Louisiana.

Ed Garding – President & CEO at First Interstate BancSystem, Inc.
Ed Garding is president and CEO of First Interstate BancSystem, Inc. He has been chief executive officer of First Interstate BancSystem since April 2012, chief operating officer from August 2010 and served as an executive vice president since January 2004. Mr. Garding served as First Interstate’s chief credit officer from 1999 to August 2010, senior vice president from 1996 through 2003, president of First Interstate Bank from 1998 to 2001 and president of the Sheridan branch of First Interstate Bank from 1988 to 1996. In addition, Mr. Garding has served as a director of First Interstate Bank since 1998.

Mark Grescovich – President & CEO at Banner Corporation
Mark Grescovich is president and CEO at Banner Corporation. He joined Banner in April 2010 as president and became CEO in August 2010 following an extensive banking career specializing in finance, credit administration and risk management. Under his leadership, Banner has executed an extremely successful turnaround plan involving credit stabilization, improved risk management, a secondary public offering and other capital raising activities and a return to profitability based on net interest margin improvements.

L. William Seidman CEO Panel

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During Bank Director’s 2014 Acquire or Be Acquired conference in January, a panel of three community bank CEOs, all of whom have completed a recent acquisition, look at what the future holds for community banks and share their individual experiences and perspectives. This session is named after the former FDIC Chairman and Bank Director’s Publisher, the late L. William Seidman, who was a huge advocate of a strong and healthy community bank system.

Video Length: 53 minutes

About the Speakers

G. William Beale, CEO, Union First Market Bank
Billy Beale is the chief executive officer of Union First Market Bankshares, a publicly traded diversified financial services company based in Richmond, Virginia. He has held this position since the formation of the company and its predecessors in July 1993. Prior to joining Union in May 1989, Mr. Beale had spent 18 years working for 3 banks in Texas.

Richard B. Collins, President, CEO & Chairman of United Bank
Dick Collins is the president, CEO & chairman of United Bank since 2001. Prior to joining United Bank, he was president and CEO at First Massachusetts Bank in Worcester, Massachusetts. Other positions Mr. Collins has held are regional president at Bank of Boston from 1994-1995 and president and CEO at Mechanics Bank from 1983-1994.

William H. W. Crawford, IV, President & CEO of Rockville Bank and Rockville Financial, Inc.
Bill Crawford is the president and CEO of Rockville Bank and Rockville Financial, Inc. In this position, he is responsible for the build out of the company’s infrastructure including the addition of a risk department, the expansion of the mortgage banking division, the enhancement of the financial advisory services division, the introduction of the private banking division and the acquisition of a commercial lending team from a competitor bank.

E. Robinson McGraw, Chairman & CEO, Renasant Corporation
Robin McGraw is the chairman and CEO of Renasant Corporation and Renasant Bank. He has been with Renasant for 38 years and assumed his current role in 2001. Mr. McGraw is past chairman of the Mississippi Bankers Association. Also active on the national banking level, he has been a member of the American Bankers Association’s government relations council.

2012 Bank M&A: Volume and Pricing Improves, Uncertainty Remains

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uncertainty-clouds.jpgOver the past several years, numerous pundits have predicted a wave of consolidation in the banking industry based on a number of factors, including increased cost of regulation, limited access to capital, and lack of growth opportunities, to name a few.

While the current level of uncertainty in the marketplace and the level of pricing available to sellers have kept the pace of consolidation consistent, the levels are well below the predicted tidal wave of consolidation.

Deal activity for the first six months of 2012 indicates a pace of consolidation ahead of 2011 and 2010 levels, but still well below levels before the credit crisis. The year-to-date price-to-book value (P/BV) and price-to-tangible book value (P/TBV) ratios for bank deals are improved over 2011 indexes and consistent with 2010 indexes.

M&A Deals*

Year

# of Deals

Avg. P/BV

Avg. P/TBV

2010

177

113.51%

119.84%

2011

154

101.83%

106.27%

YTD 2012

106

115.86%

120.54%

Source: SNL Financial / *Excludes FDIC-assisted transactions

Uncertainty Does Not Breed Confidence

In a survey on merger and acquisition conditions jointly conducted by Bank Director and Crowe Horwath LLP in October 2011, one of the primary impediments to consolidation was reluctance to take a chance on an acquisition in uncertain economic conditions. This concern can be translated into uncertainty regarding credit quality.

History has shown that high levels of credit problems in the banking industry inversely impact the number of acquisitions closed.

crowe-asset-quality.png

To put this into more qualitative terms, buyers and sellers tend to view the levels of credit issues in different ways, and bridging the chasm between the two views has impeded acquisitions. In fact, survey respondents indicated that concern over the asset quality of selling institutions was the number one reason why they would not engage in bank acquisitions.

Lower FDIC Deal Volume

As the Federal Deposit Insurance Corporation (FDIC) continues to work with troubled institutions, the number of assisted transactions has diminished from its peak in 2010.

FDIC-Assisted Deals 

Year

# of Deals

Avg. Assets Sold

2010

147

$550,097

2011

90

$355,000

YTD 2012

28

$234,770

Source: SNL Financial

In addition to a decrease in the number of deals in 2012 from prior years, the average asset size of the institutions sold has also decreased. This indicates that the FDIC has resolved the issues for most of the larger troubled institutions and is now focusing on the remaining smaller institutions.

The FDIC also has been structuring more transactions in 2012 and 2011 without loss-share agreements, which were prevalent in 2010 transactions.

FDIC-Assisted Deals and Loss Sharefdic-loss-share.png

Some of this trend can be attributed to buyers opting against having the FDIC as a future business partner, and some is the result of the FDIC not offering loss-share agreements or offering loss-share agreements on only a part of the loan portfolio. This trend likely accounts for some of the increase in the asset discount on those deals in 2012 closed with a loss-share agreement. Based on a review of recent deals, the FDIC is tending to offer loss-share agreements on commercial loans instead of on single-family mortgage loans.

It looks as though the number of FDIC-assisted transactions will remain low in 2012, with the year on track to be substantially below 2011 transaction levels.

Slow and Steady

Although overall deal volume has increased thus far in 2012, indicators still point to consistently slow activity in bank mergers and acquisitions—a far cry from the tidal wave of consolidation many had predicted. While credit is improving and the number of banks on the FDIC’s troubled bank list has decreased, the level of nonperforming loans is still higher than optimal. This higher level of nonperforming loans will continue to affect the level of bank merger and acquisition activity in 2012.