A Regulator Questions Long-Standing M&A Practice

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There seems to be broad consensus that the way bank mergers are assessed should be updated. The question facing bank regulators and the industry is how. The Office of the Comptroller of the Currency recently grappled with the question in a Bank Merger Symposium it hosted on Feb. 10. 

“There is a robust ongoing debate about the effects of bank mergers on competition, on U.S. communities, and on financial stability,” said Ben McDonough, senior deputy comptroller and chief counsel at the OCC, at the symposium’s opening, delivering remarks prepared for Acting Comptroller Michael Hsu. “At the same time, many experts have raised questions about the ongoing suitability of the current bank merger standards at a time of intense technological and societal change.”

I wrote about how community banks and regulators think about mergers and acquisitions from a competitive perspective for the first quarter 2023 issue of Bank Director magazine. The competitive analysis conducted by regulators is arguably antiquated and overly focused on geography and on bank deposits, which has become less relevant in the face of digital innovation. 

“Regulators are beginning to revise M&A rules, but it’s unclear what impact that will have,” I wrote. “Everyone wants the market to remain competitive — the question is what vision of competition prevails.”

Regulators assess a deal application for the competitive effects of the proposed merger, and the convenience and needs of the communities to be served. The framework they use was last updated in 1995 and has its roots in a 1960s Supreme Court case and the Herfindahl-Hirschman index, or HHI, which was developed in the mid-1940s and early 1950s.

The measurement is calculated by squaring the market share of each firm in the market and then calculating the sum of the resulting numbers; four firms with shares of 30, 30, 20 and 20 have an HHI of 2,600, according to the U.S. Department of Justice. The HHI ranges from zero, which is a perfectly competitive market, to 10,000, or a perfect monopoly. Deals that increase a market’s HHI by more than 200, or where the HHI exceeds 1,800 post-merger, can trigger a review. The bank HHI calculation uses bank deposits as a proxy for bank activity within geographic markets that the Federal Reserve has drawn and maintained.

Hsu highlighted HHI in his opening comments at the symposium as a “transparent, empirically proven, efficient, and easily understood measure of concentration,” but said the decades-old metric may have become “less relevant” since the 1995 update. 

He pointed out how the “growth in online and mobile banking and rise of nonbank competitors” has made HHI, which uses bank deposits as the basis for its calculation, “a less effective predictor of competition.” 

M&A activity in rural banking markets is especially impacted by the HHI calculation. More than 60% of defined geographic banking markets in 2022 were already above the 1,800 threshold, according to a speech from Federal Reserve Governor Michelle Bowman in the same year — meaning any bank deal that would impact those markets could merit further scrutiny.

Some of themes around potential changes to the bank merger application process included “updated and clearly defined concentration, competition and systemic risk analysis,” along with new requirements around “increase[ing] transparency and tools to enforce community benefits commitments,” wrote Ed Mills, managing director of Washington policy for investment bank Raymond James & Associates, in a Feb. 13 note. 

Mills wrote that proposed updates to bank merger guidance “are likely coming soon,” but expects the more extensive changes that seek to “build a better mouse trap” to be a much longer process. His firm believes that current pending mergers are likely to be approved, and that slower approvals don’t necessarily indicate a moratorium. His report occurred in the same week that Memphis, Tennessee-based First Horizon Corp. extended its agreement to sell to Toronto-based TD Bank Corp., which will create a $614 billion institution, from Feb. 27 to May 27, 2023. That would make the sale occur more than a year after announcement. 

It’s still not clear where the agencies will land, and how their changes will impact community bank deal approvals, if at all. But for now, there seems to be consensus that geographic markets and bank deposits may not be the truest measures of competition, before or after a deal.

A Conversation With PNC’s William Demchak

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When Pittsburgh-based The PNC Financial Services Group, a $557.3 billion bank, sold its 22% stake in asset manager BlackRock during the height of the financial crisis for $14.4 billion, executives didn’t know what to do with the cash. Chairman and CEO William “Bill” Demchak explained on stage at Bank Director’s Acquire or Be Acquired conference Monday why he sold BlackRock and turned around and bought BBVA USA within six months. He also offers advice to bankers doing deals. This conversation with Editor-at-Large Jack Milligan has been edited for length and clarity.

BD: What was the decision-making process to sell PNC’s stake in BlackRock in May 2020 for $14.4 billion and use the proceeds to acquire BBVA USA for $11.6 billion in November 2020?
WD: Before the government put out all the fiscal support, you’ll remember that we didn’t know if the mortality rate [of coronavirus in 2020] would be 10% or 1%. All I could think was: Make sure the bank has the most capital, a fortress balance sheet and is the one to survive the day. That led to the decision to sell BlackRock.

So I figured how my options might play out. It wasn’t a certainty that we would find a target [to buy]. If I sold BlackRock, the bank would be absolutely fine, the shareholders would be mad at me because we’d have too much capital and no BlackRock anymore and I’d get fired. That was OK: The bank, our employees and our clients would be great. If it turned out that we had a recovery and managed to land an acquisition target, that was a home run. In the end, that’s what it was. But that six months in-between was really tough.

BD: How did you prepare the board for that decision?
WD: I remember one director said, “You don’t normally sell something until you have the thing you’re going to buy in the other hand,” which is absolutely correct. But we weren’t long from the financial crisis. The bank with the most capital wins every time. We had a big stack of capital in our BlackRock stake that wasn’t recognized. Cashing in those chips was the right decision.

BD: How was the acquisition received in Washington? Did you have any sense that regulatory attitudes toward large bank M&A were changing?
WD: Yes, although we probably didn’t realize how close we were. There’s been a sea change in Washington on large scale consolidation, as they looked at the risk of combining institutions, both theory and economic risk, but also community-based risk. And we made it through a window before that. Although I will say, we made it through the approval process without a single negative letter sent to the regulators.

BD: What did the BBVA USA acquisition do for PNC that you didn’t have before?
WD: Between BBVA and markets we opened up on our own, we went from being in probably 12 of the largest MSAs just a handful years ago to now being in the top 30. It’s remarkable the growth prospects of the markets that we’ve entered. Houston has gone from not being on our radar to being almost our third largest market. What we’ve seen in Colorado is just as tremendous.

BD: Do you foresee PNC doing another acquisition?
WD: I think we have to.

BD: And you think you will be allowed to?
WD: I don’t know. There’s a horrible joke: You’re in the woods and a bear’s chasing you and you’re lacing up your shoes. You can’t outrun the bear, but you don’t have to. You just have to outrun [the person you’re with]. And there’s a lot of banks in this room I can outrun. But the bear is going to get you eventually, if they don’t change the way they look at competition and the different risks in the banking system to allow banks to grow larger.

BD: Acting Comptroller of the Currency Michael Hsu recently gave a speech raising the issue of banks that he referred to as “too big to manage.” He said the OCC is beginning to work on a structure, almost a decision-making tree, of what the regulators could do to deal with a bank that they think is too big to manage. What’s your thoughts on that? Can a bank be too big to manage?
WD: I suppose anything can be too big to manage if you don’t have the right management team to help pay attention to stuff. … We’re a large bank, but we’re in the basic business, probably in the same business as [most of the bankers attending Acquire or Be Acquired]: We serve retail customers with deposits, savings, loans, traditional products. We serve corporate customers with treasury management, and lending products. … But we’re just doing what we’ve done for 165 years.

BD: What have you learned about M&A over the years that you think would be useful for this group to hear?
WD: In the simplest form, understand the reason you’re doing it. Have a clear purpose as to why, other than just trying to get larger. Make all the tough choices that you don’t want to make on people, on technology. Make the choices that are going to hurt today that pay dividends tomorrow. Under-promise, over-perform. Deals are tough. Integration of systems, particularly if both institutions have legacy tech, is really hard. You’ve got to go into it with your eyes wide open, so that whatever comes out of the other side is worth the pain you’re going to cause your employees and sometimes your shareholders.

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.

2023 Bank M&A Survey Results: Can Buyers and Sellers Come to Terms?

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Year after year, Bank Director’s annual M&A surveys find a wide disparity between the executives and board members who want to acquire a bank and those willing to sell one. That divide appears to have widened in 2022, with the number of announced deals dropping to 130 as of Oct. 12, according to S&P Global Market Intelligence. That contrasts sharply with 206 transactions announced in 2021 and an average of roughly 258 annually in the five years before the onset of the pandemic in 2020.

Prospective buyers, it seems, are having a tough time making the M&A math work these days. And prospective sellers express a preference for continued independence if they can’t garner the price they feel their owners deserve in a deal.

Bank Director’s 2023 Bank M&A Survey, sponsored by Crowe LLP, finds that acquisitions are still part of the long-term strategy for most institutions, with responding directors and senior executives continuing to point to scale and geographic expansion as the primary drivers for M&A. Of these prospective buyers, 39% believe their bank is likely to acquire another financial institution by the end of 2023, down from 48% in last year’s survey who believed they could make a deal by the end of 2022.

“Our stock valuation makes us a very competitive buyer; however, you can only buy what is for sale,” writes the independent chair of a publicly-traded, Northeastern bank. “With the current regulatory environment and risks related to rising interest rates and recession, we believe more banks without scale will decide to sell but the old adage still applies: ‘banks are sold, not bought.’”

Less than half of respondents to the survey, which was conducted in September, say their board and management team would be open to selling the bank over the next five years. Many point to being closely held, or think that their shareholders and communities would be better served if the bank continues as an independent entity. “We obviously would exercise our fiduciary responsibilities to our shareholders, but we feel strongly about remaining a locally owned and managed community bank,” writes the CEO of a small private bank below $500 million in assets.

And there’s a significant mismatch on price that prohibits deals from getting done. Forty-three percent of prospective buyers indicate they’d pay 1.5 times tangible book value for a target meeting their acquisition strategy; 22% would pay more. Of respondents indicating they’d be open to selling their institution, 70% would seek a price above that number.

Losses in bank security portfolios during the second and third quarters have affected that divide, as sellers don’t want to take a lower price for a temporary loss. But the fact remains that buyers paid a median 1.55 times tangible book in 2022, based on S&P data through Oct. 12, and a median 1.53 times book in 2021.

Key Findings

Focus On Deposits
Reflecting the rising rate environment, 58% of prospective acquirers point to an attractive deposit base as a top target attribute, up significantly from 36% last year. Acquirers also value a complementary culture (57%), locations in growing markets (51%), efficiency gains (51%), talented lenders and lending teams (46%), and demonstrated loan growth (44%). Suitable targets appear tough to find for prospective acquirers: Just one-third indicate that there are a sufficient number of targets to drive their growth strategy.

Why Sell?
Of respondents open to selling their institution, 42% point to an inability to provide a competitive return to shareholders as a factor that could drive a sale in the next five years. Thirty-eight percent cite CEO and senior management succession.

Retaining Talent
When asked about integrating an acquisition, respondents point to concerns about people. Eighty-one percent worry about effectively integrating two cultures, and 68% express concerns about retaining key staff. Technology integration is also a key concern for prospective buyers. Worries about talent become even more apparent when respondents are asked about acquiring staff as a result of in-market consolidation: 47% say their bank actively recruits talent from merged organizations, and another 39% are open to acquiring dissatisfied employees in the wake of a deal.

Economic Anxiety
Two-thirds believe the U.S. is in a recession, but just 30% believe their local markets are experiencing a downturn. Looking ahead to 2023, bankers overall have a pessimistic outlook for the country’s prospects, with 59% expecting a recessionary environment.

Technology Deals
Interest in investing in or acquiring fintechs remains low compared to past surveys. Just 15% say their bank indirectly invested in these companies through one or more venture capital funds in 2021-22. Fewer (1%) acquired a technology company during that time, while 16% believe they could acquire a technology firm by the end of 2023. Eighty-one percent of those banks investing in tech say they want to gain a better understanding of the space; less than half point to financial returns, specific technology improvements or the addition of new revenue streams. Just one-third of these investors believe their investment has achieved its overall goals; 47% are unsure.

Capital To Fuel Growth
Most prospective buyers (85%) feel confident that their bank has adequate access to capital to drive its growth. However, one-third of potential public acquirers believe the valuation of their stock would not be attractive enough to acquire another institution.

To view the high-level findings, click here.

Bank Services members can access a deeper exploration of the survey results. Members can click here to view the complete results, broken out by asset category and other relevant attributes. If you want to find out how your bank can gain access to this exclusive report, contact [email protected].

Overcoming Regulatory Barriers to M&A in 2023

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The M&A slowdown in 2022 will shape expectations for 2023, and Adam Maier, a partner at Stinson LLP, believes deals could bounce back by mid-year. Heightened regulatory scrutiny could continue to have a chilling effect on larger bank M&A, he says, but community bank deals have been approved rather quickly. Prospective buyers would be wise to focus on due diligence and communicate with regulators to ease the approval process.

Topics include:

  • Predictions for 2023
  • Considerations for Prospective Buyers and Sellers
  • Working With Regulators
  • Branch Transactions

Tales From Bank Boardrooms

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If anyone in banking has seen it all, it’s Jim McAlpin. 

He’s sat in on countless board deliberations since he got his start under the late Walt Moeling, a fellow Alabamian who served as his mentor at Powell, Goldstein, Frazer & Murphy, which later merged with Bryan Cave in 2009. 

“That’s how I started in the banking world, literally carrying Walt’s briefcase to board meetings. Which sometimes was a very heavy briefcase,” quips McAlpin. Moeling made sure that the young McAlpin worked with different attorneys at the firm, learning various ways to practice law and negotiate on behalf of clients. “He was my home base, but I also did lending work, I did securities work, I did some real estate work. I did a lot of M&A work” in the 1990s, including deals for private equity firms and other companies outside the banking sector.

But it’s his keen interest in interpersonal dynamics and his experience in corporate boardrooms, fueled by almost four decades attending board meetings as an attorney and board member himself, that has made McAlpin a go-to resource on corporate governance matters. Today, he’s a partner at Bryan Cave Leighton Paisner, and he recently joined the board of DirectorCorps, Bank Director’s parent company. 

“I’ve gone to hundreds of meetings, and each board is different. You can have the same set of circumstances more or less, be doing the same kind of deal, facing the same type of issue or regulatory situation,” he says. “But each set of people approaches it differently. And that fascinates me.”  

McAlpin’s a consummate storyteller with ample anecdotes that he easily ties to lessons learned about corporate governance. Take the time he broke up a physical fight during the financial crisis. 

“During that time period, I saw a lot of people subjected to stress,” he says. “There are certain people who, under stress, really rise to the occasion, and it’s not always the people you think are going to do so. And then there are others who just fall apart, who crumble. Collectively as a board, it matters.”

Boards function based on the collection of individual personalities, and whether or not those directors are on the same page about their organization’s mission, goals and values. McAlpin’s intrigued by it, saying that for good boards, the culture “permeates the room.”

McAlpin experienced the 1990s M&A boom and the industry’s struggles through the financial crisis. On the precipice of uncertainty, as interest rates rise and banks weather technological disruption, he remains bullish on banking. “This is a good time to be in banking,” he says. “It’s harder to get an M&A deal done this year. So, I think it’s caused a lot of people to step back and say, ‘OK, what are we going to do over the next few years to improve the profitability of our bank, to grow our bank, to promote organic growth?’. … [That’s] the subject of a lot of focus within bank boardrooms.”

McAlpin was interviewed for The Slant podcast ahead of Bank Director’s Bank Board Training Forum, where he spoke about the practices that build stronger boards and weighed in on the results of the 2022 Governance Best Practices Survey, which is sponsored by Bryan Cave. In the podcast, McAlpin shares his stories from bank boardrooms, his views on corporate culture and M&A, and why he’s optimistic about the state of the industry. 

Banks Inherited a Wholesale Balance Sheet During the Pandemic. Here’s What to Do.

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Bank managements and directors must recognize how cash has changed significantly over the past seven quarters, from the fourth quarter of 2019 to the third quarter of 2021. The median cash-to-earning assets for all publicly traded banks has grown to 10% in recent quarters, up from 4% pre-pandemic. This is a direct impact of the Covid-19 pandemic on deposit flows from government stimulus and the reluctance to deploy cash in a time of historically low interest rates.

The result is a healthy “wholesale” balance sheet that is separate and distinct from banks’ normal operations. This must be factored into growth plans for 2022 and 2023. We think it may take several quarters to properly deploy the excess liquidity. Investors already demand faster loan growth and their tolerance towards low purchases of securities may wane. The pressure to take action on cash is real, and it should be seen as an opportunity and certainly not a curse. We see excess cash as a high-class problem that can be met with a successful response at all banks.

We expect financial institutions will become far more open about their two balance sheet positions in the near future. First, let’s talk about the “normal” operation with stated goals and objectives on growth (e.g. loans, earnings per share and returns on tangible equity). Next, segment the “wholesale” balance sheet, which contains the cash position and any extra liquidity in short-term securities. Using our industry data above (10% cash in earning assets, up from 4% pre-pandemic), a $3 billion community bank has $300 million in cash instead of the usual $120 million it carried two years earlier — this establishes a $180 million wholesale position. Company management should directly communicate how this separate liquidity will be used to enhance earnings and returns in future quarters. Likewise, boards should stay engaged on how this cash gets utilized within their risk tolerance.

Late in the fourth quarter of 2021, certain company acquisitions disclosed the use of excess cash as a key rationale of the deal. An example is Ameris Bancorp, whose executive team stated in its December 2021 purchase of Balboa Capital that the transaction was funded by excess cash. Back in May 2021, Regions Financial (which is neutral-rated by Janney) acquired EnerBank with a home improvement finance strategy that would deploy its liquidity into new loans. Regions has since completed additional M&A deals with the same explanation. Many more small M&A transactions seem likely in 2022 using cash deployment as an underlying theme.

It has been my experience for three decades as an equity analyst that banks miss chances to explain their strategy in a succinct yet powerful manner. Remaining shy under the pretense of conservatism does not generally reward a higher stock valuation. Instead, banks who are direct and loud about their strategy (and then execute) tend to be rewarded with a stronger stock price. Hence, it is a far better idea to express a game plan for cash and a bank’s distinct “wholesale” balance sheet.

The current cash positions (which produced little to no earnings return in prior quarters) are now a superb opportunity to make a difference with investors. We encourage banks to be direct on how they will utilize excess cash and liquidity separate from their existing operations. The Janney Research team estimates banks can generate nearly a 10% boost to EPS by 2023 from managing excess cash alone. This is separate from any benefit from higher interest rates and Federal Reserve policy shifts that may occur.

Outlining a cash strategy in 2022 and 2023 is a critical way to differentiate the bank’s story with investors. Bank executives and directors must take advantage of this opportunity with a direct game plan and communicate it accordingly.

Issues & Ideas for M&A Related Capital Raising

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During Bank Director’s 2015 Acquire or Be Acquired conference in January, this session explored alternatives for raising capital required to close a specific M&A transaction. The discussion included the pros and cons of both public and private transactions with specific examples of offerings that worked well and those that faltered. The presentation also focused on the evolving role of private equity as a source of acquisition related capital.

Presentation slides

Video length: 54 minutes

About the speakers

Todd Baker – Managing Director & Head of Americas Corporate Development at MUFG Americas Holdings / MUFG Union Bank NA
Todd Baker is managing director and head of Americas corporate development at MUFG Americas Holdings / MUFG Union Bank NA. He has had a lead role in scores of bank and financial services M&A transactions over the past 30+ years. Some of his more recent transactions in the community bank sphere include the 2012 acquisition of Pacific Capital Bancorp by MUFG Union Bank, the 2009 acquisition of The South Financial Group by TD Bank and the 2006 acquisition of Commercial Capital Bancorp by Washington Mutual.

Frank Cicero – Global Head of Financial Institutions, Managing Director Investment Banking at Jefferies LLC
Frank Cicero is the global head of financial institutions, managing director investment banking at Jefferies LLC. He specializes in M&A and capital markets transactions for depository institutions. Previously, Mr. Cicero was the head of investment banking coverage for banks at Lehman Brothers and Barclays Capital.

John Eggemeyer – Founding & Managing Principal at Castle Creek Capital LLC
John Eggemeyer is a founding and managing principal at Castle Creek® Capital LLC which has been a lead investor in community banking since 1990. The firm is currently one of the most active investors in community banking with approximately $700 million in assets under management. Prior to founding Castle Creek®, Mr. Eggemeyer spent nearly 20 years as a senior executive with some of the largest banking organizations in the U.S. with responsibilities across a broad spectrum of banking activities.