Issues in Selling to a Non-Traditional Buyer

Written by

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.

3 Questions to Optimizing Debit Card Profitability in a Deal

Written by

As the banking industry shrinks each year, CEOs often ask what they should look out for to improve profitability during and after a merger or acquisition. There is one area that is all too often overlooked: debit card profitability.

As an ever-growing source of demand deposit account revenue, debit card portfolios require detailed profit and performance analyses to optimize return. Done correctly, the efforts can be extremely fruitful. But there are a few things acquiring banks should keep an eye on when evaluating any acquisition target’s debit card profitability, to learn what is working for them and why.

Three items to consider when entering the M&A process:
1. Know thyself. To accurately gauge the impact of acquiring another bank’s cardholders, prospective buyers should first know where their own institution stands. How much is your bank netting per transaction, or per debit card outstanding? Every bank must know how much money is to be made when they issue a debit card to their customer. This concept is simple enough and is considered the basics of nearly all business, but putting it into practice can prove difficult without the proper knowledge base. Know your institution’s performance before the acquisition, as well as where your institution should to be after.

2. Dissect the income. If an analysis of interchange income reveals that your bank, as the acquirer, is making less interchange income per purchase than the acquired institution, find out why. The acquisition target may have better interchange rates because of a better network arrangement or even just better network agreement terms. This evaluation should not only apply to the networks or the foundation of interchange earning. Oftentimes, the acquired institution has done a better job of marketing and getting their cards into customers’ hands for use. Bigger does not necessarily mean better when it comes to debit card profitability. Choose the arrangement and agreement terms from either institution on electronic funds transfer (EFT) processing, PIN network and card brand that is most profitable.

3. On expenses, timing can be everything. While the acquiring bank often has better pricing on processing expenses, they don’t always — especially on EFT. Most bankers know to evaluate the acquired institution’s contracts to determine buyouts, deconversion and termination penalties and get a general glimpse at the pricing. But there is a present need for a pricing deep dive across all contracts in every single deal — especially when considering a merger of equals or an acquisition that really moves the needle.

Further, this evaluation should not stop at traditional data processing contracts, like core and EFT. It must consider card incentive agreements. Executives should study the analytics around buyout timing on both institutions’ card brands, along with the interchange network agreements. Consider the termination penalties, but also the balancing effect of positive impact, to incentive income of the acquirer’s agreements. Although the bank cannot disclose details of the acquisition, they can keep the lines of communication open with card vendors. There will be a sweet spot of timing in the profit optimization formula, and the bank will want an open rapport with their card-critical vendors.

Debit cards as a potential profit center are often overlooked in the merger and acquisition process, which tends to be geared toward share price and the details of the buyout. However, it is valuable for acquirers to review debit cards in context of the combined bank’s long-term success of the bank, not just focusing on the deposits retained and lost when it comes to income consideration.

Mind These Gaps

Written by


5-13-15-Al.pngProbably one of the worst moments for a bank board and management team is to make an acquisition and find out it was a bad one. Over the past few years, it strikes me that three pitfalls typically upend deals that, on paper, looked promising:

  • Loss of key talent/integration problems;
  • Due diligence and regulatory minefields; and
  • Bad timing/market conditions.

While timing is everything, I thought to address the first two pitfalls here.

Losing Key Talent
A CEO with experience selling a bank tells me that number one on her list is to “personally reach out to top revenue generators ASAP and let them know they are going to have a great future in the combined company. It always amazes me how key leaders think they can wait on that while they talk to staff folks.”

But don’t stop there. If the merger is designed to significantly reduce costs and there is a lot of overlap, your staff will know that there are going to be significant job losses. “My advice, be honest,’’ the CEO says. “If you have a plan or process, tell them what it is. If you don’t tell them, you will let them know the second you do. Don’t sugar coat it. Call the key ones you know you will need with a retention offer ASAP.”

This advice had me seeking the counsel of Todd Leone, a principal with the management consulting firm of McLagan. Leone suggests those in key positions with change-in-control contracts usually stay as they are going to get paid.  Also, those in true key positions negotiate at the time of the deal to stay on after the merger. However, it can be complicated to retain the next level of staff.  As Todd says, “[It’s best to] negotiate at time of deal.”

Regulatory and Due Diligence Minefields
Now, as much as the drain of talent threatens the long-term success of a deal, there are other minefields to navigate. Bill Hickey, principal and co-head of the Investment Banking Group at Sandler O’Neill + Partners, cautions me that in today’s interest rate environment, significant loan pay-downs could be looming.

Another due diligence matter is an IT contract that requires large termination fees. Aaron Silva, the president and CEO of Paladin fs, says that banks need to implement terms and conditions into their agreements ahead of time that protect shareholders from unreasonable termination risk, separation expense and other obligations that may impact any M&A strategy.

Building on these talent and technology risks, John Dugan and Rusty Conner, both partners at the law firm of Covington & Burling, say that in today’s bank M&A market, “all of the historical issues related to pricing, diligence, and integration remain very relevant, but there are three issues that have taken on new prominence thereby impacting execution and certainty of closing.”  They are:

  • The reaction of the regulators to the proposed transaction—particularly if the acquiring institution is approaching a designated size threshold;
  • Protests by community groups—which can materially delay a transaction even if the complaint is without merit—especially [since] these groups are now targeting much smaller deals than ever before; and
  • Shareholder suits by the acquired institution’s shareholders—which are also increasingly making their way to smaller deals.

As Dugan opines, “parties need to anticipate and build into their pricing and timing the impact of these factors.”

Their views complement those of Curtis Carpenter, managing director of Sheshunoff & Co. He’s of the opinion that in today’s market, “regulatory and compliance matters have become critical components for both the seller and buyer. It is more important than ever for sellers to put in place generous pay-to-stay bonuses for key personnel who are in positions likely to be eliminated in the merger. The heightened regulatory scrutiny surrounding the merger process can result in long approval periods—sometimes many months.” 

Where most bank mergers fail isn’t in the transaction itself. No two deals are alike, but addressing these challenges is simply good business.

The Consolidation Wave That Wasn’t

Written by


wave-crash.jpgThe past three years have seen bankers and industry pundits anxiously awaiting the so-called and highly anticipated wave of consolidation in the banking industry. There are many reasons why increased consolidation is expected, including sellers with less access to capital and, therefore, less opportunity to grow independent of a merger, a belief that banks must be larger to compete and absorb the cost of regulation, a lack of organic growth in existing markets, and compressed earnings.

Despite all of these reasons —some real and some perceived—the pace of consolidation has been modest, at least compared to the predictions of the past several years, begging the question: Where is all the M&A? According to the recently released Bank Director & Crowe Horwath LLP 2013 M&A survey, two of the primary barriers to buying other banks are concerns over credit quality and unrealistic pricing expectations of sellers, both of which we’ll examine in more detail.

Credit Quality Concerns

There is a direct correlation between the level of nonperforming loans and the number of deals that are realized. The following graph illustrates the pattern between nonperforming assets (NPAs)/loans and other real estate owned (OREO) and the number of deals announced in any given year. As the graph indicates, when the level of nonperforming assets is high, the number of announced deals is low.

crowe-exh-3.png

The period most similar to that of the past several years is the early 1990s, when the savings and loan crisis occurred and the government established the Resolution Trust Corporation to resolve a number of failed institutions. Today, the level of nonperforming assets is still too high for many acquirers to accept. While the level has improved from its high in 2010, it is still higher than historical norms. Until loan quality significantly improves, buyers will find it difficult to pay the prices sellers are requiring.

Unrealistic Pricing Concerns

Pricing concerns from sellers is another frequently mentioned reason for deals not occurring. While sellers are not expecting the high levels that occurred pre-crisis, they aren’t willing to sell for a low price. The following graph illustrates the distribution of price to tangible book value achieved by sellers for the period beginning in January 2011 and going through Dec. 7, 2012.

crowe-exh-4.png

While deal prices have improved and sellers in some regions have been able to achieve prices in excess of 200 percent price to tangible book value, the majority of the deals have closed at below 110 percent price to tangible book value, and almost 40 percent of the deals have been below 100 percent price to tangible book value. For many markets, a price to tangible book value of 140 to 150 percent would be the new “gold standard.” Until this pricing ratio average improves, though, it doesn’t seem likely that the number of deals will increase dramatically.

Looking Ahead

So where will the number of deals be in 2013? Any prediction is worth the ether it’s posted in, but all indications suggest that deal volume will continue to be steady but well below the significant levels of consolidation predicted. Through Dec. 2, 2012, the number of announced whole bank deals was at 209. During the pre-crisis years of the 2000s, the number of whole bank deals per year was approximately 225 to 250. So 2012 will finish with levels below the pre-crisis normative levels, but up from 2011. In the M&A survey, we asked respondents to provide us with their expectations as to where deal volume will be in 2013. The following chart shows that the majority of the respondents believe that deal volume will be less than 200 deals, with 80 percent estimating deal volume will be less than 225 deals in 2013.

Deal Volume Expectations for 2013

>225

20%

200-225

16%

175-200

35%

<175

29%

While the wave of consolidation might eventually occur, all indications, including banks’ own expectations, suggest consolidation levels likely will remain status quo for the time being.

The Bank Director’s Approach to M&A: Stay Out of Hot Water

Written by


trouble.jpgIn today’s environment, many bank directors are faced with difficult strategic decisions regarding the future of their organizations.  We have been involved in many great board discussions of whether it is best for the bank to continue to grind away at its business plan in this slow growth environment or to look for a business combination opportunity that will accelerate growth.  There is rarely a clear answer in these discussions, but some guidelines are helpful: All directors must respect the conclusion of the full board of directors and follow the appropriate process established by the board with respect to merger opportunities.

Over the years, we have seen a number of instances in which one or more bank directors conduct merger discussions with potential partners without bringing the opportunity to the full board of directors immediately. In many cases, these directors are acting in good faith and simply leveraging relationships they have with other bankers or bank directors. In other cases, these directors may feel the need to engage in these discussions because they disagree with the full board’s strategy of remaining independent. However, all directors should understand that it is in the bank’s best interest, and the director’s own personal best interest, not to take matters into their own hands without authorization by the board of directors.

As a result, we have long recommended that bank and holding company boards adopt a formal policy regarding corporate change. This formal policy establishes guidelines for all bank directors and members of management to follow when they become aware of merger opportunities. Specifically, the policy requires:

  • that all merger and other strategic business opportunities be presented to the full board of directors or a designated committee thereof before any substantive discussions take place;
  • that no officer or director initiate such discussions without authorization of the full board of directors; and
  • that no confidential information regarding the bank be shared with a third party without the authorization of the full board of directors.

The policy also provides talking points for each director or officer to follow if he or she is presented with an opportunity. We find that these talking points are helpful to directors who are not often involved in merger discussions. The policy may also set forth certain procedures to be followed, including requirements for the timely entry into confidentiality agreements and the identification of a designated spokesperson for the bank in the discussions.

We believe there are numerous benefits to adopting and following such a policy.  Those benefits include the following:

  • ensuring that the board of directors speaks with “one voice” and does not cloud the market with mixed signals, which often helps the bank achieve more favorable terms if it enters into a transaction;
  • ensuring that only accurate and up-to-date information is provided to interested parties, which can reduce reputation risks and legal risks; and
  • helping to insulate the directors from personal liability with respect to the transaction by following an appropriate process.

In terms of the personal liability of directors, it is very important for the bank and its directors to be able to defend the decision to shareholders to enter into a transaction, given the current environment where pricing may not meet investor expectations. From a legal standpoint, many states have a “business judgment rule” that will insulate directors from personal liability regarding such decisions so long as they are related to a rational purpose and so long as the directors acted with loyalty and due care. Courts carefully review the process followed by boards of directors in determining whether the business judgment rule should be applied. We believe following the steps outlined above provides a critical start to establishing an appropriate process for obtaining the protection of the business judgment rule, and judicial decisions confirm this notion.

Many bank directors are currently facing very interesting and challenging times with respect to the long-term strategies of their organizations. Through respecting the processes established by the full board of directors, bank directors can help ensure the best possible outcome for their banks and for themselves.

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

Written by


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.

Bank M&A Deal Volume, Pricing Remains Steady

Written by


Bank mergers and acquisition deals have remained at a steady pace so far in 2012, with 108 deals announced through July 9 having an aggregate deal value of $5.28 billion, according to SNL Financial.

The median price to tangible book value in the second quarter was 110.7 percent, compared to 116.3 percent in the first quarter, and 109 percent in the second quarter of last year.

In 2011, the median price to tangible book value was 106 percent and in 2010, it was 116 percent.

Federal Deposit Insurance Corp.-assisted deals were excluded from the figures.

In 2011, there were 177 transactions announced with a total deal value of $17 billion, compared to 215 deals in 2010 valued at $12.3 billion, according to SNL.

Other trends:

Since Jan 1, 2011, the Midwest has been the most active region for bank M&A, with 76 deals announced, followed by the Southeast, with 53.

The largest bank deal since Jan. 1, 2010, was McLean, Va.-based Capital One Financial Corp.‘s June 16, 2011, agreement to buy Wilmington, Del.-based ING Bank FSB for $9 billion, representing 102.2 percent of the target’s tangible book. This also marks the largest bank deal since 2008, when Wells Fargo & Co. acquired Wachovia Corp. for $15.1 billion. 

Audit Committee: Important Questions to Ask Regarding Your Strategic Plan

Written by


questions.jpgIt is obvious that the banking industry has undergone some dramatic changes over the past five years. The national and global economic crisis and the ongoing recovery have changed the playing field, making it more difficult for community banks to successfully operate with the same business plan as just a few years ago.

This new reality has made it increasingly important that audit committee members understand their institution’s strategic plan for the next three to five years so they can appropriately conduct their oversight role. This was a focus of my presentation at the Bank Director Audit Committee Conference in Chicago last month. After talking with audit committee members during a peer group exchange and throughout the general sessions, it was clear that some boards and management teams have gone to great lengths to make sure that they have developed a clear vision of the strategic plan and how their organization will adapt to the new environment, while other organizations have not yet turned their focus to the future.

With that in mind, there are a number of questions that audit committee members should be asking themselves, their board colleagues and their management teams:

What is our strategic plan?  It is increasing important that boards of directors and management teams have a clear direction as to the strategic focus and goals of their institution. Directors should determine with management the role that directors play in establishing the plan, measuring the institution’s progress with the plan and modifying the plan, as necessary.

How does our strategic plan affect our risk monitoring?  Different strategic goals may give rise to different risks and different risk management tools may be necessary. For instance, an institution that is focused on growth through acquisitions may have different risk thresholds and considerations than a company that is focused on steady, organic growth. These differences should be taken into account by the audit committee when approving the company’s internal audit plan and reviewing the internal audit reports.  

How is our relationship with the regulators?  It is crucial in today’s environment that your organization has a solid, respectful relationship with its regulators. As a director, you should be comfortable that your management team is responsive to the regulators’ questions and suggestions. Additionally, it is important that the directors can show the regulators that they are engaged in their oversight role and are exercising independent judgment. Directors should consider reviewing the lawsuits recently filed by the Federal Deposit Insurance Corporation against directors to understand some of the practices at other institutions that have led to potential director liability.

What is our current capital structure?  Regulators and investors place a heavy emphasis on capital levels and this will continue into the future. Basel III, the Dodd-Frank Act and the unspecified “regulatory expectation” will shape what future capital requirements will be for all institutions, regardless of size. Not only are there going to be higher capital requirements, but the components of capital will also change, with a clear bias toward more permanent common equity. Capital plays a key role in an institution’s strategic plan, and all directors should have a clear understanding of the following to help ensure that capital issues do not interfere with the company’s plan:

  • their institution’s current overall capital levels;
  • the different capital components and how their institution’s capital is comprised (levels of common capital vs. trust preferred, TARP preferred, subordinated debt, etc.);
  • how much capital will be needed in the future; and
  • how their institution can raise additional capital.

What is occurring with M&A in the industry? Are we going to participate?  Over the past 18 months, industry insiders have been indicating that a wave of consolidation is right around the corner. While the level of merger activity has remained somewhat muted, it is likely that there will be more activity in the near future. Directors should understand their institution’s M&A plan and how it fits within the company’s overall strategic plan. Whether or not the company is planning to be an active acquirer or is contemplating selling, it is important to understand the industry trends, what investors are looking for and what your competitors may be planning.  Additionally, it is important that all institutions have an understanding of what different opportunities exist within their market areas. Having such current knowledge will help ensure that the company can act quickly if the company’s circumstances change and participation in a strategic transaction is in its stockholders’ best interests.

Strategic Mergers: An Alternative in a Challenging M&A Market

Written by


vows.jpgWith the credit crisis wounds still raw for many banks, management and directors have become more risk-averse. Organic growth has stalled at most banks, forcing bankers to seek alternative avenues to return shareholder value. Furthermore, today’s low bank valuations have precluded many institutions from exploring a sale, piquing interest in strategic mergers (i.e., stock-for-stock exchanges). These transactions can enhance shareholder value at both institutions, while creating a more saleable franchise. That said, strategic mergers are not without complications and must be structured properly with a complementary partner in order to enhance shareholder value.

What is a Strategic Merger?

Strategic mergers sometimes are labeled mergers-of-equals, although this is usually a misnomer. Rarely, if ever, do two banks merge on completely equal terms. And thinking in terms of “equality” in mergers can be counterproductive. The more appropriate question is whether shareholders would be better off on a standalone basis or with a share of a combined entity. Often strategic mergers involve institutions of differing sizes and strengths, and while the two merging banks may end up with different ownership percentages, shareholder value can still be enhanced by improving the competitive position in a market, leveraging economies of scale, increasing pro forma earnings per share (EPS) and creating a stronger combined management team. In other words, a strategic merger is a marriage in which shareholders of both banks are better off on a combined basis than by remaining independent.

Rationale for Strategic Mergers

Strategic mergers tend to work best between two healthy banks struggling with growth in the present environment. Many banks have cleaned up their balance sheets and are beginning to think about future growth prospects and exit strategies. The trouble is that today’s historically low interest rate environment, anemic loan demand, and escalating operating costs due to new regulations have made it extremely difficult for many banks to grow earnings organically. And with bank valuations in the doldrums, boards are reluctant to sell. Given these realities, the key to maximizing value three to five years down the road will be building a franchise with critical mass and a substantial and consistent earnings stream. Combining two like-minded institutions with similar goals today can create a franchise better positioned to command a more significant premium in a sale down the road.

Value Creation

Generally, strategic mergers occur between two banks within the same market, which allows for greater economies of scale and higher efficiency. Often banks with differing operating strengths will combine in strategic mergers to create a more diversified and valuable franchise. For instance, a terrific loan generator with a high loan-to-deposit ratio might combine with a bank that has a deep core deposit franchise and low cost of funds. The combined institution could realize greater spread income than either bank could achieve on its own.

Whether shareholders of an individual bank will be better off in a combined entity depends on the exchange ratio of shares that is negotiated. Many factors determine the proper exchange ratio, including EPS, tangible book value (TBV) per share, franchise and asset quality, etc.

In addition to the simple economics that make strategic mergers so attractive, they are one of the only ways in today’s environment to amass scale and improve franchise value. Generally speaking, larger institutions command higher valuations. In fact, according to SNL Financial, banks with more than $1 billion in assets sold for, on average, 251.6 percent of TBV over a 10-year period compared to 179.1 percent for banks less than $1 billion. Clearly, not all banks must reach $1 billion in assets to maximize value, but larger franchises tend to attract more interested bidders and drive up valuations.

Challenges of Strategic Mergers

Strategic mergers can be difficult to structure and both banks need to acknowledge they are entering a partnership in which goals must be aligned. Besides the exchange ratio, which can be daunting to establish, other structural challenges remain in strategic mergers, including: which bank becomes the surviving legal entity, which bank becomes the surviving brand, how many board seats each bank retains and how management is restructured. These “social” issues can derail a deal no matter how compelling the economics might be. It’s critical to discuss all these factors before walking too far down the aisle. Otherwise, that strategic partner that made so much economic sense could leave one standing alone at the altar.

For a more in-depth analysis of strategic mergers detailed in a recent Hovde Group publication, please click here.

A Checklist for Buyers and Sellers

Written by


Traditional M&A activity has started to increase in certain geographies, albeit more slowly than anticipated in some states. Due to the tough economic and regulatory climate, organic top-line growth is proving to be quite difficult. In this regard, mergers are becoming one of the more popular strategies to increase earnings with cost-saving synergies as a key driver.

Molly Curl, a bank regulatory national advisory partner at Grant Thornton LLP, lays out the key considerations in an M&A transaction for both buyers and sellers.

Factors that come into play when deciding whether to buy or sell

1. Take stock of your goals and hone your strategy going forward. Work with your key stakeholders to clearly define your organizational goals. Ask critical questions like:

  • Are we focused on being a community bank, willing to accept lower current returns?
  • Are we working toward a liquidity event for our owners?
  • Are we striving to move from a midsize bank to a large regional or national bank?

2. Make sure to consider what is attractive in a bank (or acquisition/sale) when mapping out strategy. Consider factors such as core deposits, loan portfolio, asset quality, franchise value and tangible book value.

Keys for success for sellers

1. Understand the needs of the stakeholders.

Set realistic expectations. Ensure your board and other key stakeholders understand the current M&A market, the risks and rewards, all communications from interested acquirers and views of third parties and advisers.

2. Clearly communicate the M&A process to your organization.

A clear and honest communication of the M&A process to your organization will help pave the road to a smoother and more successful transaction. This should include confidentiality agreements, a full deal information package and all related contracts.

3. Understand general transaction pricing and the mechanics.

Consider how your organization fits into the buyer’s profile, including cost of funds, deposit profile, customer base, loan quality, operating costs and growth projections.

4. Optimize your financial picture based on M&A.

  • Clean up the balance sheet to the best extent possible.
  • Understand and assess potential contingent liabilities.
  • Develop pro forma financials for interested buyers.

5. Consider your interactions with potential buyers.

  • Does the buyer’s motivation align with your organizational goals?
  • Measure and understand levels of interest—keep lines of communication open.
  • Understand the financial and operational strengths and weaknesses of potential buyers.

Keys for success for buyers

1. Tie transactions to strategy.

Review your overall business and acquisition strategy and goals, including acquisition criteria. Will the transaction help you achieve your end strategy?

2. Communicate with regulators.

It’s critical in today’s climate to keep regulators top of mind. Keep the lines of communication open and honest, such as where you want to expand. Share all aspects of your strategy.

3. Assess your systems.

Your systems must be scalable to handle the onslaught of new data and must be flexible to handle different data in different forms.

4. Have an acquisition team in place.

Designate a project manager or M&A leader to coordinate all facets of the transaction; your team must be multidisciplinary. Form a due diligence team that will be prepared to strike at a moment’s notice and set forth a communications strategy to keep your existing and soon-to-be acquired customers as well as your employees informed.

5. Identify your target “wish list.”

Consider what your organization should look like in a few years. Use this long-term vision to define your overall strategy and incorporate it into how you identify the right targets. 

6. Prioritize customers and human capital. Prioritization comes down to these three processes:

  • Stabilize continuing customer relationship and business continuity by establishing a customer management process during the transition to protect existing relationships and revenues.
  • Reduce workforce with stability and efficiency by setting performance metrics during the transition, and eliminate costs from duplicative processes and positions.
  • Integrate senior executive and key sales leaders by remaining customer and business-focused during the transition.