Positive Outlook for Bank M&A as the Pandemic Subsides

Will there be an acceleration of bank merger and acquisition activity in 2021 and beyond?

The short answer is yes.

As the Covid-19 pandemic recedes, we expect bank M&A activity to rebound, both in terms of branch and whole-bank acquisitions. Banks and their advisors have evolved since the pandemic’s onset forced office closures and the implementation of a new remote working environment. In the past year, institutions and their boards of directors improved technology and online banking capabilities in response to customer needs and expectations. They also gained substantial experience providing banking products and services in a remote environment. This familiarity with technology and remote operations should cause acquirors and sellers alike to reconsider where they stand in the M&A market in 2021 and beyond.

We see a number of factors supporting an improved M&A market in 2021. First, many acquirors and potential deals were sidelined in the spring of 2020, as the pandemic’s uncertainty setting in and the markets were in turmoil. We expect a number of these deals to be rekindled in mid- to late-2021, if they haven’t already resurfaced. We also expect a robust set of acquirors to return to the market looking to add deposits, retail and commercial customers, lending teams, and additional capabilities.

Second, there remains a growing number of small banks struggling to compete that would likely consider potential merger partners with similar cultures and in similar geographic markets. Similarly, risk management and compliance costs continue to challenge bank managers amid tough competition from community banks, credit unions and other non-bank financial institutions. Some small banks have also struggled to provide the digital offerings that have become commonplace since the pandemic began. These challenges are sure to have smaller banks considering merger partners or new investors.

Third, larger banks are looking to grow deposits and market share as they look to compete with more regional players that have the necessary compliance infrastructure and digital offerings. We expect these more regional players to use acquisition partners as a way to grow core deposits and increase efficiencies. Acquiring new deposits and customers also affords these regional banks the ability to cross-sell other products that smaller banks may not have been able to offer the same customers before — increasing revenue in a sustained low-interest rate environment.

Finally, the low-interest rate environment has opened the capital markets to banks of all sizes looking to raise subordinated debt, which may support community bank M&A. Many subordinated debt offerings are priced in the 4% to 5% range, and often are oversubscribed within just a few days. Banks have found these offerings to be an attractive tool to pay off debt with higher interest rates, fund investments in digital infrastructure, provide liquidity to shareholders through buyback programs and seek branch or whole-bank acquisition targets.

We are already seeing activity pick up in bank M&A, and expect that as the economy — and life itself — begins to normalize in 2021, more transactions to be announced. The prospects for an active merger market in 2020 were cut off before spring arrived. This year, as we approach spring once again, the M&A market is not likely to return to pre-pandemic levels, but the outlook is certainly much more optimistic for bank M&A.

Bank Compensation: Should You Award a Transaction Bonus?


incentive-pay-10-12-16.pngWhen a bank suddenly finds itself in the midst of a sale, merger, or other strategic transaction, retaining key talent and senior leadership becomes critical. Without proper incentives, executives can be left to wonder whether impending changes align with their own economic interests and long-term career goals. Banks need their key players to remain sharply focused on maintaining and growing the existing business, while simultaneously handling the increased responsibilities of working through a potential transaction.

While banks typically have change-in-control (CIC) severance and equity arrangements in place for senior executives, retention bonuses—and in special cases “transaction bonuses”—may be implemented as a deal is contemplated.

When establishing awards, banks should be mindful of the total retention opportunities for the group, including potential severance and equity vesting upon termination or CIC. Awards approved should be reasonable on a standalone basis, in the aggregate when considering all CIC-related costs, and relative to deal size. When current severance, equity, and other CIC related benefits are sufficient, there may be no need for additional transaction compensation.

Used less frequently than other retention vehicles, transaction bonuses can be used to motivate executives throughout the business sale process. They are usually paid in cash upon or shortly following a deal closing, although some awards are in shares. Terms vary based on the role a key executive will play.

  • For the deal makers, the select group of executives that are responsible for driving deal terms and value, a transaction bonus can be fairly significant and often is determined as a fixed dollar value, a percentage of the equity transaction value, or fixed number of shares. Some awards are hinged on the attainment of strategic performance goals or metrics such as negotiating a threshold transaction price.
  • For key administrators, those senior level executives critical to managing the due diligence and sale process, transaction bonuses are typically used to compensate for the additional work required. These awards tend to be smaller, taking the form of fixed cash bonuses determined based on a percentage of an executive’s base salary with amounts increasing as desired retention periods lengthen.

To understand how banks are using this incentive, we examined public disclosures over the last five years for the acquisitions of 88 public banks.

  • Of those, just a small number (17 percent) disclosed paying transaction bonuses to their named executive officers (NEOs). In contrast, about a third (31 percent) of the banks reported paying retention bonuses with service periods extending beyond closing. When transaction bonuses were paid, over half of the banks (53 percent) disclosed that there would be no further cash severance benefit provided.
  • Transaction award amounts were extremely varied based on the specific circumstances and size of each transaction and each individual’s contribution. When paid, aggregate awards to all NEOs ranged between $55,000 to over $10 million (on an absolute basis). Aggregate awards as a percentage of transaction values ranged from 0.15 percent at the 25th percentile to 1.36 percent at the 75th percentile with a midpoint of 0.78 percent. Percentages in relation to deal size tended to decrease as the deal size increased.

When considered on the eve of deal, legal and compensation advisors should be actively involved in the design and approval process; banks will be under a heightened level of scrutiny to demonstrate the prudence of their decisions. Also, banks should be mindful of institutional shareholder and shareholder advisory services concerns and a number of tax, legal, and accounting potholes. For example, Internal Revenue Code Section 280G applies when the present value of all payments related to a CIC equals or exceeds three times the individual’s base amount (i.e., an individual’s five-year average W-2 earnings). When 280G is triggered, punitive excise tax penalties apply and intended CIC benefits can be significantly eroded.

In practice, transaction bonuses for senior executives are paid much less frequently than compared to standard retention awards and tend to cover a smaller, more senior group of executives. However, for deal makers, these awards can be a significant incentive and worth considering since they are meant to reward value realization. For key administrators, transaction awards are sized to effectively compensate for the additional time and effort needed to bring a transaction to close. Transaction awards may provide the right retention hold and motivation when severance and equity benefits are insufficient to retain senior level executives through or shortly following close and may help your institution get a deal over the finish line.