Coronavirus Considerations for Goodwill Impairment

Given the recent impact of Covid-19 on the economy, unemployment and operations, discussions around potential goodwill impairment — and the related testing — is a hot topic for many financial institutions as the March 31 quarter ended.

Goodwill is defined as an asset representing the future economic benefits arising from other assets acquired in a business combination. Financial institutions record goodwill as a result of a merger or an acquisition. Accounting Standards Codification (ASC) 350, Intangibles – Goodwill and Other, states that entities must evaluate their goodwill for impairment at least annually. However, during interim periods, a goodwill impairment analysis could be necessary if the entity has an indication that the fair value of a reporting unit has fallen below carrying value, defined by the guidance as a triggering event. Determining whether a triggering event has occurred is challenging for many financial institutions.

Under the guidance of ASC 350, impairment testing for goodwill is required annually and upon a triggering event. Private entities electing the accounting alternative are only required to test upon a triggering event. Here are some examples of goodwill triggering events, according to ASC 350-20-35:

Macroeconomic conditions: deterioration in general economic conditions, limitations on accessing capital, fluctuations in foreign exchange rates or other developments in equity and credit markets. 

Industry and market considerations: deterioration in the environment in which an entity operates, an increased competitive environment, a decline in market-dependent multiples or metrics (consider in both absolute terms and relative to peers), a change in the market for an entity’s products or services, or a regulatory or political development. 

Overall financial performance: negative or declining cash flows, or a decline in actual or planned revenue or earnings compared with actual and projected results of relevant prior periods.

Other entity-specific events: changes in management, key personnel, strategy or customers; contemplation of bankruptcy or litigation.

Events affecting a reporting unit: a change in the composition or carrying amount of its net assets, a highly probable expectation of selling or disposing of all, or a portion, of a reporting unit, the testing for recoverability of a significant asset group within a reporting unit, or recognition of a goodwill impairment loss in the financial statements of a subsidiary that is a component of a reporting unit.

A sustained decrease in share price: to be considered in both absolute terms and relative to peers.

It is clear that Covid-19 has global impacts on some macroeconomic conditions. Financial institutions may want to assess whether they have experienced a triggering event; if they conclude there has been such an event, they will need to proceed to a goodwill impairment test. Assessing whether there has been a triggering event, as defined by ASC 350, involves judgment.

When it comes to a decline in stock price, the guidance in ASC 350 does not define what “sustained” means. In isolation, a decrease in share price is not an automatic indicator of a triggering event. The guidance suggests comparing the relative decrease to peers — if it is consistent among the industry, one may conclude that the decrease is related to general economic events and not specific to the institution individually. Banks may determine that an overall decline in the market could be indicative of macroeconomic conditions that impact the value of the company. Entities should consider forecasts and projections to determine whether the situation is expected to be temporary, and the reduction in stock price is reflective of short-term market volatility rather than a long-term, sustained decline in fair value.

The guidance does not suggest that the existence of one negative factor results in a triggering event. Rather, the guidance requires companies to assess various factors to determine whether it is probable that the company’s fair value is less than its carrying value. One way to consider the factors mentioned in the guidance is to weight them by their impact on the entity’s fair value. If the company concludes that a triggering event has occurred, then an impairment analysis should be performed to determine if in fact goodwill is impaired.

The determination of a triggering event, or lack thereof, involves judgment; management’s analysis and conclusion should be thoroughly documented. As the economic environment and resulting impacts of Covid-19 continue to shift and evolve, companies should revisit goodwill impairment triggers on a regular basis.

Bracing for Changes in the Bank Control Rules

Executives and directors at public banks need to prepare for new rules this spring that will make it easier for investors to accumulate meaningful stakes in their companies.

The Federal Reserve Board has approved an update to the control framework for investors in banks or bank holding companies that goes into effect April 1. The update comes as the marketplace undergoes a structural shift in flows from active fund management to passive investing. The changes should make it easier for investors — both passive and active — to determine whether they have a controlling influence over a bank, and provides both banks and investors with greater flexibility.

“Anything that’s pro-shareholder, a bank CEO and board should always be happy to support,” says Larry Mazza, CEO at Fairmont, West Virginia-based MVB Financial, which has $1.9 billion in assets. “The more shareholders and possible shareholders you can have, it’s very positive for the owners.”

The Fed last updated control rules in 2008. This update codifies the regulator’s unwritten precedent and legal interpretations around control issues, which should increase transparency for investors, says Joseph Silvia, a partner at Howard & Howard.

“The goal of the regulators is to make sure that they understand who owns those entities, who runs those entities and who’s in charge, because those entities are backed by the Federal Deposit Insurance Corp.,” he says. “The regulators take a keen interest, especially the Fed, in who’s running these entities.”

The question of who controls a bank has always been complicated, and much of the Fed’s approach has been “ad hoc,” Silvia says. The latest rule is largely a reflection of the Fed’s current practice and contains few changes or surprises — helpful for banks and their investors that are seeking consistency. Large shareholder should be able to determine if their stakes in a bank constitute control in a faster and more-straightforward way. They also may be able to increase their stakes, in some circumstances. Silvia specifically highlights a “fantastic,” “wildly helpful” grid that breaks down what the regulator sees as various indicia of control, which observers can find in the rule’s appendix.

“A lot of investors don’t like the pain of some of these regulations — that helps and hurts. [The] regulation creates predictability and stability,” Mazza says. “Where it hurts is that investors may not go forward with additional investments, which hurts all shareholders.”

Shareholders, and banks themselves that may want to take stakes in other companies, now have increased flexibility on how much money they can invest and how to structure those investments between voting and non-voting shares, as well as how board representation should figure in. Silvia says this should advance the conversations between legal counsel and investors, and spare the Fed from weighing in on “countless inquires” as to what constitutes control.

“Both banks and shareholders will likely benefit from the changes, as it could lower the cost of capital for banks while allowing for a greater presence of independent perspectives in the board room,” wrote Blue Lion Capital partner and analyst Justin Hughes in an email. Blue Lion invests in bank stocks.

The change impacts active and passive investors, the latter of which have grown to be significant holders of bank stocks. Passive vehicles like exchange-traded and mutual funds have experienced $3 trillion in cumulative inflows since 2006, while actively managed funds have seen $2.1 trillion in outflows, according to Keefe, Bruyette & Woods CEO Tom Michaud. Passive ownership of bank stocks has increased 800 basis points since 2013, representing 17.1% of total shares outstanding in the third quarter of 2019. Some funds may be able to increase their stakes in banks without needing to declare control, depending on how the investments are structured.

Still, banks may be concerned about the potential for increased activism in their shares once the rule goes into effect. Silvia says the Fed is familiar with many of the activists in the bank space and will watch investment activity after the rule. They also included language in the final update that encourages investment vehicles who have not been reviewed for indicia of control from the Fed to get in touch, given than no grandfathering was provided to funds that had not been reviewed.

“They’re not really grandfathering any investments,” Silvia says. “There’s not a lot of additional protection.”

If nothing else, the rule is a chance for bank executives and directors to revisit their shareholder base and makeup and learn more about their owners, he adds. They should keep track if the makeup of their shareholders’ stakes changes once the rule goes into effect, especially investors that may become activists.

The Evolving Buyer Landscape in Bank M&A


buyer-7-16-19.pngThe recent acquisition of LegacyTexas Financial Group by Prosperity Bancshares serves as a microcosm for the changing bank M&A landscape.

The deal, valued at $2.1 billion in cash and stock, combines two publicly traded banks into one large regional institution with over $30 billion in assets. Including this deal, the combined companies have completed or announced 10 acquisitions since mid-2011. Before this transaction, potential sellers had two active publicly traded buyers that were interested in community banks in Texas; now, they have one buyer that is likely going to be more interested in larger acquisitions.

The landscape of bank M&A has evolved over the years, but is rapidly changing for prospective sellers. Starting in the mid-1990s to the beginning of the Great Recession in late 2007, some of the most active acquirers were large publicly traded banks. Wells Fargo & Co. and its predecessors bought over 30 banks between 1998 and 2007, several of which had less than $100 million in assets.

Since the Great Recession, the largest banks like Wells and Bank of America Corp. slowed or stopped buying banks. Now, the continued consolidation of former buyers like LegacyTexas is reducing the overall buyer list and increasing the size threshold for the combined company’s next deal.

From 1999 to 2006, banks that traded on the Nasdaq, New York Stock Exchange or a major foreign exchange were a buyer in roughly 48 percent of all transactions. That has declined to 39 percent of the transactions from 2012 to the middle of 2019. Deals conducted by smaller banks with over-the-counter stock has increased as a total percentage of all deals: from only 4 percent between 1999 and 2006, to over 8 percent from 2012 to 2019.

Part of this stems from the declining number of Nasdaq and NYSE-traded banks, which has fallen from approximately 850 at the end of 1999 to roughly 400 today. At the same time, the median asset size has grown from $500 million to over $3 billion over that same period of time. By comparison, the number of OTC-traded banks was relatively flat, with 530 banks at the end of 1999 decreasing slightly to 500 banks in 2019.

This means that small community banks are facing a much different buyer landscape today than they were a decade or two ago. Many of the publicly traded banks that were the most active after the Great Recession are now above the all-important $10 billion in assets threshold, and are shifting their focus to pursuing larger acquisitions with publicly traded targets. On the bright side, there are also other banks emerging as active buyers for community banks.

Privately traded banks
Privately traded banks have historically represented a large portion of the bank buyer landscape, and we believe that their role will only continue to grow. We have seen this group move from being an all-cash buyer to now seeing some of the transactions where they are issuing stock as part or all of the total consideration. In the past, it may have been challenging for private acquirers to compete head-to-head with larger publicly traded banks that could issue liquid stock at a premium in an acquisition. Today, privately traded banks are more often competing with each other for community bank targets.

OTC-traded banks
OTC-traded banks are also stepping in as an acquirer of choice for targets that view acquisitions as a reinvestment opportunity. Even though OTC-traded banks are at a relative disadvantage against the higher-valued publicly traded acquirers when it comes to valuation and liquidity, acquired banks see a compelling, strategic opportunity to partner with company with some trading volume and potential future upside. The introduction of OTCQX marketplace has improved the overall perception of the OTC markets and trading volumes for listed banks. This has helped OTC-traded banks compete with the public acquirers and gain an edge against other all-cash buyers. Some of these OTC-traded banks will eventually choose to go public, so it could be attractive to reinvest into an OTC-traded bank prior to its initial public offering.

Credit Unions
In the past, credit unions usually only entered the buyer mix by bidding on small banks or distressed assets. This group has not been historically active in community bank M&A because they are limited to cash-only transactions and subject to membership restrictions. That has changed in the last few years.

In 2015 there were only three transactions where a credit union purchased a bank, with the average target bank having $110 million in assets. In 2018 and 2019, there have been 17 such transactions with a bank, with the average target size exceeding $200 million in assets.

The bank buyer landscape has changed significantly over the past few years; we believe it will continue to evolve over the coming years. The reasons behind continued consolidation will not change, but the groups driving that consolidation will. It remains important as ever for sellers to monitor the buyer landscape when evaluating strategic alternatives that enhance and protect shareholder value.

Information contained herein is from sources we consider reliable, but is not guaranteed, and we are not soliciting any action based upon it. Any opinions expressed are those of the author, based on interpretation of data available at the time of original publication of this article. These opinions are subject to change at any time without notice.

What CEOs Want (and Directors Aren’t Giving)


compensation-7-12-19.pngChief executive officers at community banks want more equity, not more cash.

This is particularly true of community bank CEOs, who say that including equity in pay packages incentivizes them to create long-term shareholder value, aids management retention and prepares them to join the board.

While this shouldn’t come as a huge surprise, the message may be lost on some directors of these banks.

In Bank Director’s 2019 Compensation Survey—sponsored by Compensation Advisors—54 percent of CEOs said their bank should offer equity or increase the amount of equity they already provide. Directors didn’t feel as strongly about this: Only 19 percent said offering or increasing equity was a priority. They saw equity as one of a number of potential improvements, along with other options like non-equity long-term compensation, cash incentive and higher salary.

The board of directors at Talladega, Alabama-based FirstBanc of Alabama added stock grants to the compensation plan for President and CEO J. Chad Jones in 2017, after discussing how to incentivize and retain executive management. The board granted Jones 3,000 shares—1,000 of which were unrestricted and granted immediately, with the remainder consisting of restricted stock transferred over time.

“It has raised my eyebrows,” he says. “It certainly helped me focus on how to drive the stock and dividends.”

Adding the equity incentive “very minimally” diluted existing shareholders but allows Jones to benefit from the upside he creates. The board also approved a block of shares for other C-level officers, with which Jones can implement a similar equity grant program for them.

Jones added that increasing his salary beyond a certain point offered diminishing returns for him and higher expenses for First Bank of Alabama, which has $548.6 million in assets.

“You can give me 5 percent to 10 percent pay increases each year for the next 25 to 30 years. At that point in time, what good has it done?” he says. “I love the compensation side, don’t get me wrong, everyone does. But … if [the board] continues to increase my pay 5 percent and I’m the highest paid individual in this company, it doesn’t make sense for [them] to continue increasing my pay.”

Interest in and demand for equity-based compensation is expected to rise as competition for qualified executives remains stiff and a new generation of talent assumes the top spot, says J. Scott Petty, a partner at executive search firm Chartwell Partners. He says community bank boards should use it as a retention tool.

“In general, more and more CEOs want equity as a part of their compensation package,” he says. “It’s the ultimate alignment of the goals of the board and how the CEO is going to achieve those goals.”

Succession planning at First National Bank of Kentucky changed President and CEO Gregory Goff’s perspective on equity incentive compensation. He plans to retire soon from the Carrollton, Kentucky-based bank, which has $124.5 million in assets, and says he wishes he had opportunities to accumulate equity throughout his career.

“It’s one area of the bank where I didn’t push much—I did my job and went home,” he says. “I ran it like I owned all of it. But now I have no reason to stay here.”

He says the board of directors looked at different incentive compensation structures several times, but could never get comfortable with the dilution from awarding equity or alternatives like bank-owned life insurance. He says the board discussed adding him as a director after he retires, but his lack of equity makes him less interested in a seat.

When Jeffrey Rose interviewed with the board at Davenport, Iowa-based American Bank & Trust in 2016, he told them he wanted to make a bet on himself. Rose says he had been paid a salary and a bonus for turning around banks before, and it “wasn’t enough.” As president and CEO of American Bank & Trust, he hoped to capture some of the upside he created as he helped turn the bank around.

At the $366.2 million asset bank, Rose has the option to purchase a set number of shares each year at a predetermined price. The program is “very simple, very clean,” and the shares fully vest after he purchases them.

American Bank & Trust is taking the equity compensation philosophy one step further, having recently decided to compensate the board with stock instead of cash, too. Rose says the decision generated extensive discussion, but will help long-time directors become more invested in the bank and serve as a positive signal to local shareholders.

It’s tempting for a board to shy away from granting equity to executives—especially if the bank is closely held—but the benefits from doing so can outweigh the costs.

How to Design a Winning Capital Management Plan


capital-4-22-19.pngThe significant downturn in bank stock prices witnessed during the fourth quarter of 2018 prompted a number of boards and managements to authorize share repurchase plans, to increase the amounts authorized under existing plans and to revive activity under existing plans. And in several instances, repurchases have been accomplished through accelerated plans.

Beyond the generally bullish sentiment behind these actions, the activity shines a light on the value of a proactive capital management strategy to a board and management.

The importance of a strong capital management plan can’t be overstated and shouldn’t be confused with a capital management policy. A capital management policy is required by regulators, while a capital management plan is strategic. Effective capital management is, in large part, an exercise in identifying and understanding future risks today. Capital and strategy are tightly linked — a bank’s strategic plan is highly dependent on its capital levels and its ability to generate and manage it.

There are a couple of guidelines that executives should bear in mind as they develop their capital management plans. First, the plan needs to be realistic and achievable. The windows for accessing capital are highly cyclical. There’s limited value in building a plan around an outcome that is unrealistic. Second, if there is credible information from trusted sources indicating that capital is available – go get it! Certain banks, by virtue of their outstanding and sustained performance, may be able to manage the just-in-time model of capital, but that’s a perilous strategy for most.

Managements have a number of levers available to manage capital. The key as to when and which lever to pull are a function of the strategic plan. A strong plan is predicated on staying disciplined but it also needs to retain enough nimbleness to address the unforeseen curveballs that are inevitable.

Share Repurchases
Share repurchases are an effective way to return excess capital to shareholders. They are a more tax-efficient way to return capital when compared to cash dividends. Moreover, a repurchase will generally lift the value of a stock through the reduction in shares outstanding, which should increase earnings per share and the stock price itself. Share repurchases are generally the favored mechanism of institutional owners and can make tremendous sense for broadly held and liquid stocks.

Cash Dividends
Returning capital to shareholders in the form of cash dividends is generally viewed very positively in the banking industry. Banks historically have been known as cash-dividend paying entities, and the ability and willingness to pay them is often perceived as a mark of a healthy and stable company. A company’s decision regarding whether to increase a cash dividend or to repurchase shares can be driven by the composition of the shareholder base. Cash dividends are generally valued more by individual shareholders than institutional shareholders.

Business Line Investment
Community banking at its core is a spread dependent business. The ability to diversify the revenue stream through the development or acquisition of a fee generating business can be an effective and worthwhile use of capital. Common areas of investment include mortgage banking, wealth management, investment products and services and insurance. Funding the lift out of lending teams can also be a legitimate use of capital. A recent development for some is investment in technology as an offensive play rather than a defensive measure.

Capital Markets Access
Effective capital management plans also consider the ability to access the capital markets. In the community banking space, accessing capital is not always a foregone conclusion. Over the past couple of years, the most common forms of capital available have been common equity and subordinated debt. For banks of a certain size and market cap, it’s a prudent capital management strategy to file a shelf registration, also known as form S-3, which provides companies with flexibility as to how and when they access the capital markets. The optionality provided by having a shelf registration far outweighs the concern that the shelf itself suggests a shareholder dilutive activity is on the horizon.

It’s important to note that these capital management activities can be utilized individually or in combination. An acquisition may necessitate the need to access the capital markets. Or given the relative inexpensiveness of sub debt, raising some for the purpose of a share repurchase could make sense. A strong capital management plan can allow a management team to be ready both offensively and defensively to drive their businesses forward in optimal fashion.

Information contained herein is from sources we consider reliable, but is not guaranteed, and we are not soliciting any action based upon it. Any opinions expressed are those of the author, based on interpretation of data available at the time of original publication of this article. These opinions are subject to change at any time without notice.

How The Fed Changed The Game for Private Banks


stock-11-20-18.pngIn late August 2018, the Federal Reserve issued an interim final rule increasing the asset threshold from $1 billion to $3 billion under the Fed’s Small Bank Holding Company Policy Statement. The interim policy now covers almost 95 percent of the financial institutions in the U.S., significantly enhances the flexibility in capital structure, acquisitions, stock repurchases and ownership transfers, among other things, for institutions organized under a holding company structure.

No Consolidated Capital Treatment
The most significant benefit of small bank holding company status is that qualifying banks are not subject to consolidated capital rules. Instead, regulatory capital is evaluated only at the subsidiary bank level. As a result, small bank holding companies have the unique ability to issue debt at the holding company level and contribute the proceeds to its subsidiary bank as Tier 1 common equity without adversely impacting the regulatory capital condition of the holding company or the bank. Due to the expanded coverage of the new rule, banking organizations with up to $3 billion in assets can now take advantage of this benefit to support organic and acquisitive growth, stock repurchases and other corporate transactions.
Acquisition Leverage

Perhaps the most significant application of this benefit is in acquisitions by private institutions, whose equity may be less attractive or undesirable acquisition currency. For these institutions, an acquisition of any scale often requires additional capital, and, without access to public capital markets, utilizing leverage may represent the only viable option to fund the transaction.

Under the Small Bank Holding Company Policy Statement, an acquiring bank holding company may fund up to 75 percent of the purchase price of a target with debt, which equates to a maximum debt to equity ratio of 3-to-1, so long as the acquirer can reduce its debt to equity ratio to less than 0.3-to-1 within 12 years and fully repay the debt within 25 years. The enhanced ability to utilize debt in this context is designed to enable private holding companies to be more competitive with other institutions who have access to the public capital markets or who have a public currency to exchange.

Stock Repurchases
Ownership succession also remains a critical issue for many private holding companies, and the new rule extends the ability to use debt to enhance shareholder liquidity to an expanded group of organizations. In many cases, and especially for larger blocks of stock, a holding company represents the only prospective acquirer for privately-held shares. By using debt to fund stock repurchases, a small bank holding company can create liquidity to a selling shareholder, while providing a benefit to the remaining shareholders through the increase in their percentage ownership.

Moreover, stock repurchases often present themselves at times and in amounts that make equity offerings a less suitable alternative for funding. Finally, as discussed below, stock repurchases can be utilized to enhance shareholder value.

Attractiveness to Investors
While the new rule increases the operating flexibility of banking organizations by providing additional tools for corporate transactions, the use of leverage as part of an organization’s capital structure also results in a number of meaningful benefits to shareholders. First, holding company leverage, whether structured as senior or subordinated debt, generally carries a significantly lower cost of capital, as compared to equity instruments. The issuance of debt is non-dilutive to common shareholders, which means existing shareholders can realize the full benefit associated with corporate growth or stock repurchases funded through leverage without having to spread those benefits over a larger group of equity holders. In addition, unlike dividends, interest payments associated with holding company debt are tax deductible, which lowers the effective cost of the debt. Accordingly, funding growth or attractively priced stock repurchases through leverage can be immediately accretive to shareholders.

Final Thoughts
Funding growth, stock repurchases and other corporate transactions can be a challenge for banking organizations that do not have access to public capital markets or have a public currency. However, the revised Small Bank Holding Company Policy Statement provides management teams and boards of directors with additional tools to fund corporate activities and growth, manage regulatory capital, and enhance shareholder liquidity and value.

What It Takes to Go De Novo Today


de-novo-7-27-18.pngAaron Dorn spent two years putting together a checklist of things that needed to be in place and questions that needed to be answered before starting a new bank.

He considered buying an existing bank, but acquiring a company built on legacy core technology was a big inhibitor to building a digital-only bank, which was Dorn’s business plan. However, the idea of going de novo became too costly and intensive to justify the effort after the FDIC increased its capitalization requirements for startups following the financial crisis. Now, there are signs that the environment for de novos is improving. Economic conditions around the country are better and bank stock values are higher, but there are other factors that could also be significant drivers behind a recent uptick in de novo activity, all of which Dorn discovered in Nashville as he considered the de novo route.

Dorn, 37, formally began the process of raising capital in the fall of 2017 to form Studio Bank, which will officially open in a few weeks. He will serve as the CEO and also brought along a few former colleagues from Avenue Bank, where Dorn was the chief strategy and marketing officer. Avenue Bank was a 10-year-old “de facto de novo” (a recapitalized and rebranded Planters Bank of Tennessee) that sold in 2016 to Pinnacle Financial Partners, another Nashville-based bank. In fact, Studio’s music company-turned bank home sits in the shadow of Pinnacle’s headquarters building.

Just two banks have earned FDIC approval this year, but nearly more than a dozen de novo applications were awaiting approval in mid-June. That comes after just 13 banks opened in the seven preceding years, according to the agency. Capital raises for the new banks have been anywhere from a fairly standard $20 million to $100 million by Grasshopper Bank, based in New York.

This flurry of activity has naturally drawn attention and speculation about whether there will be a return to the level of new charter activity we saw previous to the financial crisis when in any given year there could be between 100 to 200 new bank formations. What exactly has inspired this growth in applications? Along with a stronger economy and higher valuations, the industry’s ongoing consolidation has created opportunities for former bankers like Dorn who are itching to get back into a business currently ripe with promise.

“These mergers are producing opportunities for groups to put together locally owned, more community focused financial institutions to service their market and also play an important role as community leaders,” said Phil Moore, managing partner at Porter Keadle Moore, an advisory and accounting firm.

But the question circulating among bankers and insiders is what has inspired the sharp increase in de novo activity. Or perhaps more importantly, what’s the recipe for starting a new bank today?

There’s a few things some agree need to be in place to get a new bank off the ground.

“The first is that these de novos are organizing in what could be considered underserved markets, secondly they are focusing on vibrant growth areas and third, they are generally organizing to serve an affinity group,” says Moore.

This is Dorn’s perspective also, who says he created Studio in part because the booming Nashville market has few local banks. Studio will focus on “creators,” as Dorn calls them, including musicians, nonprofits and startups, a very similar model to Avenue, except that Studio will operate from a digital platform.

The Nashville deposit market has doubled since the last de novo opened there in 2008, Dorn says. There is also a preference for local ownership. “Empirically, (Nashville is) a market that strongly prefers locally headquartered banks,” he says.

Studio is one of just two de novos that have been approved this year. The other, CommerceOne Bank, is in Birmingham, Alabama, another blossoming metro area that also has very few locally owned banks. Birmingham rates in the top 160 metro areas in the country, according to the Milken Institute’s 2017 Best-Performing Cities report.

Other pending applications that are also in high-performing areas like Oklahoma City, ranked 131, and Sarasota, Florida, ranked No. 6.

That’s still a far cry from the de novo activity seen in the decades prior to the financial crisis, but the interest in starting new companies can certainly be seen as encouraging.

Are the Ducks Quacking?


IPO-5-17-18.pngAn initial public offering isn’t the only path to listing your bank’s shares on the Nasdaq or New York Stock Exchange, and gaining greater liquidity and more efficient access to capital via the public markets.

Business First Bancshares, based in Baton Rouge, Louisiana, opted for a direct listing on the Nasdaq exchange on April 9, over the more traditional IPO. Coincidentally, this was the same route taken a few days prior—with greater fanfare and media attention—by Swedish entertainment company Spotify. A direct listing forgoes the selling of shares, and provides an instant and public price for potential buyers and sellers of a company’s stock.

Business First’s direct listing could be seen as an IPO in slow motion. The $1.2 billion asset company registered with the Securities and Exchange Commission in late 2014, ahead of its April 2015 acquisition of American Gateway Bank. Business First then completed a $66 million private capital raise in October—$60 million of which was raised from institutional investors—before acquiring MBL Bank in January. The institutional investors that invested in Business First last fall did so with the understanding that the bank would be listing soon. “We actually raised money from the same people as we would have in an IPO process,” says Chief Executive Officer Jude Melville.

Melville says his bank took this slow route so it could be flexible and take advantage of opportunities to acquire other banks, which is a part of the its long-term strategy. Also, bank stocks in 2015 and 2016 had not yet hit the peak levels the industry began to see in 2017. The number of banks that completed an IPO in 2017 more than doubled from the prior year, from eight to 19, according to data obtained from S&P Global Market Intelligence.

“The stars aligned in 2017” for bank stocks, says Jeff Davis, a managing director at Mercer Capital. The Federal Reserve continued increasing interest rates, which had a positive impact on margins for most banks. Bank M&A activity was expected to pick up, and the Trump administration has appointed regulators who are viewed as being friendlier to the industry. “There’s a saying on Wall Street: When the ducks are quacking, feed them, and institutional investors wanted bank stocks. One way to feed the ducks is to undergo an IPO,” Davis says. Bank stock valuations are still high, and so far, 2018 looks to be on track for another good year for new bank offerings, with four completed as of mid-April.

The more recent wave of bank IPOs, which had trailed off in 2015 and 2016, was largely a result of post-crisis private equity investors looking for an exit. As those investors sought liquidity, several banks opted for life as a public company rather than sell the bank. That backlog has cleared, says Davis. “It’s still a great environment for a bank to undergo an IPO,” he says. “Particularly for a bank with a good story as it relates to growth.”

The goals for Business First’s public listing are tied to the bank’s goals for growth via acquisition. Private banks can be at a disadvantage in M&A, having to rely on all-cash deals. A more liquid currency, in the form of an actively-traded stock, is attractive to potential sellers, and the markets offer better access to capital to fuel growth. Melville also believes that most potential employees would prefer to work for a public versus a private company. “Being publicly traded gives you a certain stability and credibility that I think the best employees find attractive,” he says.

Business First’s delayed listing was a result of leadership’s understanding of the seriousness of being a public bank, and the management team focused on integrating its acquisitions first to be better prepared for the listing.

“You really have to want to be a public company and make the sacrifices necessary to make that possible,” says Scott Studwell, managing director at the investment bank Stephens, who worked with Business First on its pre-public capital raise but not its direct listing. “There has to be a lot of support for doing so in the boardroom.” The direct preparation for an IPO takes four to six months, according to Studwell, but the typical bank will spend years getting its infrastructure, personnel, policies and procedures up to speed, says Lowell Harrison, a partner at Fenimore, Kay, Harrison & Ford. The law firm serves as legal counsel for Business First. Roadshows to talk up the IPO and tell the company’s story can have executives traveling across the country and even internationally.

And the bank will be subject to Wall Street’s more frequent assessment of its performance. If a bank hits a road bump, “it can be a rough go for management in terms of looking at the stock being graded by the Street every day, not to mention all the compliance costs that go with being an SEC registrant,” says Davis. All of this adds more to the management team’s plate.

Considering a public path is an important discussion for boards and management teams, and is ultimately a strategic decision that should be driven by the bank’s goals, says Harrison. “What is the problem you’re trying to solve? Do you need the capital? Are you trying to become a player in the acquisition market? Are you just simply trying to create some liquidity for your shares?” Filing an IPO, or opting for a direct listing, should check at least two of these boxes. If the bank just wants to provide liquidity to its shareholders, a listing on an over-the-counter market such as the OTCQX may achieve that goal without the additional burden on the institution.

In considering the bank’s capital needs, a private equity investor—which would allow the bank to remain private, at least in the near term—may suit the bank. Institutional investors favor short-term liquidity through the public markets, which is why Business First was able to obtain capital in that manner, given its near-term direct listing. Private equity investors are willing to invest for a longer period of time, though they will eventually seek liquidity. These investors are also more actively engaged, and may seek a board seat or rights to observe board meetings, says Studwell. But they can be a good option for a private bank that’s not ready for a public listing, or doesn’t see strategic value in it.

Though Business First’s less-common path to its public listing is one that could be replicated under the right circumstances, the majority of institutions that choose to go public are more likely to opt for a traditional IPO. “The reality is that direct listings are very rare, and it takes a unique set of circumstances for it to make sense for a company,” says Harrison. While a direct listing provides more liquidity than private ownership, be advised that the liquidity may not be as robust as seen in an IPO, which tends to capture the attention of institutional shareholders. “Usually, it’s the actual function of the IPO that helps kickstart your public market activity,” he adds. And if the bank needs an injection of capital—and determines that a public listing is the way to do it—then an IPO is the best strategic choice.

Emerging M&A Trends: What To Expect



Deposits promise to be the hot topic for the banking industry in 2018, but more was revealed at Bank Director’s 2018 Acquire or Be Acquired conference about growth trends and M&A for U.S. financial institutions. While many banks are seeking to buy, not all banks are attractive partners. Further, bank stock valuations have had a significant impact on the M&A marketplace. Bank Director CEO Al Dominick provides an analysis of these issues in this video, including what potential buyers and sellers can expect this year.

  • The Importance of Deposits
  • Dynamics Driving the Industry
  • Bank Stock Pricing
  • Buyer & Seller Expectations

No Time for Complacency


valuation-1-31-18.pngThe bank industry is no stranger to change. In just the past few decades, deregulation, telephone banking, ATMs, the internet and mobile phones have all caused banks and bankers to adjust how they approach their trade. But while the fundamentals of banking have remained the same throughout all of this, with the changes confined largely to the way banking products are delivered, one gets a palatable sense from attendees at Bank Director’s Acquire or Be Acquired conference this year that the industry is on the verge of a more transformational realignment.

In the short-term, bankers are upbeat about last year’s historic tax cut. You have to go back to World War II to find the last time the corporate income tax rate was as low as 21 percent. Few industries will benefit more than banks from this reduction, as three out of the four biggest taxpayers on the S&P 500 are banks. The net result is that profitability in the industry, measured by return on assets, is expected to increase by 20 basis points in one fell swoop.

The benefit to banks from the tax cut won’t just be on the expense side. In an audience poll on the second day of the conference, 84 percent of attendees said that they expect small businesses to recycle tax savings into new investments, be it better technology or higher wages for their employees. If this comes to fruition, it would pour fuel on the economy, pushing up wages and accelerating inflation. The desire to keep price increases in check, would incentivize the Federal Reserve to raise rates more aggressively, thereby pushing up net interest margins and thus revenue and profits throughout the bank industry.

This is one of the reasons that bankers are so optimistic about 2018. Bank stocks have soared over the past 14 months, pushing valuations up to the highest level in a decade. Bankers who own stock in their banks have seen their balance sheets respond in kind. For banks that have considered a sale, this presents a previously unexpected opportunity to cash in by drawing a markedly higher price for their shareholders from a merger or acquisition.

Yet, there are two underlying currents of concern. The first is that the improved outlook will lull bankers into complacency. With profits up and shareholders feeling rich, investors fear that bankers will feel less urgency to change. But as Tom Brown, CEO of hedge fund Second Curve Capital, reminded attendees earlier in the conference, bankers should be careful not to confuse a bull market with brains.

Banks have survived countless innovations that have washed over the industry in the past by adapting to them and incorporating them into their existing business models, but the changes afoot now, be it big data or mobile banking, strike at the very heart of those business models themselves. In a separate poll of audience members at this year’s conference, 83.5 percent of attendees said that big data is the new oil. The implication is that it could usher in changes as significant as the industrial revolution.

This is a point that Dennis Hudson III, the chairman and CEO of Seacoast Bank, a $5.8 billion bank based in Stuart, Florida, drove home in an interview with Bank Director. Customers are becoming less sticky. Many customers no longer walk into branches and younger generations in particular now value banks less for the ability to store money and more as the means to facilitate secure, real-time payments. Banks that don’t adapt to these realities could find themselves in the same situation as horse buggy drivers who dismissed the automobile as a toy for hobbyists.

When you also factor in the maturity of the consolidation cycle, which could leave under-performing banks with few suitors and competing against bigger and more sophisticated rivals, this may be one of the worst times in the history of banking to grow complacent. Consistently throughout the conference there was talk of the haves and have nots. The haves are banks that earn industry-leading returns and thereby serve as attractive acquisition targets or are in a position to be serial acquirers in their own right. The have nots, on the other hand, are banks that lag the performance of their peers, lack the resources to devote to innovation and could thus find themselves standing alone when the proverbial music stops playing.

Further underlining this point is that, for the first time, the nation’s biggest banks are growing customers organically, attracting them with simple and sophisticated mobile banking offerings and competing aggressively for consumer deposits as they comply with new liquidity requirements. This is a meaningful inflection point. Previously, community and regional banks benefited from the acquisitive ways of the biggest players in the industry, which shed customers as the banking behemoths worked to digest their acquisition targets. But now, with the three biggest banks in the country locked out of the acquisition game as a result of the 10 percent cap on deposits, they are focused inward, bringing them into more direct competition with smaller banks.

The overarching takeaways from this year’s gathering of over 1,000 bankers are accordingly twofold. The near-term looks promising for banks, with more money hitting the bottom line from the recent historic tax cut. But banks should use this to accelerate their transformation into the financial institutions of the future, not as an excuse to rest on their laurels and buy back stock.