The Three Pillars for Success in Peer Mergers

Recent trends indicate that many bankers are considering adding significant scale by targeting peer institutions for outright acquisition.

These transactions, which we call “peer mergers,” are comparable to so-called “merger of equals,” except that the management team, operational structure and culture of the acquiring institution will mostly remain the same for the combined institution. This avoids the most obvious difficulty with successfully executing a merger of equals: combining two institutions without one side of the equation feeling “less equal” than the other. Peer mergers still carry plenty of their own risks, but keeping the management team and operational structure mostly intact is appealing and can greatly reduce the need to cut redundancies post-merger by eliminating them at the outset. Here are three key concepts to keep in mind when considering such a merger.

Choose a Good Strategic Fit

Why are we doing this deal? Will we be solving challenges or creating new ones? Is the combined institution greater than the sum of its parts?
Choosing to do a peer merger may be as straightforward as needing to add scale. However, banks desiring scale to fortify their balance sheet and gain operational and regulatory efficiencies may find that the wrong partner creates more headaches than it solves. Long-term solutions may be more difficult to manage at a larger combined institution, especially if there is a significant clash in cultures. In most cases, identifying a target needs to be about more than just scale. Does the merger gain entry into high-growth markets, meaningfully diversify credit risk, add complementary products and teams, or create significant synergies and efficiencies? Does your bank need to merge in order to accomplish those goals, or are there simpler, cleaner alternatives?

Get Ahead of Challenges

What are the challenges posed by the merger? How can those challenges be addressed? How quickly can those challenges be overcome?
We always recommend to our clients to be as proactive as possible about identifying and solving issues as early as they can in the acquisition negotiation process. This is even more true in a peer merger, where the consequences of a miscalculation are amplified by the transaction’s scale. The merger agreement doesn’t need to be signed to start this process. In fact, addressing issues prior to execution may very well reveal even deeper problems than due diligence would have otherwise shown, and allow for solutions or protections to be negotiated into the merger agreement. Especially try to hammer out the compensation of the potentially retained management personnel as early as possible; you don’t want to find out post-signing that key personnel aren’t as keen on staying with the combined institution as you’d thought — especially if that would trigger change in control payments.

Look Down the Road

What are our long-term strategic goals, and how does the merger get us closer to them? What will the combined institution look like 3 to 5 years from now? How does this benefit our shareholders?
Forecasting what the combined institution will look like in the long term involves much more than looking at pro formas and financial projections. Will your operational structure be able to handle the combined institution’s business volume at closing? Will it be able to five years down the road without a difficult and expensive overhaul? Will you be operating in your target markets, or will further geographic growth be needed and how will you achieve it? Will you cross asset size thresholds that trigger more onerous regulatory oversight in the near future?

Another important consideration is the impact on your shareholders — both the old and the new. Consider how you will give your shareholders the ability to cash out their investments. Will you conduct stock buybacks? Is a public listing on the table? Do you give target shareholders the opportunity to cash out at closing?

Both the potential benefits and risks of a typical merger are magnified in a peer merger, due to the scale of the transaction. With extensive strategic and operational foresight and careful navigation of the potential pitfalls, peer mergers offer a way to quickly add scale and supercharge your bank.

Buying a Bank? 10 Key Compliance Due Diligence Considerations

discovery.jpgM&T Bank’s recent acquisition of Hudson City Bancorp, right on the heels of M&T’s exit from the Troubled Asset Relief Program, is a strong indication that bank consolidations and acquisitions are likely to continue in the near future.

Whether acquisitions help to shore up capital, expand markets, or serve other purposes, numerous financial institutions are pursuing these deals. But are they performing the due diligence necessary to protect themselves from the potential compliance downside of these transactions?

If you’re considering an acquisition or consolidation deal, you can’t afford to skimp on due diligence. The old adage of “one man’s trash is another man’s treasure” definitely does not apply in these situations—when you acquire an institution, its trash remains trash.

The transaction price should reflect the related risks. Higher risks and compliance issues can generate fines and penalties that should not be overlooked when negotiating, but you have to know about the risks before you can negotiate over them. And that’s where due diligence comes in.

Before acquiring or consolidating with another institution, you should consider certain questions about that institution. While the following list is not all-inclusive, answering these questions will have you headed in the right direction:

1.  Does the institution provide products to money-service business (MSB) customers (e.g. wire transfers, currency exchange)? If so, how many, and what types of controls are in place to minimize the risks associated with those customers?

2.  What are the volumes of its currency transaction reports (CTRs), suspicious activity reports (SARs), and wire transfers, both domestic and international?

3.  Does it use an automated system for transaction monitoring, and if so, has the system been validated recently? Did those validations identify any gaps?

4.  Which types of controls are in place to help confirm compliance with the Office of Foreign Assets Control (OFAC) requirements?

5.  Are the loan and deposit operations centralized or decentralized, and is any portion of its operations outsourced to a third party? The answers to these questions will determine the potential amount of risk being acquired.

6.  Which types of products does it offer its consumers? Does it offer any types of unusual products that generally are not available from other financial institutions?

7.  How many different types of loan or deposit processing systems does it currently maintain?

8.  Which types of quality control processes are in place for keeping lines of business up to date on regulatory changes? Are those changes validated once they are required and implemented?

9.  How often is compliance tested and reported to management?

10. What is the structure of the compliance management program, and how does the program define “compliance?”

You wouldn’t buy a car without looking under the hood for potential problems that could come back to bite you down the road. The same rationale should apply to bank transactions, where the potential costs stand to be much, much greater. Regulatory agencies are placing a higher emphasis on compliance. It is your responsibility to demonstrate that you did your due diligence if you acquire any potential regulatory issues. If you cannot show proof of due diligence, you could face regulatory penalties.