Nelson Mullins reviewed 43 publicly available merger agreements for bank mergers announced in 2022 to identify common market practices. The transactions ranged in deal value from $10.1 million to $13.7 billion, with a median deal value of roughly $136 million. They reflected average pricing of 1.6x tangible book and 16x earnings.
Understanding these market practices can help potential targets understand what might be available in the market, and help potential purchasers understand where they may be able to stand out from the market. Below are some of the highlights and observations of the review.
Adjustments to Merger Consideration Based on Closing Capital
Ten of the 43 transactions included an adjustment to the merger consideration based on the target’s closing capital, with nine including a dollar for dollar decrease in merger consideration based on the target missing a stated closing capital level. Only one merger agreement offered a dollar for dollar increase or decrease based on a stated closing capital level. Transactions varied with respect to whether changes in the value of available-for-sale securities were backed out of closing capital as well as whether transaction expenses were to be included or excluded in such calculations; there was no market consensus. At least one merger agreement also required the held-to-maturity securities portfolio to be marked-to-market for purposes of calculating closing capital. Only eight transactions provided a minimum capital amount as an explicit closing condition.
Closing conditions predicated on minimum capital amounts are more common in years in which financial stress overhangs the industry, such as during the 2008 financial crisis. Given the significant interest rate moves in 2022, these observations are expected. As we look to 2023, we would expect these conditions to become less common if interest rate trends moderate or even stabilize and drop, noting that any asset stress resulting from a possible economic downturn would change our opinion.
Other Adjustments to Merger Consideration
Although there has been discussion of similar provisions, only the TD Bank Group/First Horizon Corp. agreement included additional merger consideration if the transaction was delayed based on delayed regulatory approvals. No other public merger agreements included such a provision. However, there was one agreement that interestingly provided that the parties could mutually agree to reduce the merger consideration by up to $3.5 million if an event caused a material adverse decline in the value of the transaction. One has to wonder: Would a target ever subsequently agree to a discretionary reduction in merger consideration?
Must the Purchaser Act in the Ordinary Course of Business?
In roughly a third of the transactions, the purchaser undertook an affirmative covenant to only act in the ordinary course of business. This would presumably require the purchaser to obtain the target’s consent before engaging in another acquisition. Conversely, in two-thirds of the transactions, the purchaser made no such covenant.
In all transactions, the purchaser did covenant not to undertake any action that would be expected to cause a delay in the immediate transaction. In the two transactions where the target was closest in size to the purchaser — hence more likely a strategic merger or “merger-of-equals” — the purchaser and target agreed to mutual affirmative and negative covenants.
Target’s Ability to Accept Superior Proposals
Virtually all of the transactions permitted the target’s board of directors to respond to unsolicited alternative proposals. This arrangement, commonly referred to as a “fiduciary out,” is common and effectively required under most frameworks of director’s fiduciary duties.
In roughly 75% of the transactions, the target board of directors had the right to terminate the merger agreement if confronted with a superior proposal and conditioned upon paying a termination fee. However, in 25% of the transactions, while the target board of directors could change its recommendation to shareholders in light of a perceived superior proposal, only the purchaser could elect to then terminate the merger agreement and require the target to pay the termination fee. Otherwise, the target remained obligated to seek shareholder approval and likely most of the directors would remain obligated, if subject to voting support agreements, to continue to vote for the transaction. In four transactions, even the target shareholders’ rejection of the merger agreement didn’t immediately give the target the right to terminate the merger agreement; the parties remained obligated to make good faith reasonable best efforts to first negotiate a restructuring that would result in shareholder approval.
Increasingly Common New Provisions
We increasingly saw provisions addressing cooperation on data processing conversions and coordination of dividend timing, with a desire to ensure that each parties’ shareholders received one dividend payment each quarter.
It’s no longer enough for banks to provide clients with standard products and services. Clients are constantly looking for differentiators when deciding which financial institution to trust with their business. Whether your clients are baby boomers preparing for retirement or millennials interested in purchasing their first home, everyone wants their bank to make them feel special.
When implementing any initiative, strategic marketing is key. Your clients need to be aware of, and excited by, your incentives — one benefit can set your institution apart from competitors. Below are five benefits for banks to consider.
1. Partner With Other Companies
Partnering with other companies like gas stations, grocery stores and retail brands gives you a way to offer rewards to clients when they purchase their essentials. Plus, your bank will enjoy free marketing and awareness as part of the collaboration. Banks can also increase their trust, credibility and relevance when they partner with businesses that clients already know and use. For example, Bank of America Corp. offers a customizable cash back credit card that offers 2% back at grocery stores and wholesale clubs.
2. Connect Clients to Capital
Often, clients are unaware of programs that can net them working capital, like the Employee Retention Credit (ERC). ERC providers are highly qualified professionals that help clients navigate the ERC process and can work with banks to help their commercial clients collect an average of $400,000. This is another example of an alliance that’s mutually beneficial: Clients gain back money they’re owed, while the bank receives referral commissions from its agreement with a trusted ERC provider. Banks can also benefit from the goodwill built between the institution and the client.
3. Offer a Loyalty Program
A loyalty program can provide clients with compelling, ongoing reasons to continue banking with your institution. Going a step further, your institution can add different tiers of rewards that incentivize clients to take advantage of each initiative. One great aspect of a loyalty program is that banks can customize it according to clients’ unique needs, creating a personalized offering that resonates with them. As an example, Kasasa Cash and Kasasa Cash Back function as a checking account, plus include monthly rewards like exclusive savings at different stores and restaurants.
4. Provide Enrollment Incentives
To encourage potential clients to sign up with your bank, consider offering exclusive rewards only available for new clients. From exclusive discounts to no sign-up fees, there are many ways banks can provide value up front to people deciding between institutions. For example, Citigroup’s Citibank is giving new clients up to $2,000 when they open a checking account by Jan. 9, 2023.
5. Implement Digital Banking
For banks with ample resources, a digital banking app is a great way to further improve your clients’ experience. Providing a more streamlined way for clients to manage their finances allows your bank to create greater value that other institutions may not be able to offer. Digital banking allows clients to interact with your bank wherever they are, at any time. Some features your bank may want to include are:
Banks are doing very well, if you look at credit quality and profitability. But tell that to investors.
Last week, the Federal Open Market Committee raised the target federal funds rate by 75 basis points, the third hike of that magnitude in a row, to combat inflation.
The market has punished equities lately in response, but even more so, bank stocks, probably in anticipation of a recession that may have arrived. The S&P 500 fell 21.61% in 2022 as of Friday, Sept. 23, but the S&P U.S. large cap bank index was down 25.19% in that same time frame, according to Mercer Capital using S&P Global Market Intelligence data. By asset size, large banks have seen the biggest declines so far this year.
Going back further in time, the cumulative return for U.S. bank stocks in general, as measured by the S&P U.S. BMI Banks index, was down 5.30% as of Sept. 22 from the start of 2020, compared to a gain of 21.55% for the S&P 500.
Investors’ dim view of bank stocks belies the underlying strengths of many of these banks. Bank net income of $64.4 billion in the second quarter was higher than it had been in the same quarter of 2018 and 2019, according to the Federal Deposit Insurance Corp. Since 2019, in fact, bank profitability has been going gangbusters. Rising interest rates improved net interest margins, a key profitability statistic for many banks. Plus, loan growth has been good.
And credit quality remains high, as measured by the noncurrent loan and quarterly net charge-off rates at banks, important bank metrics tracked by the FDIC. Despite weaknesses in mortgage and wealth management, this combination of variables has made many banks more profitable than they were in 2018 or 2019.
“Earnings are excellent right now, and they’re going to be even better in the third and fourth quarter as these margins expand,” says Jeff Davis, managing director of Mercer Capital’s financial institutions group.
Investors don’t seem to care. “It’s been a real frustration and a real incongruity between stock prices and what’s going on with fundamentals,” says R. Scott Siefers, managing director and senior research analyst at Piper Sandler & Co. “You’ve had a year of really great revenue growth, and really great profitability, and at least for the time being, that should continue. So that’s the good news. The bad news is, of course, that investors aren’t really as concerned with what’s going on today.”
Worries about a possible recession are sending investors away from bank stocks, even as analysts join Davis in his prediction of a pretty good third and fourth quarter for earnings this year. The reason is that investors view banks as sensitive to the broader economy, Siefers says, and think asset quality will deteriorate and the costs of deposits will rise eventually.
The place to see this play out is in two ratios: price to earnings and price to tangible book value. Interestingly, price to tangible book value ratios have remained strong — probably a function of deteriorating bond values in bank securities’ portfolios, which is bringing down tangible book values in line with falling stock prices. As a result, the average price to tangible book value as of Sept. 23 was 1.86x for large regional bank stocks and 1.7x for banks in the $10 billion to $50 billion asset range, according to Mercer Capital.
Meanwhile, price to earnings ratios are falling. The average price to earnings ratio for the last four quarters was 10.3x for large regional banks, and 11.4x for mid-sized bank stocks. (By way of comparison, the 10-year average for large cap bank stocks was 13.4x and 14.6x for mid cap bank stocks, respectively.)
For bank management teams and the boards that oversee them, the industry is entering a difficult time when decisions about capital management will be crucial. Banks still are seeing loan growth, and for the most part, higher earnings are generating a fair amount of capital, says Rick Childs, a partner at the tax and consulting firm Crowe LLP. But what to do with that capital?
This might be the perfect time to buy back stock, when prices are low, but that depletes capital that might be needed in a recession and such action might be viewed poorly by markets, Childs says. Davis agrees. A lot of companies can’t or won’t buy back their own stock when it’s gotten cheap, he says. “If we don’t have a nasty recession next year, a lot of these stocks are probably pretty good or very good purchases,” he says. “If we have a nasty recession, you’ll wish you had the capital.”
It’s tricky to raise dividends for the same reason. Most banks shy away from cutting dividends, because that would hurt investors, and try to manage to keep the dividend rate consistent, Childs says.
And in terms of lending, banks most certainly will want to continue lending to borrowers with good credit, but may exercise caution when it comes to riskier categories, Davis says. Capital management going forward won’t be easy. “If next year’s nasty, there’s nothing they can do because they’re stuck with what’s on the balance sheet,” he says. The next year or two may prove which bank management teams made the right decisions.
The nationwide pandemic and persistent economic uncertainty hasn’t slowed the growth of Idaho Central Credit Union.
The credit union is located in Chubbuck, Idaho, a town of 15,600 near the southeast corner, and is one of the fastest growing in the nation. It has nearly tripled in size over the last five years, mostly from organic growth, according to an analysis by CEO Advisory Group of the 50 fastest growing credit unions. It also has some of the highest earnings among credit unions — with a return on average assets of 1.6% last year — an enviable figure, even among banks.
“This is an example of a credit union that is large enough, [say] $6 billion in assets, that they can be dominant in their state and in a lot of small- and medium-sized markets,” says Glenn Christensen, president of CEO Advisory Group, which advises credit unions.
Unsurprisingly, growth and earnings often go hand in hand. Many of the nation’s fastest growing credit unions are also high earners. Size and strength matter in the world of credit unions, as larger credit unions are able to afford the technology that attract and keep members, just like banks need technology to keep customers. These institutions also are able to offer competitive rates and convenience over smaller or less-efficient institutions.
“Economies of scale are real in our industry, and required for credit unions to continue to compete,” says Christensen.
The largest credit unions, indeed, have been taking an ever-larger share of the industry. Deposits at the top 20 credit unions increased 9.5% over the last five years; institutions with below $1 billion in assets grew deposits at 2.4% on average,” says Peter Duffy, managing director at Piper Sandler & Co. who focuses on credit unions.
As of the end of 2019, only 6% of credit unions had more than $1 billion in assets, or 332 out of about 5,200. That 6% represented 70% of the industry’s total deposit shares, Duffy says. Members gravitate to these institutions because they offer what members want: digital banking, convenience and better rates on deposits and loans.
“The only ones that can consistently deliver the best rates, as well as the best technology suites, are the ones with scale,” Duffy says.
Duffy doesn’t think there’s a fixed optimal size for all credit unions. It depends on the market: A credit union in Los Angeles might need $5 billion in assets to compete effectively, while one in Nashville, Tennessee, might need $2 billion.
There are a lot of obstacles to building size and scale in the credit union industry, however. Large mergers in the space are relatively rare compared to banks — and they became even rarer during the coronavirus pandemic. Part of it is a lack of urgency around growth.
“For credit unions, since they don’t have shareholders, they aren’t looking to provide liquidity for shareholders or to get a good price,” says Christensen.
Prospective merger partners face a host of sensitive, difficult questions: Who will be in charge? Which board members will remain? What happens to the staff? What are the goals of the combined organization? What kind of change-in-control agreements are there for executives who lose their jobs?
These social issues can make deals fall apart. Perhaps the sheer difficulty of navigating credit union mergers is one contributor to the nascent trend of credit unions buying banks. A full $6.2 billion of the $27.7 billion in merged credit union assets in the last five years came from banks, Christensen says.
Institutions such as Lakeland, Florida-based MIDFLORIDA Credit Union are buying banks. In 2019, MIDFLORIDA purchased Ocala, Florida-based Community Bank & Trust of Florida, with $743 million in assets, and the Florida assets of $675 million First American Bank. The Fort Dodge, Iowa-based bank was later acquired by GreenState Credit Union in early 2020.
The $5 billion asset MIDFLORIDA was interested in an acquisition to gain more branches, as well as Community Bank & Trust’s treasury management department, which provides financial services to commercial customers.
MIDFLORIDA President Steve Moseley says it’s probably easier to buy a healthy bank than a healthy credit union. “The old saying is, ‘Everything is for sale [for the right price],’” he says. “Credit unions are not for sale.”
Still, despite the difficulties of completing mergers, the most-significant trend shaping the credit union landscape is that the nation’s numerous small institutions are going away. About 3% of credit unions disappear every year, mostly as a result of a merger, says Christensen. He projects that the current level of 5,271 credit unions with an average asset size of $335.6 million will drop to 3,903 credit unions by 2030 — with an average asset size of $1.1 billion.
CEO Advisory Credit Union Industry Consolidation Forecast
The pandemic’s economic uncertainty dropped deal-making activity down to 65 in the first half of 2020, compared to 72 during the same period in 2019 and 90 in the first half of 2018, according to S&P Global Market Intelligence. Still, Christensen and Duffy expect that figure to pick up as credit unions become more comfortable figuring out potential partners’ credit risks.
In the last five years, the fastest growing credit unions that have more than $500 million in assets have been acquirers. Based on deposits, Vibe Credit Union in Novi, Michigan, ranked the fastest growing acquirer above $500 million in assets between 2015 and 2020, according to the analysis by CEO Advisory Group. The $1 billion institution merged with Oakland County Credit Union in 2019.
Gurnee, Illinois-based Consumers Cooperative Credit Union ranked second. The $2.6 billion Consumers has done four mergers in that time, including the 2019 marriage to Andigo Credit Union in Schaumberg, Illinois. Still, much of its growth has been organic.
Canyon State Credit Union in Phoenix, which subsequently changed its name to Copper State Credit Union, and Community First Credit Union in Santa Rosa, California, were the third and fourth fastest growing acquirers in the last five years. Copper State, which has $520 million in assets, recorded a deposit growth rate of 225%. Community First , with $622 million in assets, notched 206%. The average deposit growth rate for all credit unions above $500 million in assets was 57.9%.
CEO Advisory Group Top 50 Fastest Growing Credit Unions
“A number of organizations look to build membership to build scale, so they can continue to invest,” says Rick Childs, a partner in the public accounting and consulting firm Crowe LLP.
Idaho Central is trying to do that mostly organically, becoming the sixth-fastest growing credit union above $500 million in assets. Instead of losing business during a pandemic, loans are growing — particularly mortgages and refinances — as well as auto loans.
“It’s almost counterintuitive,” says Mark Willden, the chief information officer. “Are we apprehensive? Of course we are.”
He points out that unemployment remained relatively low in Idaho, at 6.1% in September, compared to 7.9% nationally. The credit union also participated in the Small Business Administration’s Paycheck Protection Program, lending out about $200 million, which helped grow loans.
Idaho Central is also investing in technology to improve customer service. It launched a new digital account opening platform in January 2020, which allows for automated approvals and offers a way for new members to fund their accounts right away. The credit union also purchased the platform from Temenos and customized the software using an in-house team of developers, software architects and user experience designers. It purchased Salesforce.com customer relationship management software, which gives employees a full view of each member they are serving, reducing wait times and providing better service.
But like Idaho Central, many of the fastest growing institutions aren’t growing through mergers, but organically. And boy, are they growing.
Latino Community Credit Union in Durham, North Carolina, grew assets 178% over the last five years by catering to Spanish-language and immigrant communities. It funds much of that growth with grants and subordinated debt, says Christensen.
Currently, only designated low-income credit unions such as the $536.5 million asset Latino Community can raise secondary capital, such as subordinated debt. But the National Credit Union Administration finalized a rule that goes into effect January 1, 2022, permiting non-low income credit unions to issue subordinated debt to comply with another set of rules. NCUA’s impending risk-based capital requirement would require credit unions to hold total capital equal to 10% of their risk-weighted assets, according to Richard Garabedian, an attorney at Hunton Andrews Kurth. He expects that the proposed rule likely will go into effect in 2021.
Unlike banks, credit unions can’t issue stock to investors. Many institutions use earnings to fuel their growth, and the two measures are closely linked. Easing the restrictions will give them a way to raise secondary capital.
A separate analysis by Piper Sandler’s Duffy of the top 263 credit unions based on share growth, membership growth and return on average assets found that the average top performer grew members by 54% in the last six years, while all other credit unions had an average growth rate of less than 1%.
Many of the fastest growing credit unions also happen to be among the top 25 highest earners, according to a list compiled by Piper Sandler. Among them: Burton, Michigan-based ELGA Credit Union, MIDFLORIDA Credit Union, Vibe and Idaho Central. All of them had a return on average assets of more than 1.5%. That’s no accident.
Top 25 High Performing Credit Unions
Credit unions above $1 billion in assets have a median return on average assets of 0.94%, compared to 0.49% for those below $1 billion in assets. Of the top 25 credit unions with the highest return on average assets in 2019, only a handful were below $1 billion in assets, according to Duffy.
Duffy frequently talks about the divide between credit unions that have forward momentum on growth and earnings and those who do not. Those who do not are “not going to be able, and have not been able, to keep up.”
Banks that belong to the American Financial Exchange (AFX) are not waiting until 2021 to make the switch away from the troubled London Interbank Offered Rate, or LIBOR, interest rate benchmark for pricing their offerings in the capital markets.
These institutions, which represent $3 trillion in assets and more than 20% of the U.S. banking sector, are using AMERIBOR® to price debt offerings now. They say AMERIBOR®, an unsecured benchmark, better reflects the cost of funds as represented by real transactions in a centralized, regulated and transparent marketplace. The benchmark has been used to price loans, deposits, futures and now debt — a critical step in a new benchmark’s development and financial innovation.
In October, New York-based Signature Bank announced the closing of $375 million aggregate principal amount of fixed-to-floating rate subordinated notes due in 2030 — the first use of AMERIBOR® in a debt deal. The notes will bear interest at 4% per annum, payable semi-annually. For the floating component, interest on the notes will accrue at three-month AMERIBOR® plus 389 basis points. The offering was handled by Keefe Bruyette & Woods and Piper Sandler. The transaction was finalized the first week of October 2020.
Signature Bank Chairman Scott Shay highlighted the $63 billion bank’s involvement as a “founder and supporter” of AFX.
“We are pleased to be the first institution to use AMERIBOR® on a debt issuance. … AMERIBOR is transparent, self-regulated and transaction-based, and we believe that it is already a suitable alternative as banks and other financial institutions transition away from LIBOR,” Shay said.
The inaugural incorporation of AMERIBOR® in a debt offering paves the way for more debt deals and other types of financial products linked to the benchmark. The issuance adds to the list of U.S. banks that have already pegged new loans to the rate, including Birmingham, Alabama-based ServicFirst Bancshares, Boston-based Brookline Bancorp and San Antonio-based Cullen/Frost Bankers. As AFX adds to deposits, loans and fixed income linked to AMERIBOR, the next risk transfer instrument up for issuance will be a swap deal.
Banks of all sizes have options to choose from when it comes to an interest rate benchmark best suited to their specific requirements. AMERIBOR® was developed for member banks and others that borrow and lend on an unsecured basis. Currently, AFX membership across the U.S. includes 162 banks, 1,000 correspondent banks and 43 non-banks, including insurance companies, broker-dealers, private equity firms, hedge funds, futures commission merchants and asset managers.
This article does not constitute an offer to sell or a solicitation of an offer to buy the notes, nor shall there be any offer, solicitation or sale of any notes in any jurisdiction in which such offer, solicitation or sale would be unlawful.
How important is net interest margin (NIM) to your institution?
In 2019, banks nationally were 87% dependent on net interest income. With the lion’s share of earnings coming from NIM, implementing a disciplined approach around margin management will mean the difference between underperforming institutions and outperforming ones. (To see how your institution ranks versus national and in-state peers, click here.)
Anticipating the next steps a bank should take to protect or improve its profitability will become increasingly difficult as they manage balance sheet risks and margin pressure. Cash positions are growing with record deposit inflows, pricing on meager loan demand is ultra-competitive and many institutions are experiencing accelerated cash flows from investment portfolios.
It is also important to remember that stress testing the balance sheet is no longer an academic exercise. Beyond the risk management, stressing the durability of capital and resiliency of liquidity can give your institution the confidence necessary to execute on strategies to improve performance and to stay ahead of peers. It is of heightened importance to maintain focus on the four major balance sheet position discussed below.
Capital Assessment, Position Capital serves as the cornerstone for all balance sheets, supporting growth, absorbing losses and providing resources to seize opportunities. Most importantly, capital serves as a last line of defense, protecting against risk of the known and the unknown.
The rapid changes occurring within the economy are not wholly cyclical in nature; rather, structural shifts will develop as consumer behavior evolves and business operations adjust to the ‘next normal.’ Knowing the breaking points for your capital base — in terms of growth, credit deterioration and a combination of these factors — will serve your institution well.
Liquidity Assessment, Position Asset quality deterioration leads to capital erosion, which leads to liquidity evaporation. With institutions reporting record deposit growth and swelling cash balances, understanding how access to a variety of funding sources can change, given asset quality deterioration or capital pressure, is critical to evaluating the adequacy of your comprehensive liquidity position.
Interest Rate Risk Assessment, Position In today’s ultra-low rate environment, pressure on earning asset yields is compounded by funding costs already nearing historically low levels. Excess cash is expensive; significant asset sensitivity represents an opportunity cost as the central bank forecasts a low-rate environment for the foreseeable future. Focus on adjusting your asset mix — not only to improve your earnings today, but to sustain it with higher, stable-earning asset yields over time.
Additionally, revisit critical model assumptions to ensure that your assumptions are reflective of actual pricing behaviors, including new volume rate floors and deposit betas, as they may be too high for certain categories.
Investment Assessment, Position Strategies for investment portfolios including cash can make a meaningful contribution to your institution’s overall interest income. Some key considerations to help guide the investment process in today’s challenging environment include:
Cost of carrying excess cash has increased: Most institutions are now earning 0.1% or less on their overnight funds, but there are alternatives to increasing income on short-term liquidity.
Consider pre-investing: Many institutions have been very busy with Paycheck Protection Program loans, and we anticipate this will have a short-term impact on liquidity and resources. Currently, spreads are still attractive in select sectors of the market.
Taylor Advisors’ Take: Moving into 2021, liquidity and capital are taking center stage in most community banks’ asset-liability committee discussions. Moving away from regulatory appeasement and towards proactive planning and decision-making are of paramount importance. This can start with upgrading your bank’s tools and policies, improving your ability to interpret and communicate the results and implementing actionable strategies.
Truly understanding your balance sheet positions is critical before implementing balance sheet management strategies. You must know where you are to know where you want to go. Start by studying your latest quarterly data. Dissect your NIM and understand why your earning asset yields are above or below peer. Balance sheet management is about driving unique strategies and tailored risk management practices to outperform; anything less will lead to sub-optimal results.
Will deal volume pick up pace in 2021? Despite credit concerns and negotiation hurdles, Stinson LLP Partner Adam Maier predicts a stronger appetite for deals — but adds that potential acquirers will have to be aggressive in pursuing targets that align with their strategic goals.
Banks are making lemonade out of investors’ lemons — in the form of buybacks.
Fears about how the coronavirus will impact financial institutions has depressed bank valuations. A number of community banks have responded by announcing that they’ll buy back stock.
Bank Director reached out to Eric Corrigan, senior managing director at Commerce Street Capital, to talk about why this is happening.
The Community Bank Bidder Much of the current buyback activity is driven by community banks with small market capitalizations. The median market cap of banks announcing new buybacks now is $64 million, compared to a median of $377 million for 2019, according to an Aug. 27 report from Janney Montgomery Scott.
One reason community banks might be buying back stock now is that their illiquid shares lack a natural bidder — a situation exacerbated by widespread selling pressure, Corrigan says. By stepping in to buy its own stock, a bank can help offset the absence of demand.
“You can help support it or at least mitigate some of the downward pressure, and it doesn’t take a lot of dollars to do that,” he says.
Buybacks Are Accretive to Tangible Book Value Many bank stocks are still trading below tangible book value. That makes share buybacks immediately accretive in terms of both earnings per share and tangible book value.
“If you can buy your stock below book value, it’s a really attractive financial trade. You are doing the right thing for shareholders, you’re supporting the price of the stock, and financially it’s a good move,” Corrigan says.
Buying Flexibility Share buyback announcements are a statement of intention, not a promise chiseled in stone. Compared to dividends, buybacks offer executives the flexibility to stop repurchasing stock without raising concerns in the market.
“If you announce a buyback, you can end up two years later with exactly zero shares bought,” Corrigan says. “But you signaled that you’re willing, at a certain price under certain circumstances, to go out there and support the stock.”
Buybacks Follow Balance Sheet Bulk-Up Many of the nation’s largest banks are under buyback moratoriums intended to preserve capital, following the results of a special stress test run by the Federal Reserve. Banks considering buybacks should first ensure their balance sheets are resilient and loan loss provisions are robust before committing their capital.
“I think a rule around dividends or buybacks that’s tied to some trailing four-quarter performance is not the worst thing in the world,” he says. “The last thing you want to do is buy stock at $40 and have to issue it at $20 because you’re in a pinch and need the equity back.”
Many of the banks announcing repurchase authorizations tend to have higher capital levels than the rest of the industry, Janney found. The median total common equity ratio for banks initiating buybacks in 2020 is about 9.5%, compared to 9.1% for all banks.
Why a Buyback at All? A stock price that’s below the tangible book value can have wide-ranging implications for a bank, impacting everything from a bank’s ability to participate in mergers and acquisitions to attracting and retaining talent, Corrigan says.
Depressed share prices can make acquisitions more expensive and dilutive, and make potential acquirers less attractive to sellers. A low price can demoralize employees receiving stock compensation who use price as a performance benchmark, and it can make share issuances to fund compensation plans more expensive. It can even result in a bank taking a goodwill impairment charge, which can result in an earnings loss.
Capital markets are open — for now — and community banks have taken note.
The coronavirus pandemic and recession have created an attractive environment for banks to raise certain types of capital. Executives bracing for a potentially years-long recession are asking themselves how much capital their bank will need to guard against low earnings prospects, higher credit costs and unforeseen strategic opportunities. For a number of banks, their response has been to raise capital.
A number of banks are taking advantage of interested investors and relatively low pricing to pad existing capital levels with new funds. Other banks may want to consider striking the markets with their own offerings while the iron is hot. Most of the raises to-date have been subordinated debt or preferred equity, as executives try to avoid diluting shareholders and tangible book value with common equity raises while they can.
“I think a lot of this capital raising is done because they can: The markets are open, the pricing is attractive and investors are open to the concept, so do it,” says Christopher Marinac, director of research at Janney Montgomery Scott. “Banks are in survival mode right now. Having more capital is preferred over less. Hoarding capital is most likely going to be the norm — even if it’s not stated expressly — that’s de facto what they’re doing.”
Shore Bancshares’ CEO Lloyd “Scott” Beatty, Jr. said the bank is “cautiously optimistic” that credit issues will not be as dire as predicted. But because no one knows how the recession will play out, the bank decided to raise “safety capital” — $25 million in subordinated debt. The raise will grow the bank’s Tier 2 capital and boost overall risk-based capital from 14.1% to about 16%, according to analysts.
“If credit issues do not develop, we will be in a position to use this capital offensively in a number of ways to improve shareholder value,” Beatty said in the Aug. 8 release.
That mindset resonates with Rick Weiss, managing director at PNC’s Financial Institutions Group, who started his career as a regulator at the U.S. Securities and Exchange Commission.
“I’ve never seen capital I haven’t liked,” he says. “I feel safer [when banks have higher] capital — in addition to avoiding any regulatory problems, especially in a bad economy, it gives you more flexibility with M&A, expanding your business, developing new lines, paying dividends, doing buybacks. It allows you to keep the door open.”
Raising capital is especially important for banks with thinner cushions. Republic First Bancorp raised $50 million in convertible preferred equity on Aug. 27 — a move that Frank Schiraldi, managing director at Piper Sandler & Co., called a “positive, and necessary, development.” The bank had capital levels that were “well below peers” and was on a significant growth trajectory prior to the pandemic. This raise boosts tangible common equity and Tier 1 capital by 100 basis points, assuming the conversion.
Banks are also taking advantage of current investor interest to raise capital at attractive interest rates. At least three banks were able to raise $100 million or more in subordinated offers in August at rates under 5%.
Lower pricing can also mean refinancing opportunities for banks carrying higher-cost debt; effortlessly shaving off basis points of interest can translate into crucial cost savings at a time when all institutions are trying to control costs. Atlantic Capital Bancshares stands to recoup an extra $25 million after refinancing existing debt that was about to reset to a more-expensive rate, according to a note from Stephen Scouten, a managing director at Piper Sandler. The bank raised $75 million of sub debt that carried a fixed-to-floating rate of 5.5% on Aug. 20.
*Company specified this figure is gross and includes the full allotment exercised by the underwriters. **Date offering closed Source: company press releases
A new trend has emerged as small businesses across the U.S. seek capital to ensure their survival through the Covid-19 pandemic: a significantly more crowded and competitive market for small business lending.
Community banks are best-equipped to meet the capital needs of small businesses due to existing relationships and the ability to offer lower interest rates. However, many banks lack the ability to deliver that capital efficiently, meaning:
Application approval rates are low;
Customer satisfaction suffers;
Both the bank and small business waste time and resources;
Small businesses seek capital elsewhere — often at higher rates.
When community banks do approve small credit requests, they almost always lose money due to the high cost of underwriting and servicing them. But the real risk to community banks is that large players like Amazon.com and Goldman Sachs Group are threatening to edge them out of the market for small business lending. At stake is nothing less than their entire small business relationships.
Over the past few years, nonbank fintechs have infiltrated both consumer and business banking, bringing convenience and digital delivery to the forefront. Owners of small businesses can easily apply for capital online and manage their finances digitally.
Yet in 2018, only 11% of small banks had a digital origination channel for small business lending. In an age of smartphones, community banks still heavily rely on manual, paper-based processes for originating, underwriting and servicing small business loans.
It was no surprise, then, when Amazon and Goldman Sachs announced a lending partnership geared toward third-party merchants using the retail giant’s platform. Soon, invited businesses can apply for a revolving line of credit with a fixed APR. Other major companies like Apple and Alphabet’s Google have also debuted innovative fintech products for consumers —it’s only a matter of time before they make headway into the small business space.
A 2016 Well Fargo survey found that small business owners are willing to pay more for products and services that make their lives easier. It makes sense that an independent retailer that already sells on Amazon would be more inclined to work with a lender that integrates directly into the platform. If your small business lending program isn’t fully online, customers will take the path of least resistance and work with institutions that make the process easier and more seamless.
Serving small business borrowers better The issue isn’t that small businesses lack creditworthiness as prospective customers. Rather, it’s that the process is stacked against them. Small businesses aren’t large corporations, but many banks apply the same process and requirements for small credit requests as they do for commercial loans, including collecting and reviewing sophisticated financials. This eliminates any chance of profit on small credit requests. The problem is with the bank’s process — not its borrowers.
The solution is clear cut:
Digitize the lending process so customers don’t have to take time out of their busy day to visit a branch or speak with a loan officer. Note that this includes more than just an online application. The ability to collect/manage documents, present loans offers, provide e-contracts and manage payments are all part of a digitally-enabled lending process.
Incorporate SMB-specific credit criteria that accurately assess creditworthiness more effectively, like real-time cash flow and consumer sentiment.
Take advantage of automation without giving up control or increasing risk. For example, client notifications, scoring and application workflow management are all easy ways to save time and cut costs.
Free up lending officers to spend more time with your most-profitable commercial customers.
These changes can help turn small business customers into an important, profitable part of your bank. After all, 99% of all U.S. businesses are considered “small” — so the ability to turn a profit on small business lending represents significant upside for your bank.
With better technology and data, along with a more flexible process, community banks can sufficiently reduce the cost of extending capital to small businesses and turn a profit on every loan funded. Next, banks can market their small business loan products to existing business customers in the form of pre-approved loan offers, and even gain new business customers from competitors that push small business borrowers away.
Think about it: small business customers already have a deposit relationship at your bank. Community banks have this advantage over the likes of Amazon, Goldman Sachs, Apple and others. But when time is limited, small businesses won’t see it that way. By rethinking your small business lending process, it’s a win for your bank’s bottom line as well as a win in customer loyalty.
