Deciding Whether to Sell or Go Public

10-15-14-Al-MA.pngThere is no for banks—finding and attracting the right merger partner takes time, effort and skill. While the decision to sell a company weighs heavily on every CEO, there comes a point where a deal makes too much financial and cultural sense to ignore.

Finding the right merger partner means being realistic, as two bank leaders shared with me during a recent Bank Director conference in San Francisco. David R. Brooks, the chairman and CEO at $3.7-billion asset Independent Bank Group based in McKinney, Texas, and Jim Stein, the former CEO of the Bank of Houston and now vice chairman of Independent Bank, talked about their experiences and decision to merge their banks.

While there has been an increase in bank IPOs in 2014, as Hovde Group described in a recent article, credit might be paid to one of the few banks to take the path in the wake of the financial crisis. The story of Independent Bank Group’s combination with its peer, BOH Holdings Inc. and its subsidiary bank, the Bank of Houston, begins in the summer of 2012, when Independent Bank decided to do an IPO based upon a belief that many banks would have to consider strategic alternatives coming out of the Great Recession and possibly sell.

At the time, the bank’s board placed a bet that this would result in an opportunity to consolidate significant market share in the major Texas metro areas. Brooks and his team had successfully completed four smaller bank acquisitions in the previous three years, from 2010 to 2012, ranging in assets from $40 million to $180 million—paid primarily in cash.

As Brooks explained to an audience of CEOs, CFOs and board members at the Ritz-Carlton San Francisco during Bank Director’s Valuing the Bank conference, he wanted to buy larger institutions in the $300-million to $1.5-billion asset range, but the purchase price would be significantly higher and would exceed the company’s ability to pay using cash. There also was significant resistance to sellers taking privately held stock as consideration. So, his objective was to have a strong public stock “currency” to use as a tool to execute strategy. Since the IPO, it has been clear he and his team have had success with this strategy.

The IPO raised $100 million at 2.2 times tangible book value in 2012, and the stock rose from $26 per share at issue to more than $45 per share as of last week. The company has announced eight acquisitions since 2010.

While this was going on, Jim Stein observed the success of Brooks and his team. Indeed, Stein was plotting a similar path. A de novo in March 2005, the Bank of Houston’s board found the lack of a liquid currency proved to be an impediment to successful M&A. Like Independent Bank, BOH Holdings considered an IPO in the spring of 2013 and began the process of gearing up to go public. Concurrently, Stein’s conversations with Brooks became more frequent.

For Stein, the rationale behind joining Brooks as opposed to pursuing an IPO or another suitor was simple: As Independent Bank was already public and well received, Bank of Houston could grow faster, and return better shareholder value, by teaming up with Independent Bank. Indeed, Stein knew the bank needed to expand in markets outside of Houston to achieve the highest franchise value. Doing so, however, would necessitate rebranding and loss of focus on the Houston market the bank knew very well. Thinking about the execution risks of entering new, unknown markets, the timing seemed to be ideal for the two to join forces.

Based on their relative sizes and geographic locations, Brooks and Stein both believed a deal would represent a game changing event, as adding the Metro Houston market to Independent’s existing footprint in Texas would be a huge driver of franchise value. Bank of Houston would add more than $1 billion in assets to Independent Bank when the deal closed in April 2014. The acquisition was valued at $170 million and included $34 million in cash and 3.6 million shares of Independent Bank Group’s stock at roughly $37 per share. Most importantly, the two shared similar cultures and that was vital in sealing the deal. This was especially true at the leadership level, where the two banks had similar goals and ideas and the two teams’ recognized each other’s strengths. Two Bank of Houston directors joined the board of Independent Bank Group.

It was not an easy decision to sell Bank of Houston but it has turned out well. As in dating, knowing the qualities you are looking for and being patient helps a lot.

The IPO Market is Red Hot. What’s Driving It?

The market for bank initial public offerings (IPOs) has become scorching. In fact, through the first three quarters of this year, nine initial public offerings of commercial banks have been successfully completed. Based on the current pipeline, this year will mark the most bank IPO activity in the last decade.


Source: SNL Financial; Year-to-date through September 30,2014

During September, Citizens Financial Group Inc. (NYSE: CFG) completed the largest bank IPO on record, at $3.4 billion in gross proceeds. To put the size of this offering into perspective, the second largest offering this year was approximately $232 million for Talmer Bancorp Inc.

Given the active IPO market, bank directors and investors alike have asked us: What has spurred the pick-up in IPOs? What characteristics do great IPO candidates have in common? Are there more to come? Will this have an effect on M&A activity? To shed some light on these, we will address each question.

What Has Spurred the Pick-Up in IPOs?
A number of factors that have contributed to or helped facilitate the pick-up in activity such as higher valuations, the emerging growth company provisions in the JOBS Act, the need to repay Troubled Asset Relief Program money or another form of capital, as well as supportive capital markets. Bankers have referenced a combination of pent-up demand for liquidity from some shareholders and the need to fund future growth. Going public provides shareholder liquidity for those who want it while allowing management teams and committed investors alike to continue to pursue the long-term strategic plan. Furthermore, having access to the public markets is a significant advantage for growth-minded companies regardless of whether the growth is organic or through acquisitions. 

Characteristics of Good IPO Candidates
So what makes a good IPO candidate?

  • Management: Investors are interested in banks led by an exceptional management team with a proven track record.
  • Size: While a few have fallen outside of the range, most banks are between $1 billion to $5 billion in assets at the time of their IPO. 
  • Profitability: Investors want to see both a solid profitability trend and earnings growth— top line growth while managing expenses to improve the bottom line.
  • Clean balance sheet: Especially at this point in the cycle, balance sheets should be in good shape.
  • Growth: A growing bank in a high-growth market is the ideal situation, but solid growth prospects are  key, whether organic or through acquisition opportunities.

Are Rising Valuations Justified?
While IPO valuations are up on average, the pricing of recent deals has been reasonable relative to the valuations of similar public banks. For example, of the thirteen banks that have completed an initial public offering during the last two years, nine of these were within $1 billion and $5 billion in assets at the time of their IPO. Three of the four others were within $350 million of this size range with Citizens Financial Group being the exception. We analyzed all publicly traded banks in this size range and found that the group currently trades at approximately 163 percent of tangible equity, which supports the pricing of recent offerings. Interestingly, banks in this size range are currently trading close to the same multiples they traded at roughly three and a half years ago; however, they have returned over 51 percent on average to investors during this same period.


Source: SNL Financial; Data from 1/3/2011-9/29/2014

Will This Affect M&A Activity?
Issuing stock in a merger or acquisition helps a buyer achieve the higher capital levels that regulators want on a pro forma basis while helping to ensure attractive payback periods for investors. In fact, during the past two years approximately 86 percent of deals where the purchase price was $25 million or more have included stock as a portion of the consideration. Accordingly, the majority of banks that have completed an IPO this year have stated the intent to evaluate acquisition opportunities.

We expect this pick-up in IPOs to continue into 2015. Furthermore, we expect this trend to drive more M&A activity as well. Current valuations are drawing more banks to access the public markets and investors are interested in profitable institutions with compelling growth prospects. Many of these newly public banks intend to pursue acquisitions which will be conducive to continued consolidation throughout the banking industry. Accretive acquisitions are a catalyst supporting higher stock prices for the buying banks, which will serve to further lure more growth-minded bankers to consider an initial public offering.

Building a Better Mousetrap: Executing a Merger of Equals

10-6-14-bryan-cave.pngWith merger activity on the rise during 2014, some boards of directors are considering whether the time is right for their financial institution to find a strategic partner. These boards, particularly those serving institutions with less than $1 billion in assets, may believe their banks need to gain size and scope to maintain a competitive footing. However, these boards may also want to maintain the strategic direction of the institution or capture additional returns on their shareholders’ investment. For these boards, a merger of equals with a similarly-situated financial institution may hold the greatest appeal, as a combined institution could gain greater competitive resources and additional return for its investors than if it were to remain an independent institution. Although a merger of equals may be appealing to both management and the board, the particular circumstances required to execute such a transaction can often be elusive. A merger of equals may involve structural considerations that are slightly different from other acquisitions:

  • Geography. The merging institutions typically have complementary, rather than overlapping, market areas. Some commonality among the markets is helpful, but significant overlap can eliminate many of the synergies associated with a merger.
  • Competitive Advantages. A merger of equals may make sense for financial institutions that have different specialties or expertise. For example, a bank with a high volume of commercial real estate loans may be able to diversify into C&I by finding the right merger partner. Deposit pricing can also create attractive opportunities, with low-cost deposits from slower-growing markets funding loan growth in an adjacent market.
  • Enhanced Currency. Mergers of equals are usually stock deals, allowing the shareholders of each institution to maintain their investment in the combined company. The goal is for the value of the combined entities’ stock to receive an uptick in value at the conclusion of not only the initial merger, but also upon the ultimate sale of the combined institution.
  • Management Integration. Combining the management teams and the boards into an effective team for the surviving bank without bruising egos can be challenging. However, a common goal and meaningful relationships between members of the leadership team of the two institutions can be helpful in finding a path forward.

If two like-minded banks are able to identify each other, negotiating the terms of the transaction can be a complex process, as many management and cultural issues must be resolved prior to entry into the merger agreement. Who is going to be the chief executive officer of the combined institution? Who is going to be on the board? Often, new employment agreements will be negotiated in order to lock in the new management team through the integration of the two institutions. The merger partners should also use the negotiation process to formulate an identity for the resulting bank. While a strategic plan for the combined institution is not a component of the merger agreement, a merger of equals demands that the two merger partners work together to chart a future course for the combined company. Unlike other acquisitions, where the work of integration will begin in earnest following the signing of the merger agreement, formulating a management team, as well as the strategic and business plans of the combined bank, starts at the negotiating table in a merger of equals.

Accordingly, executing a merger of equals can be very difficult. These transactions require each party to approach most matters with trust and with a clean slate, because there is no presumption that one institution’s process is better than the other. Having full buy-in from the respective management teams is essential, as the process for building a new bank can be tedious and can challenge long-standing practices in each institution. But it is through this hard work that a merger of equals can be so powerful, for it provides an opportunity to incorporate the best ideas and people from two successful organizations into a single institution.

So while the successful execution of a merger of equals can be challenging, with the right partner and commitment from the management and boards of directors of each bank, it can result in a bank that is greater than its two component institutions. Innovation is never easy, but building a better institution for your customers and shareholders rarely is.

Understanding M&A Accounting: What to Watch For

9-29-14-Crowe.pngOne of the worst things for an acquirer to find out after the fact is that the target wasn’t worth what the acquirer thought it was. That egg is on the board’s face and can cause significant headaches. The following are key trends and issues we have found recently in merger and acquisition (M&A) due diligence reviews.

Asset Quality
There is no better indicator of credit quality than a thorough loan review. We have seen a significant rise in collateral values in areas that were the hardest hit and modest recovery in others. Once-troubled institutions are recovering and finally are beginning to move other real estate owned and problem loans that sat unmarketable for several years. While the cleanup might not lead to a recapitalization of a bank for a variety of financial and legacy reasons, it has positioned many institutions as attractive acquisition targets at reasonable franchise values.

However, the not-so-happy news is that weak loan demand and the need to deploy capital efficiently have led to easing credit standards in commercial and industrial (C&I) and commercial real estate loans. It is important to check for deficiencies such as borrower base certificate compliance, waived or reset covenants, and lack of field audits. Also, current underwriting with extended amortizations and lower debt service requirements can present long-run risk to an acquirer. Additionally, we see institutions engaging in new loan products, which can present long-term risk if lender qualifications and track records have not been tested through a variety of economic cycles.

Quality of Earnings and Balance Sheet
Tangible book value (TBV), a common metric within the financial services industry, is used as an anchor for pricing a potential acquisition. Understanding the ways in which improper accounting or one-time income or expense items may skew this figure is important in arriving at a proper value for the bank. In the private company setting, we often find the rigor applied to interim accounting records does not match that applied to the annual audited financials. As management teams are more focused on normalizing yearly results, non-operating expense items might level out over the course of the year to not dramatically affect monthly results. We’ve observed a number of improperly capitalized items buried in other assets and underaccrued liabilities that can significantly distort the net book value of a bank. When establishing a fair purchase price based on a multiple of TBV, a $1 million interim balance sheet misstatement could mean a $1.5 million to $2 million purchase price adjustment.

Similarly, a $100,000 overstatement of core earnings could be a $1.6 million to $2 million purchase price adjustment using current multiples. We continue to see earnings supported by reserve releases, investment security salesA, and various other anomalies that have to be deciphered in order to get a true picture of normalized earnings. Determining a bank’s core earnings potential is more difficult in the current landscape because many acquisition targets have completed bank acquisitions of their own in the past few years. Both open-bank and failed-bank acquisitions come with accounting complexities related to recognition of interest income on the loans acquired. It’s imperative to understand the difference between the accounting yields and the cash income created from these acquired assets in order to avoid overestimating core earnings.

If a target bank has completed a failed-bank acquisition with loss-share agreements in place, significant consideration should be given to the accounting and record keeping of the loss-share arrangement. Acquirers should focus on understanding the remaining terms of any loss sharing, the ability to collect under the loss-share terms, and the potential hole that might be created from overstatement of the indemnification asset. Many of these arrangements may not be completely settled with the Federal Deposit Insurance Corp. (FDIC) for several more years, and many agreements contain a “true-up” provision whereby the FDIC could be owed significant sums of money if the loans perform better than expected. Each loss-share contract is unique, and potential acquirers need to fully understand the complexities associated with these agreements during the due diligence phase.

The issues highlighted here are just a few of the more common issues we’re seeing in current due diligence findings. Execution of a well-conceived due diligence plan can help eliminate surprises from an accounting, operational and credit perspective and lead to a successful transaction.

Weak Consumer Exams Are Holding Up M&A Deals

9-15-14-DavisPolk.pngIt has been several years since the financial crisis, and now banks seeking acquisitions know that they need to have high levels of capital, strong management teams and good asset quality if they hope to get the deal across the regulatory finish line. The key handicap these days, however, is the increased scrutiny on compliance issues at both the acquiring bank and the target bank.

After two years and two extensions of its drop dead date, the M&T Corp-Hudson City Bancorp deal remains in a highly visible state of regulatory purgatory. Others are suffering in a less visible way, and for a broader range of compliance reasons than the anti-money laundering (AML) problems that trapped M&T. Moreover, compliance-related delays can arise from problems at the target even when the acquirer has a strong rating and systems. One of the newest reasons for the delay in M&A regulatory approvals arises because of increased regulatory expectations around consumer financial protection.

For many banks, the results of consumer compliance exam reports are not quite as good as they were a few years ago. For some banks and thrifts, the increased examination standards are an unpleasant surprise, demanding increased infrastructure and investment at a time when there are many competing demands. Just as expectations and examinations gradually increased in intensity in the AML arena a few years ago, they are now increasing in the consumer protection arena, with the expectations of the Consumer Financial Protection Bureau (CFPB) informing the consumer compliance and enforcement practices of the traditional banking agencies. These agencies do not want to appear lax as compared to the CFPB. The CFPB examines banks above $10 billion in assets, but as a result of other banking agencies’ focus, consumer compliance is now a concern even for those banks that are not subject to CFPB examination and enforcement authority. This is leading to two new trends:

  1. For those banks that are subject to CFPB jurisdiction, we are increasingly seeing that the Federal Reserve will seek informal assurances from the CFPB that the most recent exam report is or will be satisfactory before approving an acquisition at the bank holding company level.
  2. A threatened, but unresolved memoranda of understanding or cease and desist in the consumer compliance area, whether at the acquirer or the target, can delay approvals of an acquisition even when all other issues are resolved. This is especially the case when after the closing there is a change of primary regulator.

Whether and how long this trend will hold is unclear but, for now, it is sometimes a reason for an unexpected delay.

As a result, bank boards and managements need to think carefully about consumer compliance issues as they consider their strategic options. There is, of course, a bit of a chicken-and-egg problem here. Community and smaller regional banks may need to get larger in order to have the scale to invest in the new infrastructure that the rising standards demand and yet perceived current problems with poor consumer compliance marks can prevent or delay acquisitions that might bring about scale and scope. The art is to avoid the trap.

You’re Buying Their Branches. Now What?

Editor’s note: This article has been changed from an earlier version.9-3-14-crowe.png

The number of branches changing hands is on an upswing. According to research by SNL Financial LC, nearly 2,500 branches either changed ownership or are slated to change ownership as a result of announced and completed open-bank, branch and Federal Deposit Insurance Corp.-assisted acquisitions during the first seven months of 2014, compared with 2,239 during all of 2013.

As the state of the acquisition market continues to improve, it can be useful to think about what happens with the acquired branches after the deal is done. Getting the most value from acquired branches often depends on management’s ability to look beyond tactical issues (such as branding, integrating systems, updating policies and procedures, and onboarding employees) and address issues that are more fundamental—and more strategic.

Here are some principles to keep in mind.

Measure Value—Not Just Activity
When evaluating a newly acquired branch, traditional metrics—such as account openings, deposits, and sales per employee—might not present the complete picture of a branch’s value to the institution. This fact is especially true in today’s banking environment, where more and more transactions are conducted electronically.

Although overall traffic in branches continues its downward trend, branch location remains one of the top three selection criteria that customers cite when they consider a banking relationship. They might visit the branch infrequently, but they still want to know there’s a physical facility nearby if they have a problem or a complex need.

As management evaluates newly acquired branches, it’s important to remember all three roles that brick-and-mortar branches perform: sales, service and customer retention. Slow sales activity or a lack of deposits can obscure the overall value that a branch contributes to the institution as a whole. This value encompasses a variety of factors, including new products sold, processing transactions for customers, customer account retention, and community visibility.

Evaluate the Fit
In addition to branch value, management should analyze the potential difficulty of integrating the new branches. Again, management should look beyond technology and systems integration alone to consider the prevailing sales and service cultures at the new branches.

These are some critical questions to ask: How do the new branches compare with existing branches of similar size? How well do the new branches’ sales and service philosophies match those of the existing organization? What changes need to be made to integrate the two cultures?

Customer fit should be evaluated as well. How do age, wealth and other customer demographic measures at the new branches compare with those in the existing customer base? Should management consider adjustments to product and service offerings to accommodate the new population?

Remember Your Employees
The ability to retain newly acquired customers depends in large part on how employees react to the acquisition. Customers can detect if the integration is going smoothly from the employees’ perspective. If employees complain about new policies they don’t understand, new priorities they don’t share, or new systems that don’t operate as expected, customers will pick up on their negative perceptions.

Banks with extensive experience in acquiring branches typically have well-developed integration protocols and project management checklists for managing the transition. But successfully integrating branch personnel requires that management move beyond the project checklists to connect with staff on a deeper level.

The cultural integration of branch personnel should be a dedicated work stream in the overall integration project. Moreover, because salary and benefits are only one aspect of the transition, the responsibility for retaining and integrating capable employees should be assigned to managers in the business operation rather than to the human resource function.

In addition to tracking customer and employee retention, the management team also can use tools such as employee surveys to better understand the issues that are of concern to new employees and to evaluate how well management is addressing those issues.

Take a Balanced Approach
In broad terms, today’s most successful financial institutions are those that effectively manage four general areas of concern: their people, their products, the processes they use and their technology platforms.

As the pace of branch acquisitions continues to accelerate, the most successful acquirers will evaluate and manage their newly acquired properties using those same four considerations. Ultimately, they must balance those priorities in a way that delivers the greatest value to customers and other stakeholders.

Finding Inspiration From CIT’s Acquisition of OneWest

The key is being big enough so that you can support all of the costs of regulation.

8-15-14-al-ma.pngThat is John Thain, the CEO of the $35-billion asset CIT Group, after he announced the biggest bank M&A deal of the year, the purchase of Pasadena, California-based OneWest Bank for the equivalent of $3.4 billion in cash and stock.

Isn’t it curious that a bank that large would want to get bigger in part because of the costs of regulation? There are other benefits to the deal:

  • The transaction is immediately accretive to CIT’s earnings per share;
  • CIT’s total assets will increase to $67 billion and its total deposits will increase to $28 billion; and
  • The deal combines CIT’s national lending platform with OneWest’s 73 regional branch banking network in Southern California.

CIT has no plans to become a “serial acquirer,” of financial firms, Chief Executive Officer John Thain said on Bloomberg Television last week. Still, could this be the beginning of more traditional M&A activity, as banks try to get bigger to manage costs better, including the costs of regulation such as the Dodd-Frank Act? Thain seems to think so.

Every year, we have our mergers and acquisitions conference in Phoenix in January, Acquire or Be Acquired, the biggest event on our calendar in terms of attendance. Last year, the topic that returned again and again was the so-named mergers-of-equals (MOEs). As we discussed from the stage in Arizona, the market for such strategic mergers appeared ideal. With many noting that banking is an economy of scale business, historically low valuations meant less opportunity for a premium in a sale. With a lack of organic growth plaguing many institutions, I wasn’t surprised to see other MOEs announced in the subsequent months. (Good examples include the merger of $2-billion asset VantageSouth Bancshares and $2-billion asset Yadkin Financial Corporation, which will result in North Carolina’s largest community bank with more than 80 branches). But that environment is changing. Bank valuations are increasing, asset quality has improved, and deal premiums are making a come-back, along with the banks able to pay them.

Of course, no two deals are alike—and as the structure of certain deals becomes more complex, bank executives and boards need to prepare for the unexpected. The sharply increased cost of regulatory compliance might lead some to seek a buyer; others will respond by trying to get bigger through acquisitions so they can spread the costs over a wider base. So as I consider last year’s MOE with this summer’s CIT deal, I see a real shift happening in the environment for M&A.

I see larger regional banks becoming more active in traditional bank M&A following successful rounds of regulatory stress testing and capital reviews. Also, it appears that buyers are increasingly eyeing deposits, not just assets. This may be to prepare for an increase in loan demand and a need to position themselves for rising interest rates.

In the end, no one knows what will happen with bank M&A in the coming months, but we can guess. As Crowe Horwath LLP pointed out in a recent post, 2014 may actually turn out to be the year of M&A.

Will 2014 Be the Year of M&A?

8-13-14-crowe.pngMany bank merger and acquisition (M&A) experts have predicted for years that consolidation would increase significantly due to pressures from regulatory burdens, lack of growth in existing markets, and aging boards and management teams that are ready to exit.

2014 might be the year when these expectations are realized. While activity the first quarter of 2014 was only slightly ahead of prior years, the second quarter saw a dramatic increase—74 deals were announced, which is the highest of any quarter since the credit crisis of 2008. Annualized, the total number of announced transactions will exceed 260, which is on par with many of the pre-crisis years of the 2000s.

The level of deal volume is below many expectations. However, historical perspective might help clarify why 2014 is shaping up to be a pretty strong year for M&A. From 1991 through mid-2014, the absolute number of deals declined over time, as has the number of available charters to acquire. The percent of charters acquired in any given year fluctuates from between 2.0 percent and 4.5 percent, with a 3.3 percent average over this period. On an annualized basis, 2014 will be close to the high of 4.5 percent, which means that 2014 could be a very good year based on the number of available charters. Regardless of any future predictions, one fact seems clear: The banking system has a capacity for a certain number of transactions in any given year, and it might be that the industry’s current pace is the maximum number of deals in a year given the number of available targets.

What has been driving deal volume in 2014? The first focus is credit quality in the industry. As illustrated in the following chart, credit quality has continued to improve industrywide, which is directly correlated to deal volume. When credit quality is poor, deal volume decreases; when credit quality improves, deal volume follows suit.

Pricing is another issue that affects deal volume. Obviously, when prices are high more sellers consider a transaction as opposed to when the prices are depressed. Over the past six years, pricing has been lower than prior to the credit crisis. It seems unlikely given accounting rules for acquisitions and the related impact on capital that the heady prices realized in the late 1990s will be reached again. There are indications of improvement in pricing, however, as many have reconciled to the new norm.

While the largest concentration of prices is slightly below tangible book value, the total percentage of deals with prices below tangible book values is smaller than in prior years and a strong band of deals with pricing of between 140 percent and 150 percent of tangible book value has emerged. In general, prices have increased from one year ago. Credit quality affects pricing, and because industrywide credit quality has improved, it should come as no surprise that pricing also has improved and that some deals that had been stalled by low pricing are seeing renewed movement.

Reviewing deal characteristics by region also shows improved credit quality and improved pricing.

The Midwest experienced the largest number of transactions, but it also includes the largest number of charters. Additionally, the average size of selling banks in the Midwest is the lowest of all regions, which is reflected in the pricing. One region that changed significantly from prior years was the Southeast. Previously, the average return on assets (ROA) of the sellers in that region was negative, and average nonperforming asset levels were very high compared to other regions. This trend has reversed, and for the first time since the credit crisis, the Southeast experienced positive average ROA and improved levels of nonperforming assets. The result is an average price-to-tangible book value in excess of 100 percent. Previously, this ratio was less than 100 percent (from 2012 through June 30, 2013). The West experienced the highest average price-to-tangible book value for the period.

*Note: Median deal values are in millions. Median assets are in thousands.

FDIC Transactions Continue to Decline
The Federal Deposit Insurance Corp. (FDIC) reported that as of March 31, 2014, there were 411 banks on the agency’s Problem Bank List—almost half of the 813 banks included at year-end 2011. As a result, the number of FDIC closures also has declined dramatically, and it appears that about 25 problem banks will be resolved through a sale in an FDIC-assisted transaction. Based on anecdotal experiences, the FDIC has been very patient with a number of the banks it is closely monitoring as many of these institutions have been able to complete recapitalizations or their credit issues have improved enough to be acquired in a non-FDIC-assisted transaction. This trend likely will continue, and the level of available transactions should be modest.

Branch Transactions Continue at Consistent Pace
Branch deal volume has been fairly consistent over the past four years and is on pace to be similar to 2012. Deposit premiums have held fairly steady at approximately 2.5 percent of deposits. For many community banks, small one- or two-branch networks are the only feasible acquisition opportunities. As larger and regional bank holding companies continue to evaluate their branch networks, there likely will continue to be acquisition opportunities available.

M&A: How to Review Deals at the Board Level

8-6-14-Bryan-Cave.pngMany bank boards are considering a sale of their institution for a variety of reasons—heightened regulatory burdens, board and management fatigue, or an opportunity to partner with a growing bank are just a few. But while the financial crisis has taught important lessons about bank management, for many bank directors, the sale of their financial institution is uncharted territory. As you typically only have one opportunity to get it right, directors considering a sale should focus first on establishing a sound process around the board table.

Although it is rational for directors to worry more about specific aspects of the proposed deal than procedural matters, we have found that establishing an appropriate process for considering a possible transaction is often a prerequisite for success on the business issues. Moreover, in today’s world of heightened scrutiny of board actions, directors cannot neglect procedure and expect to fulfill their duties of loyalty and due care. In most states, fulfilling those duties gives directors the benefit of the business judgment rule, which insulates directors from liability provided the decision is related to a rational purpose.

In the context of a sale, most directors can meet their duty of loyalty by acting in good faith to achieve the best result for the company and its shareholders and by disclosing any conflicts of interest to the board prior to the beginning of the deliberations. But with respect to the duty of care, establishing a thorough process leading to a sale is key. A recent court case decided in Georgia provides a helpful roadmap.

In the recent opinion on FDIC v. Loudermilk, the Georgia Supreme Court, in applying the business judgment rule to bank directors, distinguished between claims alleging negligence in the decision-making process from claims that do no more than question the wisdom of the decision itself. The court’s opinion indicates that claims relating to the board’s process will be subject to more scrutiny in the context of litigation than claims that ask the court to be a Monday morning quarterback for board decisions made in good faith.

Considering the emphasis on the board’s deliberation and diligence in making business judgments, it falls on the directors to ensure that the board puts into place procedural controls as it considers a strategic transaction. Hallmarks of a strong process include the following:

  • Having a meaningful strategic plan. Prior to entering into a discussion of a significant transaction, the board, with the help of management, should have formed a strategic plan, complete with financial projections, for continuing to operate independently. This exercise will give the board a base case against which offers can be compared.
  • Hiring the right experts. The duty of care doesn’t require directors to become experts in legal or technical financial matters, so building the right team of investment bankers, accountants and lawyers is essential. Experienced professionals who understand and care about the strategic plan of the bank, rather than pushing a particular result, will add value to the board’s process.
  • Doing your homework. Selling the bank is perhaps the most important decision you’ll make, so studying the board packet in advance of the meeting (and making sure there is ample time to study it), asking good questions, and pushing management and your experts for answers that make sense are all part of discharging your duties. The selling bank should not be pressed by artificial deadlines that hinder due deliberations by directors.
  • Documenting the process. Corporate minutes allow the board to document its consideration of a potential transaction, and while the minutes shouldn’t be a play-by-play of the discussion, they should summarize the key points from each meeting and establish that appropriate steps were taken by the board.
  • Speaking with one voice. For most community banks, directors are the face of the institution to its community. Once the deal is announced, work with management to communicate some simple talking points with your shareholders. It is fair to acknowledge the big picture risks, but be sure to emphasize the strategic view of the board. While this messaging isn’t technically part of the deliberative process, communicating with shareholders that an appropriate process took place can pay future dividends.

Bank directors certainly find themselves living in interesting times, with their obligations and responsibilities changing rapidly. But if a board fosters communication and participation around the board table to reach a deal, the directors can discharge their duties successfully, and bring value to their shareholders.

Key Ingredients for a Deal Done Right

7-21-2014-Als-Deal-Me-In-1.pngThere is a lot of talk right now about merger transactions becoming more expensive. As prices to acquire a bank rise, so too do the short and long-term risks incurred by the board of an acquiring institution. Today’s column, based on feedback from bank directors and officers, looks at the ingredients for a successful M&A deal three years down the road.

Deal Activity on the Rise
The year is shaping up to be the strongest since 1998 in terms of M&A deal flow activity as a percentage of institutions in the market, according to investment bank Raymond James. Investment bankers tout this as a wonderful development, with the Darwinian spirit of “only the strong survive” cited frequently. Efficiency and productivity continue to appear as key elements in positioning a bank for continued success. Not surprisingly, most industry insiders agree that mergers and acquisitions remain the principal growth strategy for banks today.

While we have had a few notable transactions this year, the majority of deals have been relatively small in size. Nonetheless, “it seems as though valuations have increased nicely, with the average Price to Tangible Book Value multiple standing at 1.8x today versus just 1.1x at the end of June last year. The increase in both deal multiples, and volume, is likely driven by stronger buyer currencies, improving economic conditions, and increased need for scale,” according to a research report by investment banking firm Keefe, Bruyette & Woods.

What Not to Do
This is all well and good, but what positions a deal today to look smart a few years after it closes? If you are a frequent flier, I think you might agree on what an airline merger should not look like. To see for yourself, go sit in any airport and observe the integration of American Airlines and US Airways. You will find demoralized gate agents, technologies that do not sync, marketing messages that look similar, but not the same. Does this reflect a deal done right?

Did You Know

In the first half of 2014, there were 136 acquisitions announced versus 115 announced in the first half of 2013. Moreover, total deal value is reported at $6.1 billion versus $4.6 billion in the first half of 2013.
Source: Raymond James

In many ways, the answer to what makes a good buy depends on the acquiring board’s intent. For those looking to consolidate operations, efficiencies should provide immediate benefit and remain sustainable over time. If the transaction dilutes tangible book value, investors expect that earn back within three to five years. However, some boards may want to transform their business (for instance, a private bank selling to a public bank) and those boards should consider more than just the immediate liquidity afforded shareholders and consider certain cultural issues that might swing a deal from OK to excellent.

Retaining Key Employees
Regardless, what is clear for a long-term win is the absolute need to keep a strong, committed and cohesive team in place. Living in Washington, D.C., I have seen repeated examples of a bank announcing an in-market acquisition that precipitates an almost immediate departure of key staff. Be it a star employee or an entire lending team, retention of the most valuable team members is the number one characteristic, in my opinion, of a well-done deal. These can be accomplished with retention measures and contracts for key employees, but those employees must be identified ahead of time. A close second is the ability of the newly combined leadership team to successfully balance “new” products, platforms, distribution, funding and asset generation capabilities.

Yes, the need and desire to grow exists at virtually every bank, so I anticipate more deals in the coming months. But what if you lose the staff you just paid for, right out of the gate? That is a recipe for disaster.