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.

The Merger Window for Small Regional Banks is Already Closing

3-3-14-Jefferies.pngLast year I wrote an article for entitled “Winning Over Shareholders with a Well-Constructed Merger.” In it, I laid out several suggestions for boards on how to structure a merger transaction that investors support. Also at this time last year, several investment bankers who presented at the Acquire or Be Acquired Conference advocated reasonably priced stock-for-stock mergers as the best M&A alternative for community and regional banks. In an instance of investment bankers correctly predicting a trend (many would say a rare instance), 2013 was in fact characterized by a series of well-structured mergers which produced a dramatic improvement in shareholder reaction to bank M&A.

Banks under $10 billion in assets have had an unprecedented opportunity to pursue merger transactions while larger regional banks have remained on the sidelines.

The preferred transaction structure of 2013 and early 2014 has been the friendly all stock (or nearly all stock) merger with the following characteristics:

  • two banks of similar size
  • exchange ratio and financial projections that produce shared long term upside
  • price to tangible book value premiums below historic bank M&A averages
  • meaningful non-financial deal terms for seller
  • continuity of interest for both sides rather than a full change of control

I think there are a number of factors that will change the bank M&A environment as we move through 2014. In general, I expect a more competitive environment to emerge as the number of willing buyers gradually increases and the ability of sellers to pick the “friendliest” potential merger partner decreases. There will be more focus on price by selling shareholders and greater scrutiny of merger transactions, especially those labeled as mergers of equals (MOEs).

This is not to disparage the shared upside merger model or the many excellent transactions that have been announced in the past year. Rather, it is to caution boards that they will need to adjust their M&A planning as the environment changes.

Boards should consider the following environmental changes:

  • Large regional banks (assets greater than $20 billion) will gradually become more active in traditional bank M&A assuming a successful round of regulatory stress testing and capital reviews.
  • Banks that have already announced and integrated a recent merger and benefited from increased market valuation and balance sheet capacity are better positioned to be aggressive pursuing their next target and will be less likely to make major concessions on non-financial issues.
  • Investors have become more tolerant of buyers paying market premiums.
  • Banks that have not been able to execute a well-received M&A transaction will be under increased pressure to find a deal that works.
  • Fewer potential buyers are feeling restrained by concerns over regulatory approval.
  • The overall health of the industry continues to improve and more banks are able to consider acquisitions.

Also, a potential risk to M&A transactions is the possibility of an interloper disrupting an announced transaction. Boards need to consider a gradual increase in the number of potential buyers and in the capacity of these buyers to pay a meaningful premium. This risk remains limited but it is increasing.

For many healthy banks in good markets there has been only one viable buyer or merger partner. This situation will change and a merger may be more difficult to justify to shareholders if they perceive that a higher price is available from another bank.

Thus, selling banks may find more willing buyers and higher prices than was the case in the past several years. However, they will have less ability to merge with their preferred long term partner if that partner cannot be competitive on price.

Buying banks will encounter more competition and those with weaker relative multiples or less balance sheet capacity will not be able to structure deals that work.

The level and nature of M&A activity that we will see in 2014 and beyond is of course governed by many difficult to predict factors. For instance, a volatile bank stock market is always detrimental to deal activity. Also, if any of the 2013 vintage deals run into integration problems, investor receptivity to new deals will decline.

The window of available deals for smaller banks may be closing, but likely will remain open for at least the first half of 2014. However, boards should not be lulled into assuming that they can execute their preferred merger at any time and in any market. Do it while you can.

Getting to Strong: Should Your Bank Acquire?

2-28-14-KPMG.pngWith the number of bank mergers thus far in 2014 marginally ahead of the pace set in the same period last year, it is tempting to think that this could be the year when the much-anticipated mergers and acquisitions (M&A) wave finally materializes. SNL Financial reported that 14 deals were announced in January, two more than the 12 in the same period last year, and—perhaps more interestingly—the median price-to-tangible book ratio of the deals had risen 43 basis points to 140.86 percent, compared to January 2013.

As encouraging as that report might be, no one at this point can say with any confidence that the M&A engine is primed to roar. Nevertheless, KPMG LLP’s view of the marketplace allows us to suggest that, if nothing else, it makes sense for hundreds of banks and thrifts to merge, acquire or form strategic alliances. Let’s list a handful of factors we believe auger well for the M&A pace to pick up:

Not a week has gone by in the past several months, it seems, without any of us hearing about the growing popularity of a “merger of equals’’ in the industry as a way for the smaller-asset banks to combine strengths to compete with bigger, stronger banks. After all, that “if-you-can’t-beat-‘em-join-‘em’’ posture fits with one of the key findings of KPMG LLP’s 2013 Community Banking Outlook Survey. A hefty 77 percent of respondents in the November 2013 survey said they believe a bank must achieve an asset level of at least $1 billion or more to remain independent in today’s market.

Then, there are the other reasons in the litany of drivers arguing that smaller banks join with peers or sell to bigger brethren in more deals: the escalating costs associated with staying in compliance with regulatory demands, the attractiveness of spreading into new geographies where specific demographics would make sense for expansion, and the attractiveness of acquiring a competitor that holds rich talent to drive new sources of revenue or to enhance technological capabilities.

On the flip side, it’s always prudent to be aware of “deal fever,’’ a desire to do a deal just to do a deal— which can be brought on by a sometimes poorly thought out plan to buy or sell just because others around you are doing deals. Our belief is that the chances of a successful deal are enhanced when the board and management team maintain a rigorous target-selection process that strictly focuses on strategic alignment. There must be a fit, a focus, and a follow through—without shortcuts.

As part of our panel discussion at Bank Director’s recent Acquire or Be Acquired conference, Roberto Herencia, chairman at FirstBancorp and FirstBank Puerto Rico, also reminded us that, because banks are sold, and not bought, acquirers will need to sharpen their business cases. An acquirer, therefore, must frequently convince a reluctant target that a sale make sense for both parties, and equally must respect the emotions of the sellers as much as dollar and cents, because of the role that smaller banks play in the fabric of smaller communities.

That said, we also believe that deals today must be game changers, given that so much time and effort is required in the current highly regulated environment, and that many targets may still struggle with possible toxic assets on the books. Such realities, in our view, mean most of the sellers will be in the $500-million to $2.5-billion asset range, which encompasses about 1,000 banks.

Through it all, we would argue that bank directors must have comfort that management presents the board with documentation that a target is aligned with the bank’s strategic objectives, that the deal has passed through the critical pre-signing phase where significant value drivers have been vetted, and that there has been an aggressive focus on risk and synergy implications. Further, no deal can be successful without the board having evidence that an effective governance structure— complete with realistic processes—has been established.

Bank M&A in 2014: What to Expect

In this video, Rick Childs of Crowe Horwath LLP highlights findings from the 2014 Bank Director & Crowe Horwath LLP Bank M&A survey, revealing a shift in which banks are expected to be the active acquirers this year. In addition, Rick shares his insights on regulatory approval trends, mergers of equals and the continued disconnect between buyers and sellers on pricing.