The Choice Facing Every Bank

Has your executive team been approached by leaders of another bank interested in an acquisition? It likely means your bank is doing something right. But, now what?

Many CEOs’ visceral response to being asked to consider a deal is to say, “Thanks, but no thanks” and continue running the bank. While this may be the correct response, this overture is a chance for leadership to objectively revisit the bank’s strategic alternatives to determine the best option for its shareholders and other stakeholders.

Stay the Course
Boards must objectively identify where their bank is in its life cycle — be it turn-around, growth or stability — and what will be needed to successfully compete at the next stage. Ultimately, they must determine if the bank can drive more long-term shareholder value staying independent than it could with a partner. They must also weigh the risk of remaining independent against the potential reward.

Directors should prepare five-year projections, ideally with the help of a financial advisor, that assume the bank continues to operate independently. They should forecast growth and profitability that reasonably reflect current marketplace dynamics and company strategy, and are generally consistent with past performance. Consider opportunities to lower funding costs, consolidate or sell unprofitable branches, add lines of business, or achieve economies of scale through acquisitions or organic growth. However, be cognizant of market headwinds: low interest rate environment, slower projected loan growth, increasing cost of technology and cybersecurity, regulatory burden, competition, demographic trends, upcoming presidential election and so on. The board should also consider organizational issues such as succession planning — a major issue for many community banks. How do these factors impact the future performance of your institution? Will your bank be able to meet shareholder expectations?

Merge with Peer
Peer mergers have been a hot topic of late. The bank space has seen several high-profile transactions: the merger between BB&T Corp. and SunTrust Banks to form Truist Financial Corp.; Memphis, Tennessee-based First Horizon National Corp. and Lafayette, Louisiana-based IBERIABANK Corp.; Columbia, South Carolina-based South State Corp. and Winter Haven, Florida-based CenterState Bank Corp.; and McKinney, Texas-based Independent Bank Group and Dallas-based Texas Capital Bancshares.

The opportunity to double assets while achieving economies of scale can drive significant shareholder value. But these transactions can be tough to nail down because both parties must be willing to compromise on key negotiation topics. Which side selects the chairman? The CEO? How will the board be split? Where will the company be headquartered? What will be the name of the future bank?

Peer mergers can be risky propositions for banks, as cultures don’t always match and integration can take several years. However, the transaction can be a windfall for shareholders in the long run.

A decision to sell almost always generates the greatest immediate value for shareholders. Boards must ascertain if now is the right time, or if the bank can do better on its own.

Whether or not selling creates the highest long-term value for shareholders depends on several factors. One factor is the consideration mix, if any, between stock and cash. Cash gives shareholders the flexibility to invest and diversify the net proceeds as they see fit, but capital gains will be taxed immediately. Stock consideration is generally a tax-free exchange, when structured correctly, but it is paramount to select the right partner. Look for a bank with a strong management team and board, a proven track record of building shareholder value and a plan to continue to do so. That partner may not offer you the highest price today, but will most likely deliver a better return to shareholders in the long run, compared to other potential acquirers. Furthermore, a partner that is likely to sell in the near-term could provide a double-dip — a potential homerun for your shareholders.

It is crucial to consider what impact a sale would have on other stakeholders, like employees and the community. Prepare your bank to sell, well in advance of any conversations with potential acquirers. Avoid signing new IT contracts with material termination costs; it is an opportune time to sell when core processing contracts are nearing expiration. In addition, review existing employment agreements and consider establishing a severance plan to protect employees ahead of time.

Being approached by a potential acquirer gives your bank an opportunity to objectively reflect on its strategy and potentially adjust it. Even if your bank hasn’t been contacted by a potential acquirer, the board should still review the bank’s strategic alternatives annually, at a minimum, and determine the best path forward.

Did Regulatory Concerns Torpedo the New York Community/Astoria Merger?

merger-1-6-17.pngIt’s highly unusual for the partners in a bank merger to terminate an agreement that they’ve already made public, so the recent announcement that New York Community Bancorp in Westbury, New York, and Astoria Financial Corp. in Lake Success, New York, would abandon their proposed $2 billion deal led to immediate speculation that the regulators had secretly torpedoed the proposed transaction. The banks did not give a reason in their joint statement in December 2016.

Announced in October 2015, the deal was supposed to close in December 2016. But New York Community issued a statement in November 2016 that “based on discussions with its regulators, it does not expect to receive the regulatory approvals required to consummate the proposed merger …by the end of 2016.” Instead, the banks agreed to terminate the merger agreement effective January 1, 2017.

The voluntary termination of a publicly announced bank merger because of regulatory complications is unusual because acquirers generally do their best to anticipate any possible roadblocks before entering into a formal merger agreement. This generally includes informal discussions with their primary regulator about any potential issues that could be problematic. Although these discussions should not be construed as a kind of pre-approval, it would be unusual for an acquirer to proceed with a proposed merger if its principal regulator expressed serious concern about any aspects of the deal in private.

It is unknown whether New York Community and Astoria decided to pursue their merger despite concerns that might have been voiced privately by their regulator, or if serious regulatory issues surfaced later upon a formal review. However, according to the investment banking firm Keefe Bruyette & Woods, the percentage of M&A applications to the Federal Reserve that have later been withdrawn have been on the rise in recent years, jumping from 15 percent in 2013 to 23 percent in 2015, and to 22 percent in the first six months of 2016. This increase occurred while annual M&A deal volume was growing at a much slower rate, which would suggest that the Fed has been taking a more critical perspective during its review process.

Issues that could have complicated the New York Community/Astoria deal include a high concentration of commercial real estate assets that would have comprised the combined entity’s balance sheet. New York Community is one of the top multifamily housing lenders in the country, while commercial real estate, multifamily and residential mortgages account for the majority of Astoria’s total loan portfolio.

Another factor that most likely complicated the deal’s regulatory approval process is that the combined bank would have crossed the $50 billion asset threshold level—New York Community had $49.5 billion in assets as of September 30, 2016, while Astoria had $14.8 billion. At this point, it would have become a Systemically Important Financial Institution, or SIFI, which would have exposed it to higher capitalization requirements and tougher regulatory scrutiny than are applied to smaller banks. The regulators generally require banks to have a SIFI compliance plan in place before crossing the $50 billion threshold, so New York Community most likely had already been preparing for this transition. However, the elevated SIFI requirements, combined with the bank’s significant commercial and residential real estate concentrations, might have made it difficult to gain regulatory approval in a timely manner.

In a research report published subsequent to the announced termination, KBW expected both banks to continue to seek out a merger combination. New York Community would seem to face the greater challenge in terms of finding an acceptable partner that won’t magnify its own commercial real estate concentration issues, and also because the bank’s organic growth trajectory will probably take it past the $50 billion threshold in 2017. Life as a SIFI grows more challenging—merger or no merger.