How to Respond to LendingClub’s Bank Buy

For me, the news that LendingClub Corp. agreed to purchase Radius Bancorp for $185 million was an “Uh oh” moment in the evolution of banking and fintechs.

The announcement was the second time I could recall where a fintech bought the bank, rather than the other way around (the first being Green Dot Corp. buying Bonneville Bank in 2011 for $15.7 million). For the most part, fintechs have been food for banks. Banks like BBVA USA Bancshares, JPMorgan Chase & Co and The Goldman Sachs Group have purchased emerging technology as a way to juice their innovation engines and incorporate them into their strategic roadmaps.

Some fintechs have tried graduating from banking-as-a-service providers like The Bancorp and Cross River Bank by applying for their own bank charters. Robinhood Markets, On Deck Capital, and Square have all struggled to apply for a charter. Varo is one of the rare examples where a fintech successfully acquired a charter, and it took them two attempts.

It shouldn’t be surprising that a publicly traded fintech like LendingClub just decided to buy the bank outright. But why does this acquisition matter to banks?

First off, if this deal receives regulatory approval within the company’s 12 to 15 month target, it could forge a new path for fintechs seeking more control over their banking future. It could also give community banks a new path for an exit.

Second, banks like Radius typically leverage technology that abstract the core away from key digital services. And deeper pockets from LendingClub could allow them to spend even more, which would create a community bank with a dynamic, robust way of delivering innovative features. Existing smaller banks may just fall further behind in their delivery of new digital services.

Third, large fintechs like LendingClub don’t have century-old divisions that don’t, or won’t, communicate with each other. Banks frequently have groups that don’t communicate or integrate at all; retail and wealth come to mind. As a result, companies like LendingClub can develop and deploy complementary banking services, whereas many banks’ offerings are limited by legacy systems and departments that don’t collaborate with each other.

The potential outcome of this deal and other bifurcations in the industry is a new breed of bank that is supercharged with core-abstracted technology and a host of innovative, complementary technology features. Challenger banks loaded with venture capital funds and superior economics via bank ownership could be potentially more aggressive, innovative and dangerous competitors to traditional banks.

How should banks respond?

Start by making sure that your bank has a digital channel provider that enables the relatively easy and cost-effective insertion of new third-party features. If your digital channel partner can’t do this, it’s time to draft a request for proposal.

Next, start identifying and speaking to the myriad of enterprise fintechs that effectively recreate the best features of the direct-to-consumer fintechs in a white-label form for banks. Focus on solutions that offer a demonstrable path to revenue retention, growth and clear cost savings — not just “cool” features.

After coming up with a plan, find a partner to help you market the new services either through  the third-party vendors you select or another marketing partner. Banks are notorious for not doing the best job of marketing new products and features to their clients. You can’t just build it and hope that new and existing customers will come.

Finally, leverage the assets you already have: physical branches, a mobile banking app that should be one of the top five on a user’s phone, and pricing advantage over fintechs. Most fintechs won’t be given long runways by their venture capital investors to lose money in order to acquire clients; at some point, they will have to start making money via pricing. Banks still have multiple ways to make money and should use that flexibility to squeeze their fintech competitors.

Change is the only constant in life — and that includes banking. And it has never been more relevant for banks that want to stay relevant in the face of rapidly developing technology and industry-shifting deals.

The Uncertain Impact of COVID-19 on the Bank M&A Playbook

As banks across the country grapple with market and economic dynamics heavily influenced by COVID-19, or the new coronavirus, separating data from speculation will become difficult.

The duration and ultimate impact of this market is unknowable at this point. The uncertain fallout of the pandemic is impacting previously announced deals and represents one of the biggest threats to future bank M&A activity. It will force dealmakers to rethink risk management in acquisitions and alter the way deals are structured and negotiated.

As we have seen in other times of financial crisis, buyers will become more disciplined and focused on shifting risk to sellers. Both buyers and sellers should preemptively address the impact of the coronavirus outbreak on their business and customers early in the socialization phase of a deal.

We’ve compiled a non-exhaustive list of potential issues that banks should consider when doing deals in this unprecedented time:

  • Due Diligence. Due diligence will be more challenging as buyers seek to understand, evaluate and quantify the ways in which the coronavirus will impact the business, earnings and financial condition of the target. Expect the due diligence process to become more robust and protracted than we have seen in recent years.
  • Acquisition Funding. Market disruption caused by the virus could compromise the availability and pricing of acquisition financing, including both equity and debt financing alternatives, complicating a buyers’ ability to obtain funding.
  • Price Protections. For deals involving publicly traded buyer stock, the seller will likely be more focused on price floors and could place more negotiating emphasis around caps, floors and collars for equity-based consideration. However, we expect those to be difficult to negotiate amid current volatility. Similarly, termination provisions based upon changes in value should also be carefully negotiated.

In a typical transaction, a “double trigger” termination provision may be used, which provides that both a material decline in buyer stock price on an absolute basis (typically between 15% and 20%) and a material decline relative to an appropriate index will give the seller a termination right. Sellers should consider if that protection is adequate, and buyers should push for the ability to increase the purchase price (or number of shares issued in a stock deal) in order to keep the deal together and avoid triggering termination provisions.

  • Representations and Warranties. As we have seen in other economic downturns, expect buyers to “tighten up” representations and warranties to ensure all material issues have been disclosed. Likewise, buyers will want to consider including additional representations related to the target business’ continuity processes and other areas that may be impacted by the current pandemic situation. Pre-closing due diligence by buyers will also be more extensive.
  • Escrows, Holdbacks and Indemnities. Buyers may require escrows or holdbacks of the merger consideration to indemnify them for unquantifiable/inchoate risk and for breaches of representations and warranties discovered after closing.  
  • Interim operating covenants. Interim operating covenants that require the seller to operate in the ordinary course of business to protect the value of their franchises are standard provisions in bank M&A agreements. In this environment we see many banks deferring interest and principal payments to borrowers and significantly cutting rates on deposits. Sellers will need some flexibility to make needed changes in order to adapt to rapidly changing market conditions; buyers will want to ensure such changes do not fundamentally change the balance sheet and earnings outlook for the seller. Parties to the agreement will need focus on the current realities and develop reasonable compromises on interim operating covenants.
  • Investment Portfolios and AOCI. The impact of the rate cuts has created significant unrealized gains in most bank’s investment portfolio. The impact of large gains and fluctuations in value in investment securities portfolios will also come into focus in deal structure consideration. Many deals have minimum equity delivery requirements; market volatility in the investment portfolio could result in significant swings in shareholders’ equity calculations and impact pricing.
  • MAC Clauses. Material Adverse Change (MAC) definitions should be carefully negotiated to capture or exclude impacts of the coronavirus as appropriate. Buyers may insist that MAC clauses capture COVID-19 and other pandemic risks in order to provide them an opportunity to terminate and walk away if the target’s business is disproportionally affected by this pandemic.
  • Fiduciary Duty Outs. Fiduciary duty out provisions should also be carefully negotiated. While there are many variations of fiduciary duty outs, expect to see more focus on these provisions, particularly around the ability of the target’s board to change its recommendation and terminate because of an “intervening event” rather than exclusively because of a superior proposal. Likewise, buyers will likely become more focused on break-up fees and expense reimbursements when these provisions are triggered.
  • Regulatory approvals. The regulatory approval process could also become more challenging and take longer than normal as banking regulators become more concerned about credit quality deterioration and pro forma capitalization of the merged banks in an unprecedented and deteriorating economic environment. Buyer should also consider including a robust termination right for regulatory approvals with “burdensome conditions” that would adversely affect the combined organization.

While bank M&A may be challenging in the current environment, we believe that ample strategic opportunities will ultimately arise, particularly for cash buyers that can demonstrate patience. Credit marks will be complex if the current uncertainty continues, but valuable franchises may be available at attractive prices in the near future.

How Consolidation Changed Banking in Five Charts

Over the past 35 years, few secular trends have reshaped the U.S. banking industry more than consolidation. From over 18,000 banks in the mid-1980s, 5,300 remain today.

Consolidation has created some very large U.S. banks, including four that top $1 trillion in assets. The country’s largest bank, JPMorgan Chase & Co., has $2.7 trillion in assets.

Historically, very large banks have been less profitable on performance metrics like return on average assets (ROAA) and return on average tangible common equity (ROTCE) than smaller banks. The standard theory is that banks benefit from economies of scale as they grow until they reach a certain size, at which point diseconomies of scale begin to drag down their performance.

This might be changing, according to interesting data offered Keefe, Bruyette & Woods CEO Thomas Michaud in the opening presentation at Bank Director’s 2020 Acquire or Be Acquired conference. The rising profitability of large publicly traded banks and one of the underlying factors can be seen in five charts from Michaud’s presentation.

Profitability is High

Profitability
Banking has been highly profitable since the early 1990s — except, of course, for that big dip starting in 2006 when earnings nosedived during the financial crisis. The industry’s profitability reached a post-crisis high in the third quarter of 2018 when its ROAA hit 1.41%. Keep in mind, however, this chart looks at the entire industry and averages all 5,300 banks.

Banking 2016

Sweet Spot of Profitability
Banking is also highly differentiated by asset size: many very small institutions at the bottom of the stack,  four behemoths at the top. Michaud’s “sweet spot” in banking refers to a specific asset category that allows banks to maximize their profitability relative to other size categories. They have enough scale to be efficient but are still manageable enterprises. In 2016, this sweet spot was in the $5 billion to $10 billion asset category, where the banks’ pre-tax, pre-provision income was 2.32% of risk weighted assets.

Banking 2019

Sweet Spot Shifts
It’s a different story three years later. In 2019, the category of banks with $50 billion in assets and above captured the profitability sweet spot, with pre-tax, pre-provision income of 2.43% of risk weighted assets. What’s especially interesting about this shift is that, by my count, there are just 31 U.S. domiciled banks in this size category. (I excluded the U.S. subsidiaries of foreign banks, but included The Goldman Sachs Group and Morgan Stanley.) Of course, these 31 banks control an overwhelming percentage of the industry’s assets and deposits, so they wield disproportionate power to their actual numbers. But what I find most interesting is that as a group, the biggest banks are now the most profitable.

Big Banks

Big Bank Profitability
Even the behemoths have stepped up their game. You can see from the chart that KBW expects five of the six big banks — Bank of America Corp., JPMorgan, Wells Fargo & Co., Morgan Stanley and Goldman Sachs — to post ROTCEs of 12% or better for 2019. And some, like JPMorgan and Bank of America, are expected to perform significantly better. KBW expects this trend to continue through 2021, for the most part. What’s behind this improved performance? Buying back stock is one explanation. For example, between 2017 and 2021, KBW expects Bank of America to have repurchased 27.6% of its outstanding stock at 2017 levels. But there is more to the story than that.

bank share

Taking Market Share
The 20 largest U.S. banks have aggressively grown their national deposit market share – a trend that seems to be accelerating. Beginning during the financial crisis in 2008, the top 20 began gaining market share at a faster rate than the rest of the industry. The differential continues to widen through at least the third quarter of last year. But the financial crisis ended over a decade ago, so a flight to safety can no longer explain this trend. Something else is clearly going on.

Consumers across the board are increasingly doing their banking through digital channels. Digital banking requires a significant investment in technology, and this is where the biggest banks have a clear advantage. Digital has essentially aggregated local deposit markets into a single national deposit market, and the largest banks’ ability to tap this market through technology gives them a significant competitive advantage that is beginning to drive their profitability.

Having too much scale was once a disadvantage in terms of performance — that may no longer be the case. Banking increasingly is becoming a technology-driven business and the ability to fund ambitious innovation programs is quickly becoming table stakes.

When the Earnings Get Tough, the Mergers Get ‘Strategic’

Pressure on earnings and a continued evolution in bank operations could give rise to more “strategic mergers,” according to presenters during the first two days of Bank Director’s 2020 Acquire or Be Acquired Conference.

Deal activity, specifically “strategic mergers,” could accelerate in 2020 because of slowing growth and continued momentum in the space, say presenters ranging from the heads of investment banks to CEOs who had undertaken or announced their own transformational mergers. Factors like declining interest rates and a decreasing number of potential partners could motivate executives to look to acquisitions to leverage capital, add growth or find scale and efficiencies.

Community banks across the country are grappling with the realization that superregionals like BB&T Corp. and SunTrust Banks decided last year to combine to form Truist Financial in a bid for scale — and what those decisions mean for their own prospects, says Gary Bronstein, a partner at Kilpatrick Townsend & Stockton. In a nonscientific, real-time poll conducted during one session, 48% of respondents believe their bank will be an acquirer during the year, with a plurality seeking to either acquire core deposits or gain scale.

One reason could be that loan growth among small and mid-cap banks has been slowing since 2015, says Keefe, Bruyette & Woods President and CEO Tom Michaud. His firm is modeling no earnings per share growth for these banks in 2020 because of net interest margin compression. At the same time, banks’ net income has been bolstered by share repurchases: excluding buybacks, earnings per share would be lower by 6% in 2020, and log no growth in 2021.

Bigger banks have been thinking about how to achieve meaningful, strategic change that can jumpstart internal transformation and external results. Enter the “strategic merger,” Michaud says, which his firm defines as transactions where the target owns 25% or more of the pro-forma company. Many of these recent deals have been among regionals and were structured as mergers-of-equals, which helped define M&A activity in 2019.

The MOEs are back. That was a popular method of consolidation in 2019, and I believe we’re going to see more of it,” he says. “It is the major theme as to how this industry is consolidating.”

Indeed, for the second year in a row, the conference coincided with an MOE announcement — this time, between Winter Haven, Florida-based CenterState Bank Corp and Columbia, South Carolina-based South State Corp. to form a Southeastern institution with $34 billion in assets.

The financial attractiveness of these deals is undeniable, say investment bankers and executives: the no-premium deals carry low dilution and quick tangible book value earn-back periods as well as double-digit earnings per share accretion and enviable returns on tangible common equity. The logic seemed to resonate with attendees: 61% of respondents during the nonscientific, real-time poll conducted during a session indicated they would consider an MOE during the year.

“These deals are being structured to make these companies more profitable … and to build better companies,” he says.

Michaud wasn’t the only presenter convinced that MOE interest and momentum will continue this year. Joe Berry, managing director and co-head of depositories investment banking at Keefe, Bruyette & Woods, points out the potential stock outperformance of certain MOEs and other strategic mergers, especially after they announce capital actions.

But recording the eye-popping results from a strategic merger only comes about after the “soft issues” are hammered out, Berry says. The MOE announcement between TCF Financial Corp. and Chemical Financial Corp., which occurred during the 2019 Acquire or Be Acquired conference, was motivated partially by a desire to achieve scale to serve larger credits, says David Provost, executive chairman at TCF Bank. The bank is now based in Detroit and has $45.7 billion post-merger. But first, executives needed to negotiate a “reverse divorce” to determine the new name and headquarters location.

It then comes down to who gets the dog, and you both love the dog. That’s the CEO title,” he says. Deal filings indicated that Provost “was going take the dog for 18 months and then [President and CEO Craig Dahl] was going to take the dog. In the end, I decided to give up the dog and create $1 billion in value for shareholders.”

The MOE catalyst has not been limited to regional banks. Randy Greene, president and CEO of Richmond, Virginia-based Bay Banks of Virginia, says an MOE transformed his bank. The 2016 deal allowed two more-rural based banks to combine and move to a more-urban area; Bay Banks now has $1.1 billion in assets.

But bankers contemplating an MOE must also ensure that internal expansion doesn’t erode the strategic financial gains of the deal. BJ Losch, CFO at $43.3 billion First Horizon National Corp., says the bank is trying to “become bigger without becoming big” as part of its MOE with Lafayette, Louisiana-based IBERIABANK Corp.

An MOE allows a bank to “build Star Wars from an IT perspective, but then you become big —like the bigger banks that you want to be more nimble than,” he says.

The MOE spared Memphis, Tennessee-based First Horizon and IBERIA from needing an “upstream” buyer, says fellow panelist Daryl Byrd, IBERIA’s current president and CEO, who will serve as the pro forma bank’s executive chairman. The dearth of potential buyers has emerged as a competitive dynamic for institutions of all sizes, including the $31.7 billion bank.

“It’s a musical chair game and you don’t want to be left without a chair. And we recently lost two very big chairs,” he says.

Michaud points out that many of the companies involved in these strategic mergers are “really good banks in their own right,” deserving of their independence. These executives do not need to find a merger partner but believe the transactions’ defensive attributes will allow them to keep up with digital transformations and changes in the bank space down the road.

He says executives are asking, “‘If we don’t do this, what’s the industry going to look like in three to five years? How relevant are we going to be and how much are we going to … make sure our shareholders have a long-term play here?’”

The Measure of a “Good” Deal

What makes a good bank deal? Depends on who you ask.

Mergers and acquisitions are a vital strategic undertaking for banks, and consolidation trends continue to shape the industry. To that end, I asked four presenters speaking at Bank Director’s 2020 Acquire or Be Acquired Conference the same question: “What is the most important metric of a bank deal? And what is the most important thing that can’t be measured?”

The response of the interviewees — a community bank CEO, two attorneys and an investment banker — were kept secret from each other. Their unique and varied responses belie their perspectives and experiences when it comes to bank M&A, and hopefully can shed some light on how others in the industry think about, and measure, a “good” deal.

Before Announcement
For Curtis Carpenter, principal and head of investment banking at Sheshunoff & Co. Investment Banking, the most important criteria to getting a good deal done comes down to location. “Geography is the most reliable characteristic to getting the deal done in today’s market. Where a bank is located is driving deals more than ever,” he says.

He points out that institutions in high-growth areas have a “high probability” of commanding a strong price, whereas a robust, profitable bank in a rural area with declining demographics may be challenged to get a deal done at a reasonable valuation.

For buyers, coming up with a reasonable purchase price and accurately assessing a seller’s asset quality are the most important elements in a good deal, says Bob Monroe, a partner at Stinson LLP.

“If you buy a bunch of junk, you’re going to get a bunch of junk, and you generally won’t have a successful deal,” he quips.

To account for the uncertain performance of acquired loans, Monroe says buyers will either not acquire certain assets or set up an escrow account that is equal to the present value of the assets in question so they can get worked out.

Frank Sorrentino III, chairman and CEO of ConnectOne Bancorp in Englewood Cliffs, New Jersey, says it was difficult to try to nail down an answer, even though “I knew what the question was going to be.”

Sorrentino has guided the $6.2 billion bank through three deals since 2014, and initially felt that a good deal can be measured by the market’s response. But he says the market might pan some deals that it doesn’t “fully digest or understand” because the deal may not generate immediate value at announcement.

For Sorrentino, good deals are ones that provide better internal opportunities for the pro forma bank and create additional value.

“I don’t care which metric you use, I don’t care what spreadsheet you use for your modeling — at the end of the day, are you creating more value? There are various components to values: some are financial, some are nonfinancial, but I think it really comes down to value,” he says. “Are you adding 1 and 1 and getting something north of 2?”

At, and After, Announcement
During Day 1 of the conference, Keefe, Bruyette & Woods President and CEO Tom Michaud highlighted that the premium that acquirers have offered sellers has declined since 2010. Part of that decline has come from a decline in potential buyers, but he added that investor concern around the pro forma company’s earnings per share and tangible book value growth has imposed discipline on deals.

One metric that Carpenter says can indicate a good deal is the performance of the buyer’s stock after the merger is announced, relative to the valuation the seller received.

The most measurable tangible metric for grading the success of a bank sale would be price to tangible book value, and then how that stock performs in the 12 months after announcement,” he says. This is especially important for prospective sellers that would consider a merger that includes stock.

Peter Weinstock, a partner at Hunton Andrews Kurth, extends this to the second full year after a merger is consummated. Weinstock wrote in an email that the most important metric is the pro forma bank’s earnings per share accretion in that second year.

“While tangible book value earn-back is much ballyhooed — and has lately been a metric that has led to some good deals not being done — the true success of the deal is measured in what it does for the acquirer’s profitability once the majority of cost savings and synergies are achieved,” he wrote.

Sorrentino cautions that value creation doesn’t always carry a time stamp, and that bankers should resist short-term thinking or relying solely on metrics when assessing the value of a company or a deal.

“Sometimes the value is not necessarily created on financial terms. There could be value created [in a deal] because of talent, or because of the business lines you’re taking on,” Sorrentino says, adding that technological capabilities, efficiencies and cultural elements can also be acquired in a deal. “Everyone wants to look at the EPS accretion at announcement or tangible book value dilution. It may not be that simple.”

After Close
There is some agreement as to the most important unmeasurable aspect of a good deal. The consensus coalesces around integration and the cultural fit of the two banks. Buyers must manage the deal integration in a way that incentivizes and excites the seller’s employees, lest they look for other opportunities.

“Being able to fit your culture in with the seller’s culture is extremely important, because otherwise you’ll have a flat tire running down the road,” Monroe says. “It won’t be smooth.”

Adding to that, Weinstock wrote that the buyer’s “willing[ness] to spend the leadership time, devote the financial resources and risk overcommunicating” in order to integrate the banks’ operations, vision and culture is the most important immeasurable metric of a good deal.

For sellers, the hardest thing for banks to measure in a deal is how it will affect their employees, Carpenter says. Executives at selling banks often hope that a deal only furthers the opportunities and careers of its employees, as well as benefits the selling bank’s community. One way prospective buyers can help sellers with this concern is by putting the prospective seller in touch with former CEOs of previously acquired banks.

“More often than not in this environment, [deals] really come down to one buyer courting a seller, or you’ve reduced the number of bidders down. The seller is wondering ‘Is this a good deal? Can we trust this guy?’” Carpenter says. “The buyer can offer up, ‘Here’s two people that ran banks we bought, call them and asked them how it went.’”

Michaud says banks considering engaging in M&A should “start at the end,” identifying what they want a deal to achieve.

“It needs to be all of these things to work: well-priced, strategic merit and be logical, earn-back that fits within the barrier. It can’t be complex and have a lot of noise, it must be accretive or investors will want to know why you did it, and it needs to be well-structured too so everyone stays in their seat and is there to execute,” he says. “If you do all of these things, you can create a lot of shareholder value.”

Industry Perspectives at Acquire or Be Acquired 2020

People, Products & Performance – In this interview with Bank Director CEO Al Dominick, John Eggemeyer shares his thoughts on what drives performance.
Super-Connected Customers – Data, payments and other technology-related issues were top of mind for bankers at the 2020 Acquire or Be Acquired conference.
Who Gets the Dog? – On the heels of the CenterState Bank Corp./South State Corp. merger, Al Dominick evaluates a core cultural issue around these deals.
Spotlight on M&A – Drivers of M&A, balancing organic growth with acquisitions, and nonbank deals were key topics discussed from the stage at Acquire or Be Acquired.
Exploring Opportunities – Bank Director CEO Al Dominick shares three important takeaways from the first day of the 2020 Acquire or Be Acquired conference.
Technology’s Impact – Hear how banking industry leaders view today’s quickly evolving technology landscape.
Focus on Consolidation – Big mergers of equals and tech deals defined the banking market in 2019.

On the Docket of the Biggest Week in Banking

Think back to your days as a student. Who was the teacher that most inspired you? Was it because they challenged your assumptions while also building your confidence?

In a sense, the 1,312 men and women joining me at the Arizona Biltmore in Phoenix for this year’s Acquire or Be Acquired Conference are in for a similar experience, albeit one grounded in practical business strategies as opposed to esoteric academic ideas.

Some of the biggest names in the business, from the most prestigious institutions, will join us over three days to share their thoughts and strategies on a diverse variety of topics — from lending trends to deposit gathering to the competitive environment. They will talk about regulation, technology and building franchise value. And our panelists will explore not just what’s going on now, but what’s likely to come next in the banking industry.

Mergers and acquisitions will take center stage as well. The banking industry has been consolidating for four decades. The number of commercial banks peaked in 1984, at 14,507. It has fallen every year since then, even as the trend toward consolidation continues. To this end, the volume of bank M&A in 2019 increased 5% compared to 2018. 

The merger of equals between BB&T Corp. and SunTrust Banks, to form Truist Financial Corp., was the biggest and most-discussed deal in a decade. But other deals are worth noting too, including marquee combinations within the financial technology space.

In July, Fidelity National Information Services, or FIS, completed its $35 billion acquisition of Worldpay, a massive payment processor. “Scale matters in our rapidly changing industry,” said FIS Chairman and Chief Executive Officer Gary Norcross at the time. Fittingly, Norcross will share the stage with Fifth Third Bancorp Chairman and CEO Greg Carmichael on Day 1 of Acquire or Be Acquired. More recently, Visa announced that it will pay $5 billion to acquire Plaid, which develops application programming interfaces that make it easier for customers and institutions to connect and share data.

Looking back on 2019, the operating environment proved challenging for banks. They’re still basking in the glow of the recent tax breaks, yet they’re fighting against the headwinds of stubbornly low interest rates, elevated compliance costs and stiff competition in the lending markets. Accordingly, I anticipate an increase in M&A activity given these factors, along with stock prices remaining strong and the biggest banks continuing to use their scale to increase efficiency and bolster their product sets.

Beyond these topics, here are three additional issues that I intend to discuss on the first day of the conference:

1. How Saturated Are Banking Services?
This past year, Apple, Google and Facebook announced their entry into financial services. Concomitantly, fintechs like Acorns, Betterment and Dave plan to or have already launched checking accounts, while gig-economy stalwarts Uber Technologies and Lyft added banking features to their service offerings. Given this growing saturation in banking services, we will talk about how regional and local banks are working to boost deposits, build brands and better utilize data.

2. Who Are the Gatekeepers of Customer Relationships?
Looking beyond the news of Alphabet’s Google’s checking account or Apple’s now-ubiquitous credit card, we see a reframing of banking by mainstream technology titans. This is a key trend that should concern bank executives —namely, technology companies becoming the gatekeepers for access to basic banking services over time.

3. Why a Clear Digital Strategy Is an Absolute Must
Customer acquisition and retention through digital channels in a world full of mobile apps is the future of financial services. In the U.S., there are over 10,000 banks and credit unions competing against each other, along with hundreds of well-funded start-ups, for customer loyalty. Clearly, having a defined digital strategy is a must.

For those joining us at the Arizona Biltmore, you’re in for an invaluable experience. It’s a chance to network with your peers and hear from the leaders of  innovative and elite institutions.

Can’t make it? We intend to share updates from the conference via BankDirector.com and over social media platforms, including Twitter and LinkedIn, where we’ll be using the hashtag #AOBA20.

Bank M&A: Setting Expectations for 2020

What’s driving bank M&A today? That’s one of the questions explored in Bank Director’s 2020 Bank M&A Survey, sponsored by Crowe LLP. In this video, Crowe Partner Rick Childs explains how M&A drivers and barriers will impact deal activity in 2020. He also weighs in on how to effectively measure the success of a transaction and shares the important role strategic discipline plays in achieving long-term success.

  • Pricing Expectations
  • Defining a Successful Deal
  • Predictions for 2020

In accordance with applicable professional standards, some firm services may not be available to attest clients. © 2020 Crowe LLP, an independent member of Crowe Global.   crowehorwath.com/disclosure

Tackling M&A as a Board

Success in executing a bank’s growth strategy — from acquiring another institution to even selling the bank — begins with the discussions that should take place in the boardroom. But few — just 31%, according to Bank Director’s 2020 Bank M&A Survey — discuss these issues at least quarterly as a regular part of the board’s agenda.

Boards have a fiduciary duty to act in the best decisions of shareholders, and these discussions are vital to the bank’s overall strategy and future. Even if management drives the process, directors must deliberate these issues, whether it’s the prospective purchase or another entity of selling the bank.

The survey affirms the factors driving M&A activity today: deposits, increased profitability and growth, and the pursuit of scale. There are common barriers, as well; price in particular has long been a sticking point for buyers and sellers.

M&A plays an important role in most banks’ strategies. One-quarter intend to be active acquirers, and 60% prefer to focus on organic growth while remaining open to making an acquisition.

However, roughly 4% of banks are acquired annually — a figure that doesn’t line up with the 44% of survey respondents who believe their bank will acquire another institution this year.

Conversations in the boardroom, and the strategy set by the board, will ultimately lead to success in a competitive deal landscape.

“Having strong, frequent communications with the board is very much part of our M&A process, and I can’t emphasize how important it is,” says Alberto Paracchini, CEO at Chicago-based Byline Bancorp. The $5.4 billion asset bank has closed three deals in the past five years. “With proper communication, good transparency and frequent communication as to where the transaction stands, the board is and can be not only a great advisor but a good check on management.”

The board at Nashville, Tennessee-based FB Financial Corp. discusses M&A as part of its annual strategic planning meeting. Typically, an outside advisor talks to the board at that time about the industry and provides an outlook on M&A. Also, they’ll “talk about our bank and how we fit into that from their perspective,” including potential opportunities the advisor sees for the organization, says Christopher Holmes, CEO of the $6.1 billion asset bank. Progress on the strategy is discussed in every board meeting; that includes M&A.

So, what should directors discuss? Overall, survey respondents say their board focuses on markets where they’d like to grow (69%), deal pricing (60%), the size of deals their bank can afford (57%) and/or specific targets (54%).

“It starts with defining what your acquisition strategy is,” says Rick Childs, a partner at Crowe LLP. Identifying attractive markets and the size of the target the bank is comfortable integrating is a good place to start.

At $6.1 billion asset Midland States Bancorp, strategic discussions around M&A center around defining the attributes the board seeks in a deal. Annually, directors at the Effingham, Illinois-based bank discuss “what do we like in M&A — deposits and wealth management and market share,” says CEO Jeffrey Ludwig. “[We] continue to define what those types of items are, what the marketplace looks like, where’s pricing today.”

Given the more than 400 charters in Illinois, the board sees ample opportunity to acquire, and the board evaluates potential deals regularly. The framework provided by the board ensures management focuses on opportunities that meet the bank’s overall strategy.

The board at $13.7 billion asset Glacier Bancorp, based in Kalispell, Montana, is “very involved in M&A,” says CEO Randall Chesler. Management shares with the board which potential targets they’re having conversations with and how these could fuel the bank’s strategy. “We start to show them financial modeling early on [so] that they can start to understand what a transaction might look like,” he says. “They’re really engaged early on, through the process and afterwards.” Once a transaction goes through, the board keeps tabs on the status of the conversion and integration.

Having M&A experience on the board can aid these discussions. Overall, 78% of respondents say their board includes at least one director with an M&A background.

These directors can help explain M&A to other board members and challenge management when necessary, says Childs. “They can be a really valuable member of the team and add their experience to the overall process to make sure that it isn’t all groupthink; that there’s somebody that can challenge the process, and make sure [they’re] asking the right questions and keeping everybody focused on what the impact is.”

A number of banks don’t plan to acquire via acquisition. How often should these boards discuss M&A? More than half of survey respondents who say their bank is unlikely to acquire reveal that their board discusses M&A infrequently; another 20% only discuss M&A annually.

Jamie Cox, the board chair at $265 million asset Alamosa State Bank, based in Alamosa, Colorado, says her bank strongly prefers organic growth. Still, the board discusses M&A quarterly at a minimum. “We would be remiss if we ignored it completely, because opportunity is always out there, but you’ve got to be looking for it,” she says. “Whether it’s your key strategy or a secondary strategy, it’s always got to be on the table.”

In charter-rich Wisconsin, Mike Daniels believes too many community bank boards aren’t adequately weighing whether now’s the time to sell. “I don’t want to be as bold as to say that they’re not doing their fiduciary responsibility to their shareholders, but are they really looking at what their strategic options are?” says Daniels, executive vice president at $3.1 billion asset Nicolet Bancshares and CEO of its subsidiary, Nicolet National Bank.

Green Bay, Wisconsin-based Nicolet has an investment banker on staff who can model the financial results for potential acquisition targets. “We’re having M&A dialogue on a regular basis at the board level because we can do this modeling — here’s who we’re talking to, here’s what we’re talking about, here’s what it would mean,” says Daniels.

The board sets the direction for what the bank should evaluate as a potential target. How success is measured should derive from those initial discussions in the boardroom.

“We’re real disciplined on that tangible book value earnback and making sure there’s enough earnings accretion,” says Ludwig. A deal isn’t worth the effort if earnings per share accretion is less than 2% in his view. Any cost saves or revenue synergies are factored into the bank’s earnback estimate. “We’re fairly conservative on the expense saves and diligent about getting at least what we’ve disclosed we could get, and we don’t put any revenue synergies in our model.”

Bank Director’s 2020 Bank M&A Survey, sponsored by Crowe, surveyed more than 200 independent directors, CEOs and senior executives to examine acquisition and growth trends. The survey was conducted in August and September 2019. Bank Director’s 2020 RankingBanking study, also sponsored by Crowe, examines the best M&A deals completed between Jan. 1, 2017, and Jun. 30, 2018, detailing what made those deals successful. Additional context around some of these top dealmakers can be found in the article “What Top Acquirers Know.” The Online Training Series also includes a unit on M&A Basics.

Keeping Benefits Simple During M&A

Mergers and acquisitions are an attractive growth strategy for many banks, but deals are increasingly and needlessly complicated by existing employee benefit plans.

The United States entered the longest economic expansion in history during the third quarter of 2019, surpassing the 120-month run between March 1991 to March 2001. There have been parallels of economic events and potential perils between then and now: a strong housing market, corporate tax cuts, low interest rates, and a mergers and acquisitions environment that rivals the 1990s, resulting in a loss of more than 4% of the nation’s banks per annum on average. From March 1991 to today, the number of U.S. banks has decreased by over 60%. The industry is not only used to M&A but expects it.

But in recent years, we’ve seen a growing burden and complexity in navigating through bank M&A deals, in part due to existing nonqualified benefit plans and bank-owned life insurance, or BOLI, programs. Burdens include heightened regulations on allowable plan designs, evolving tax laws and stricter compliance and due diligence requirements.

Now more than ever, it has become increasingly likely that BOLI or nonqualified benefit plans will be involved in a transaction, and odds are that the acquired portfolio and plans were part of a previous deal.

About 64% of banks across the country owned BOLI at the end of 2018, according to data from S&P Global Market Intelligence, including 63% of banks under $2.5 billion in total assets, 82% of banks between $2.5 billion and $35 billion, and 64% of banks over $35 billion.

The BOLI market continues to expand as banks continue to consolidate, and new premium sales have averaged over $3.5 billion annually in the past five years. Additionally, approximately 65% of banks have a nonqualified benefit plan, split-dollar life insurance plan or both, based on records of Newcleus’ 750 clients.

Program sponsorship continues to expand, because BOLI and nonqualified benefits continue to be important programs for institutions. Implementing nonqualified benefit plans can serve as a valuable resource for banks looking to attract and retain key talent. Both selling and acquiring institutions need to understand the mechanics of benefit and BOLI programs in order to avoid inaccurate plan administration and mismanagement following a combination. This includes:

Non-Qualified Benefit Plans

  • Reviewing the plan agreement: Complete a thorough analysis of the established plan agreements. Understand all triggering events for benefits, available options to exit the plan and the agreement’s change-in-control language.
  • Accounting implications: The bank, in partnership with their plan administrator, should properly vet the mechanics and assumptions used in existing plan accounting. For example, change-in-control benefits could specify a discount rate that must be used for benefit payments, which may differ from rates used on existing accounting reports. They should also ensure that all plan benefits deemed de minimis have been accounted for, such as small split-dollar plans.
  • 280G: Complete a 280G analysis to understand the possible implications of excess parachute payments, including limitations (i.e. net best benefit provisions) caused by existing employee agreements and related non-compete provisions.

BOLI Programs

  • Insurance carrier due diligence: Bankers should complete a thorough review to ensure that acquired BOLI meets the holding requirement that is outlined by the bank’s existing BOLI investment policy, if applicable.
  • Active/inactive BOLI population: As the insured and surviving owner relationship becomes more separated, it is paramount that executives maintain detailed census information, including Social Security numbers, for mortality and insurable interest purposes.
  • Policy ownership: Many banks have implemented trusts to act as the owner of certain BOLI policies. While this setup is permissible, changes in control can impact a trust’s revocability. Institutions should review this information prior to closing, given that there may be limited options to directly manage those policies post-deal close.

These programs are not in the executives’ everyday purview, nor should they be. That’s why it’s so important for institutions to establish partnerships that help guide them through the analysis, documentation and due diligence process for BOLI and nonqualified benefit plans.

Banks may want to consider working with external advisors to conduct a thorough review of existing programs and examine all plan details. They may also want to consider administrative systems, like Newcleus MINTS, that streamline reporting and compliance requirements. Taking these steps can help reduce unnecessary headaches, and create a solid foundation for future BOLI purchases and new nonqualified benefit plans.