What 2022’s M&A Market Practice Can Teach Banks

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Nelson Mullins reviewed 43 publicly available merger agreements for bank mergers announced in 2022 to identify common market practices. The transactions ranged in deal value from $10.1 million to $13.7 billion, with a median deal value of roughly $136 million. They reflected average pricing of 1.6x tangible book and 16x earnings.

Understanding these market practices can help potential targets understand what might be available in the market, and help potential purchasers understand where they may be able to stand out from the market. Below are some of the highlights and observations of the review.

Adjustments to Merger Consideration Based on Closing Capital
Ten of the 43 transactions included an adjustment to the merger consideration based on the target’s closing capital, with nine including a dollar for dollar decrease in merger consideration based on the target missing a stated closing capital level. Only one merger agreement offered a dollar for dollar increase or decrease based on a stated closing capital level. Transactions varied with respect to whether changes in the value of available-for-sale securities were backed out of closing capital as well as whether transaction expenses were to be included or excluded in such calculations; there was no market consensus. At least one merger agreement also required the held-to-maturity securities portfolio to be marked-to-market for purposes of calculating closing capital. Only eight transactions provided a minimum capital amount as an explicit closing condition.

Closing conditions predicated on minimum capital amounts are more common in years in which financial stress overhangs the industry, such as during the 2008 financial crisis. Given the significant interest rate moves in 2022, these observations are expected. As we look to 2023, we would expect these conditions to become less common if interest rate trends moderate or even stabilize and drop, noting that any asset stress resulting from a possible economic downturn would change our opinion.

Other Adjustments to Merger Consideration
Although there has been discussion of similar provisions, only the TD Bank Group/First Horizon Corp. agreement included additional merger consideration if the transaction was delayed based on delayed regulatory approvals. No other public merger agreements included such a provision. However, there was one agreement that interestingly provided that the parties could mutually agree to reduce the merger consideration by up to $3.5 million if an event caused a material adverse decline in the value of the transaction. One has to wonder: Would a target ever subsequently agree to a discretionary reduction in merger consideration?

Must the Purchaser Act in the Ordinary Course of Business?
In roughly a third of the transactions, the purchaser undertook an affirmative covenant to only act in the ordinary course of business. This would presumably require the purchaser to obtain the target’s consent before engaging in another acquisition. Conversely, in two-thirds of the transactions, the purchaser made no such covenant.

In all transactions, the purchaser did covenant not to undertake any action that would be expected to cause a delay in the immediate transaction. In the two transactions where the target was closest in size to the purchaser — hence more likely a strategic merger or “merger-of-equals” — the purchaser and target agreed to mutual affirmative and negative covenants.

Target’s Ability to Accept Superior Proposals
Virtually all of the transactions permitted the target’s board of directors to respond to unsolicited alternative proposals. This arrangement, commonly referred to as a “fiduciary out,” is common and effectively required under most frameworks of director’s fiduciary duties.

In roughly 75% of the transactions, the target board of directors had the right to terminate the merger agreement if confronted with a superior proposal and conditioned upon paying a termination fee. However, in 25% of the transactions, while the target board of directors could change its recommendation to shareholders in light of a perceived superior proposal, only the purchaser could elect to then terminate the merger agreement and require the target to pay the termination fee. Otherwise, the target remained obligated to seek shareholder approval and likely most of the directors would remain obligated, if subject to voting support agreements, to continue to vote for the transaction. In four transactions, even the target shareholders’ rejection of the merger agreement didn’t immediately give the target the right to terminate the merger agreement; the parties remained obligated to make good faith reasonable best efforts to first negotiate a restructuring that would result in shareholder approval.

Increasingly Common New Provisions
We increasingly saw provisions addressing cooperation on data processing conversions and coordination of dividend timing, with a desire to ensure that each parties’ shareholders received one dividend payment each quarter.

A Regulator Questions Long-Standing M&A Practice

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There seems to be broad consensus that the way bank mergers are assessed should be updated. The question facing bank regulators and the industry is how. The Office of the Comptroller of the Currency recently grappled with the question in a Bank Merger Symposium it hosted on Feb. 10. 

“There is a robust ongoing debate about the effects of bank mergers on competition, on U.S. communities, and on financial stability,” said Ben McDonough, senior deputy comptroller and chief counsel at the OCC, at the symposium’s opening, delivering remarks prepared for Acting Comptroller Michael Hsu. “At the same time, many experts have raised questions about the ongoing suitability of the current bank merger standards at a time of intense technological and societal change.”

I wrote about how community banks and regulators think about mergers and acquisitions from a competitive perspective for the first quarter 2023 issue of Bank Director magazine. The competitive analysis conducted by regulators is arguably antiquated and overly focused on geography and on bank deposits, which has become less relevant in the face of digital innovation. 

“Regulators are beginning to revise M&A rules, but it’s unclear what impact that will have,” I wrote. “Everyone wants the market to remain competitive — the question is what vision of competition prevails.”

Regulators assess a deal application for the competitive effects of the proposed merger, and the convenience and needs of the communities to be served. The framework they use was last updated in 1995 and has its roots in a 1960s Supreme Court case and the Herfindahl-Hirschman index, or HHI, which was developed in the mid-1940s and early 1950s.

The measurement is calculated by squaring the market share of each firm in the market and then calculating the sum of the resulting numbers; four firms with shares of 30, 30, 20 and 20 have an HHI of 2,600, according to the U.S. Department of Justice. The HHI ranges from zero, which is a perfectly competitive market, to 10,000, or a perfect monopoly. Deals that increase a market’s HHI by more than 200, or where the HHI exceeds 1,800 post-merger, can trigger a review. The bank HHI calculation uses bank deposits as a proxy for bank activity within geographic markets that the Federal Reserve has drawn and maintained.

Hsu highlighted HHI in his opening comments at the symposium as a “transparent, empirically proven, efficient, and easily understood measure of concentration,” but said the decades-old metric may have become “less relevant” since the 1995 update. 

He pointed out how the “growth in online and mobile banking and rise of nonbank competitors” has made HHI, which uses bank deposits as the basis for its calculation, “a less effective predictor of competition.” 

M&A activity in rural banking markets is especially impacted by the HHI calculation. More than 60% of defined geographic banking markets in 2022 were already above the 1,800 threshold, according to a speech from Federal Reserve Governor Michelle Bowman in the same year — meaning any bank deal that would impact those markets could merit further scrutiny.

Some of themes around potential changes to the bank merger application process included “updated and clearly defined concentration, competition and systemic risk analysis,” along with new requirements around “increase[ing] transparency and tools to enforce community benefits commitments,” wrote Ed Mills, managing director of Washington policy for investment bank Raymond James & Associates, in a Feb. 13 note. 

Mills wrote that proposed updates to bank merger guidance “are likely coming soon,” but expects the more extensive changes that seek to “build a better mouse trap” to be a much longer process. His firm believes that current pending mergers are likely to be approved, and that slower approvals don’t necessarily indicate a moratorium. His report occurred in the same week that Memphis, Tennessee-based First Horizon Corp. extended its agreement to sell to Toronto-based TD Bank Corp., which will create a $614 billion institution, from Feb. 27 to May 27, 2023. That would make the sale occur more than a year after announcement. 

It’s still not clear where the agencies will land, and how their changes will impact community bank deal approvals, if at all. But for now, there seems to be consensus that geographic markets and bank deposits may not be the truest measures of competition, before or after a deal.

A Conversation With PNC’s William Demchak

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When Pittsburgh-based The PNC Financial Services Group, a $557.3 billion bank, sold its 22% stake in asset manager BlackRock during the height of the financial crisis for $14.4 billion, executives didn’t know what to do with the cash. Chairman and CEO William “Bill” Demchak explained on stage at Bank Director’s Acquire or Be Acquired conference Monday why he sold BlackRock and turned around and bought BBVA USA within six months. He also offers advice to bankers doing deals. This conversation with Editor-at-Large Jack Milligan has been edited for length and clarity.

BD: What was the decision-making process to sell PNC’s stake in BlackRock in May 2020 for $14.4 billion and use the proceeds to acquire BBVA USA for $11.6 billion in November 2020?
WD: Before the government put out all the fiscal support, you’ll remember that we didn’t know if the mortality rate [of coronavirus in 2020] would be 10% or 1%. All I could think was: Make sure the bank has the most capital, a fortress balance sheet and is the one to survive the day. That led to the decision to sell BlackRock.

So I figured how my options might play out. It wasn’t a certainty that we would find a target [to buy]. If I sold BlackRock, the bank would be absolutely fine, the shareholders would be mad at me because we’d have too much capital and no BlackRock anymore and I’d get fired. That was OK: The bank, our employees and our clients would be great. If it turned out that we had a recovery and managed to land an acquisition target, that was a home run. In the end, that’s what it was. But that six months in-between was really tough.

BD: How did you prepare the board for that decision?
WD: I remember one director said, “You don’t normally sell something until you have the thing you’re going to buy in the other hand,” which is absolutely correct. But we weren’t long from the financial crisis. The bank with the most capital wins every time. We had a big stack of capital in our BlackRock stake that wasn’t recognized. Cashing in those chips was the right decision.

BD: How was the acquisition received in Washington? Did you have any sense that regulatory attitudes toward large bank M&A were changing?
WD: Yes, although we probably didn’t realize how close we were. There’s been a sea change in Washington on large scale consolidation, as they looked at the risk of combining institutions, both theory and economic risk, but also community-based risk. And we made it through a window before that. Although I will say, we made it through the approval process without a single negative letter sent to the regulators.

BD: What did the BBVA USA acquisition do for PNC that you didn’t have before?
WD: Between BBVA and markets we opened up on our own, we went from being in probably 12 of the largest MSAs just a handful years ago to now being in the top 30. It’s remarkable the growth prospects of the markets that we’ve entered. Houston has gone from not being on our radar to being almost our third largest market. What we’ve seen in Colorado is just as tremendous.

BD: Do you foresee PNC doing another acquisition?
WD: I think we have to.

BD: And you think you will be allowed to?
WD: I don’t know. There’s a horrible joke: You’re in the woods and a bear’s chasing you and you’re lacing up your shoes. You can’t outrun the bear, but you don’t have to. You just have to outrun [the person you’re with]. And there’s a lot of banks in this room I can outrun. But the bear is going to get you eventually, if they don’t change the way they look at competition and the different risks in the banking system to allow banks to grow larger.

BD: Acting Comptroller of the Currency Michael Hsu recently gave a speech raising the issue of banks that he referred to as “too big to manage.” He said the OCC is beginning to work on a structure, almost a decision-making tree, of what the regulators could do to deal with a bank that they think is too big to manage. What’s your thoughts on that? Can a bank be too big to manage?
WD: I suppose anything can be too big to manage if you don’t have the right management team to help pay attention to stuff. … We’re a large bank, but we’re in the basic business, probably in the same business as [most of the bankers attending Acquire or Be Acquired]: We serve retail customers with deposits, savings, loans, traditional products. We serve corporate customers with treasury management, and lending products. … But we’re just doing what we’ve done for 165 years.

BD: What have you learned about M&A over the years that you think would be useful for this group to hear?
WD: In the simplest form, understand the reason you’re doing it. Have a clear purpose as to why, other than just trying to get larger. Make all the tough choices that you don’t want to make on people, on technology. Make the choices that are going to hurt today that pay dividends tomorrow. Under-promise, over-perform. Deals are tough. Integration of systems, particularly if both institutions have legacy tech, is really hard. You’ve got to go into it with your eyes wide open, so that whatever comes out of the other side is worth the pain you’re going to cause your employees and sometimes your shareholders.

Are Regulatory Delays Overblown?

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Nicolet Bankshares bought three banks during the last two years that doubled the size of the now $8.8 billion Green Bay, Wisconsin-based banking company. How hard was it to get regulatory approval? Well, if you ask CEO Mike Daniels, it was a breeze.

Despite all the talk of the tough regulatory environment for deal-making, not all banks experience problems, let alone delays. Nicolet’s latest acquisition, the purchase of $1.1 billion Charter Bankshares in Eau Claire, Wisconsin, took all of five months from announcement to conversion, including core conversion and changing branch signage.

“I hear deals are getting delayed, and you never know what the reason is,” says Daniels, who is speaking about mergers and acquisitions as part of a panel at Bank Director’s Acquire or Be Acquired conference in Phoenix this week. He attributes Nicolet’s ease of deal-making to lots of experience with conversions, good communications with its primary regulator, the Office of the Comptroller of the Currency, and an “outstanding” Community Reinvestment Act score. “We spend a lot of time with our primary regulator, the OCC, so they know what we’re thinking about,” he says. “We’re having those conversations before [deals] are announced.”

Are regulators taking longer to approve deals? “I’m in the mid-sized and smaller deal [market], and I’m not seeing that,” says Gary Bronstein, a partner in the law firm Kilpatrick Townsend in Washington, D.C. In fact, an S&P Global Market Intelligence analysis of all whole bank deals through August of 2022 found that the median time from announcement to close was 141 days from 2016 to 2019, ticking up to 145 days from 2020 through Aug. 22, 2022.

Attorneys say regulators are scrutinizing some bank M&A deals more than others, particularly for large banks. The median time to deal close for consolidating banks with less than $5 billion in combined assets was 136 days during the 2020-22 time period, compared to a median 168 days for consolidated banks with $10 billion to $100 billion in assets, according to S&P. Bronstein says in part, there’s pressure from Washington politicians to scrutinize such deals more carefully, including from U.S. Sen. Elizabeth Warren, D-Mass., who has tweeted that the growing size of the biggest banks is “putting our entire financial system at risk.” The biggest deals, exceeding $100 billion in assets, took 198 days to close in 2020-22.

President Joe Biden issued an executive order in June 2021 directing agencies to crack down on industry consolidation across the economy, including in banking, under the theory that consolidation and branch closures raise costs for consumers and small businesses, and harm access to credit.

Regulatory agencies haven’t proposed any specific rules yet, says Rob Azarow, a partner at the law firm Arnold & Porter, in part because Biden has been slow to nominate and then get Senate approval for permanent appointments to the heads of agencies.

Regulators scrutinize larger deals, especially deals creating institutions above $100 billion in assets, because of their heightened risk profiles. “It does take time to swallow those deals and to have regulators happy that you’ve done all the right things on integration and risk management,” Azarow says.

Smaller, plain vanilla transactions are less likely to draw as much scrutiny, says Abdul Mitha, a partner at the law firm Barack Ferrazzano Kirschbaum & Nagelberg in Chicago. Some issues will raise more concerns, however. Regulators are interested in the backgrounds of investor groups that want to buy banks, especially if they have a background in crypto or digital assets. Regulators are also looking for compliance weaknesses such as consumer complaints, fair lending problems or asset quality issues, so buyers will have to be thorough in their due diligence. “Regulators have asked for due diligence memos,” Mitha says. “They’re deep diving into due diligence more recently due to factors such as the economic environment.”

Bronstein concurs that regulators are asking more questions about fair lending in deals. The Consumer Financial Protection Bureau, which regulates banks above $10 billion in assets, is very much focused on consumer regulation and underserved communities, Bronstein says. So is the OCC and Federal Deposit Insurance Corp., which have traditionally focused on safety and soundness issues. They still do that as well, but fair lending has become a hot topic.

In the fall of 2022, the Fed signed off on a merger between two Texas banks, $6.7 billion Allegiance Bancshares and $4.3 billion CBTX, noting that the FDIC required the two institutions to come up with a plan to increase mortgage applications and lending to African American communities.

Still, the regulatory environment isn’t a major factor pulling down deal volume, the attorneys agreed. The economic environment, buyers’ worries about credit quality and low bank valuations have far greater impact. Buyers’ stock prices took a tumble in 2022, which makes it harder to come up with the currency to make a successful acquisition. Also, with bond prices falling, the FDIC reported that banks in aggregate took almost $690 billion in unrealized losses in their securities portfolio in the third quarter of 2022, which impacts tangible book values. Banks are wary of selling when they don’t think credit marks reflect the true value of their franchise, says Piper Sandler & Co.’s Mark Fitzgibbon, the head of financial institutions research.

An analysis by Piper Sandler & Co. shows deal volume dropped off a cliff in 2022, with 169 bank M&A transactions, compared to 205 the year before. But as a percentage of all banks, the drop looks less dramatic. The banks that sold or merged last year equated to 3.6% of total FDIC-insured institutions, close to the 15-year average of 3.4%.

“I would expect M&A activity to look more like 2022 in 2023, maybe a little lower if we were to go into a hard recession,” Fitzgibbon says. “You’d expect to see a lot of activity when we were coming out of that downturn.”

Hazy Outlook for Bank M&A in 2023

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The bank M&A landscape in 2023 will likely be affected by several factors, including concerns about credit quality and turmoil in the stock market, says Rick Childs, partner at Crowe LLP. While sellers will naturally want to get the best price possible, rising interest rates and weak bank stock valuations will impact what buyers are willing to pay. Bankers that do engage in dealmaking will need to exercise careful due diligence to understand a seller’s core deposits and credit risk. Concern about the national economy could prompt bankers to look more closely at in-market M&A, when possible. 

Topics include: 

  • Credit Quality 
  • Customer Communication 
  • Staff Retention
  • Impact of Stock Valuations 

The 2023 Bank M&A Survey examines current growth strategies, including expectations for acquirers and what might drive a bank to sell, and provides an outlook on economic and regulatory matters. The survey results are also explored in the 1st quarter 2023 issue of Bank Director magazine.

The Bumpy Road Ahead

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Banks are in the risk business, and 2023 is shaping up to be a risk-on environment that will keep management teams busy. 

The transformation of last year’s tailwinds into this year’s headwinds is stunning. Slowing economic growth, driven by monetary policy aimed at halting inflation, could translate into weaker loan growth. Piper Sandler & Co. analysts expect net interest margins to peak in the first quarter, before being eroded by higher deposit costs. Credit costs that cannot go any lower may start to rise. Banks may see little boost from fee income and may grapple with controlling expenses. Piper Sandler expects that financial service firms will have a “bumpy” 2023. 

The environment is so novel that Moody’s Analytics Chief Economist Mark Zandi made headlines by describing a new phenomenon: not a recession but a coming “slowcession — growth that comes to a near standstill but that never slips into reverse.” The research firm is baking a slowcession into its baseline economic forecast, citing “generally solid” economic fundamentals and well-capitalized banks, according to a January analysis.

This great uncertainty — and the number of ways banks can respond to it — is on my mind as I get ready for Bank Director’s 2023 Acquire or Be Acquired conference, which will run from Jan. 29-31 in Phoenix. Is growth in the cards this year for banks, and what would it look like? 

Historically, growth has been a necessity for banks. As long as banks can generate growth that outpaces the costs of that growth, they can generate increased earnings. Banks grow their asset base organically, or through mergers and acquisitions, have been two popular ways to generate growth. In a slowdown, some banks may encounter attractive opportunities to buy other franchises at a discount. But growth won’t be in the cards for all — and maybe that’s a blessing in disguise.

“[W]ith the threat of a recession and dramatically increasing cost of funds, there is a solid argument to be made that banks should be shrinking rather than growing,” wrote Chris Nichols in a recent article. Nichols is the director of capital markets at the $45 billion banking company known as SouthState Corp., in Winter Haven, Florida. Growth can exacerbate issues for banks that are operating below their cost of capital, which can push them toward a sale faster. Instead, he’s focused on operational efficiency.

“Financial pressure will be greater, and bank margins will be higher. This combination means that banks will need to focus on the quality of their earnings,” he wrote. Instead of growth, he argued bankers should focus on making their operations efficient, which will direct more profits toward their bottom line.

It makes sense. In a bumpy slowcession, banks aren’t able to control the climb of interest rates and the subsequent changes in economic activity. They may not encounter growth opportunities that set them up for long-term success in this type of environment. But they can control their operational efficiency, innovation and execution — and we’ll talk about that at #AOBA23.

Why Mutual Banks Won’t Sell

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Two Massachusetts banks hope to preserve their mutual status for years to come by merging their holding companies now, in an example of how M&A tends to be a different story for mutual institutions.

Newburyport Five Cents Bancorp and Pentucket Bank Holdings recently received board approval to merge into a single holding company. The combined organization, with $2.5 billion in assets, will likely get a new name, Newburyport CEO Lloyd Hamm told a local news outlet. Meanwhile, $1.5 billion Newburyport Five Cents Savings Bank and $947 million Pentucket Bank will maintain their separate brands.

“We definitely want to emphasize it’s not a merger of the banks, and we will likely select a new name for the co-branded holding company,” Hamm told The Daily News in Newburyport. The new organization also plans to change its bylaws in order to make it more difficult for a future leadership team to take the company public. “This is ensuring mutuality for decades to come,” Hamm said.

All employees of the two banks will keep their jobs, and executives intend to invest more in technology, training and talent, and increase charitable giving under the combined holding company. No branch closures are planned as part of the deal.

According to data from S&P Global Market Intelligence, there have been just three combinations of mutual banks in the past five years, including the deal between Newburyport Bank and Pentucket Bank, which was announced in December 2022.

The dearth of mutual bank M&A essentially comes down to numbers: The U.S. had just 449 mutual institutions at the end of 2021, according to the Federal Deposit Insurance Corp., out of 4,839 total banks. In some respects, mutual banks may more closely resemble credit unions than public or privately held banks, though credit unions have been more actively acquiring FDIC-insured institutions, accounting for 56 deals over the past five years. Mutual banks have no shareholders and are effectively owned by their depositors. Any profits they generate are returned to their depositors in some fashion, for example, in the form of lower rates on mortgages. Last year, the FDIC approved the first de novo mutual bank to launch in over 50 years, Walden Mutual in Concord, New Hampshire.

Because mutual banks don’t have shareholders, they don’t need to always focus on the next, most profitable move, says Stan Ragalevsky, who has worked extensively with mutual banks as a partner with K&L Gates in Boston.

“If you’ve been sitting on the board of a small [mutual] bank, you realize there’s a lot of changes going on in banking, but you also think ‘We’re making money. We may not be making 80 basis points, but we’re making 45 basis points,’” Ragalevsky says. “They feel comfortable that they’re doing the right thing.”

Some of those sentiments showed up in Bank Director’s 2023 Bank M&A Survey: 77% of mutual bank executives and directors participating in the survey say they’re open to M&A but focus primarily on organic growth. Just 12% want to be active acquirers, compared to 23% of all respondents.

Furthermore, all of the 20 mutual participants say their bank’s board and management would not be interested in selling within the next five years, compared to 52% overall. When asked why they were unlikely to sell, many refer back to their institution’s mutual status and a wish to maintain an independent banking option in their communities.

Compared with deals involving publicly held banks, mutual bank deals also tend to be driven by the board more than the management, Ragalevsky adds. While board members may be motivated to some degree by personal self interest — retaining a board seat, for example — “there’s also a sense of commitment to the community,” he says.

Additionally, many prospective mutual bank sellers may be constrained by a lack of like-minded buyers. This very reason is partly why $1.4 billion Cooperative Bank of Cape Cod, based in Hyannis, Massachusetts, is unlikely to sell anytime soon, says CEO and Chair Lisa Oliver.

“We don’t sell, because there’s nobody to buy [us]. We’re owned by our depositors in a non-stock kind of way. If anything, it would be a merger for lack of succession planning, if that were really critical,” Oliver says. “But there are plenty of potential candidates that can be hired to become CEOs of a small bank.”

Some also argue that mutuals’ independent streak is, to some degree, woven into their history. Many mutual banks, particularly in the Northeast, trace their roots back over 100 years, when they were initially founded to provide banking services for poor and working class families.

“The mutual bank movement has been one of the greatest, most successful social and business experiments,” Ragalevsky says. “Mutual banks were formed to improve people’s lives — they weren’t formed to make money. They were formed to improve people’s lives, and they’ve done that.”

4 Critical Success Factors for Bank M&A in 2023

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After rebounding in 2021, bank merger and acquisition, or M&A, activity slowed again in 2022, a trend that is likely to continue.

In this economic environment, growth-oriented organizations need to make the most of the limited acquisition opportunities they find. To maximize the potential of sought-after deals in 2023, bank directors and executive teams should recognize the current critical factors that contribute to successful acquisitions.

Modest Growth Expectations
Bank M&A activity accelerated in 2021 from 2020’s pandemic-depressed levels, but the pace fell off again in 2022. By the end of the third quarter, only 123 deals had been announced, compared to 160 deals over the same period in 2021, according to S&P Global Market Intelligence.

The 2023 Bank Director M&A Survey suggests this situation will probably continue. Although 85% of survey respondents said their banks either plan to be active acquirers or were at least open to acquisitions, only 11% said they were very likely to acquire another bank in 2023, and 28% said they were somewhat likely.

Even fewer said they expect to acquire nondepository business lines, such as wealth management, fintechs or other technology companies. So although conventional acquisitions likely will remain the most common type of transaction during 2023, bank M&A activity overall could remain sluggish. 

4 Bank M&A Success Factors
With fewer opportunities available, the success of every deal becomes even more crucial. Bank boards and executive teams must take care to increase the likelihood that acquisitions produce expected results. Four critical success factors can greatly improve the chances, particularly in the bank-to-bank acquisitions that could make up most of 2023’s activity.

1. Detailed Analysis of the Loan Portfolio. Loan quality always matters, but with a potential industrywide increase in credit losses on the horizon, a buyer having a granular understanding of the seller’s loan portfolio is essential to determine if its allowance for losses is adequate.

Current economic expectations and likely rate changes during the interval between a deal’s announcement and completion mean it is important to analyze the portfolio as early as possible during due diligence. Advanced data analytics can help acquiring banks identify patterns — such as certain loan types, industries, geographic areas, and loan officers — that merit special attention.

Additionally, banks should prepare loan valuations as a part of due diligence. They should include expected rate increases in that analysis, as it is important to home in on the metrics that suggest the quality of the deal.

2. In-depth Understanding of the Deposit Customer Base. In addition to reviewing loan customers during credit due diligence, it’s important that prospective buyers also analyze the deposit customer base. Changing interest rates mean liquidity can become a concern if customers leave for higher returns or online competitors.

Pinpointing top customers, identifying the services they use, quantifying the revenue those relationships generate and developing customized communication plans to ease the transition are prudent initial steps. These plans should assign specific responsibility for communicating with customers; management should be ready to implement them immediately upon the transaction announcement, when such accounts become particularly vulnerable.

3. Proactive Talent Management. Although banks normally eliminate or consolidate positions in an acquisition, they still need to retain the best talent. Losing personnel with critical skills could jeopardize the investment thesis of the transaction; banks should identify these individuals before announcing the transaction. Consistent and open communication helps preempt rumors and minimizes employee uncertainty, while early retention bonuses and other tools can target essential team members who might be vulnerable to poaching while the transaction is pending.

Fair treatment for those who leave is also important. Outplacement services, severance packages, and other transition programs are worth their one-time costs for buyers, since they can help assuage negative community perceptions that could escalate quickly on social media.

4. Effective Technology Integration. Not every bank has adapted to digitization in the same way or at the same speed. Glitches in routine processes, such as online account access, direct deposits or electronic funds transfers, can alienate customers and employees, creating a bad first impression for the blended organization.

A gap analysis that identifies differences in virtual banking, remote workplace policies, fintech relationships and other technology issues is an important early step to successful M&A. This analysis should be followed quickly by a comprehensive technology integration plan that draws on the best ideas from each organization.

In view of the mixed bank M&A outlook for 2023, addressing these four broad issues can help bank directors and executives meet their fiduciary responsibility to recognize potential opportunities, while still managing the risk that is inherent in today’s banking environment.

Issues in Selling to a Non-Traditional Buyer

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We have seen a surge in the number of sales of smaller banks to non-traditional buyers, primarily financial technology companies and investor groups without an existing bank.

This has been driven by outside increased interest in obtaining a bank charter, the lack of natural bank buyers for smaller charters and, of course, money. Non-traditional buyers are typically willing to pay a substantially higher premium than banks and including them in an auction process may also generate pricing competition, resulting in a higher price for the seller even if it decides to sell to another bank. Additionally, buyers and sellers can structure these transactions as a purchase of equity, as opposed to the clunky and complicated purchase and assumption structure used by credit unions.

But there are also many challenges to completing a deal with a non-traditional buyer, including a longer regulatory approval process and less deal certainty. Before going down the road of entertaining a sale to a buyer like this, there are a few proactive steps you can take to increase your chances for success.

The Regulatory Approval Process
It is important to work with your legal counsel at the outset to understand the regulatory approval process and timing. They will have insights on which regulators are the toughest and how long the approval process may take.

If the potential buyer is a fintech company, it will need to file an application with the Federal Reserve to become a bank holding company. In our recent experience, applications filed with the Federal Reserve have taken longer, in part because of the increased oversight of the Board in Washington, but also because the Federal Reserve conducts a pre-transaction on-site examination of the fintech company to determine whether it has the policies and procedures in place to be a bank holding company. Spoiler alert: most of them don’t.

If the potential buyer is an individual, the individual will need to file a change in control application with the primary federal regulator for the bank. The statutory factors that regulators need to consider for this type of application are generally less rigorous than those for a bank holding company application. We have seen the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp. show more openness to next-generation business plans, as they understand the need for banks to innovate.

Conduct “Reverse” Due Diligence
Find out more about the buyer. You would be surprised at what a simple internet search will uncover and you can bet that the regulators will do this when they receive an application. We have encouraged sellers take a step further and conduct background checks on individual buyers.

Ask the buyer what steps have been taken to prepare for the transaction. Has the investor had any preliminary meetings with the regulators? What advisors has the buyer hired, and do they have a strong track record in bank M&A? Does the buyer have adequate financial resources?

Understand the key aspects of the buyer’s proposed business plan. Is it approvable? Are the new products and services to be offered permissible banking services? A business plan that adds banking as a service is more likely to be approved than one that adds international payments or digital assets. Does the buyer have a strong management team with community bank experience? What impact will the business plan have on the community? Regulators will not approve an application if they think the charter is being stripped and a community is at risk of being abandoned. We have seen buyers offer donations to local charities and engage in community outreach to show the regulators their good intentions.

Negotiate Deal Protections in the Agreement
Additional provisions can be included in the definitive agreement to protect the selling bank. For example, request a deposit of earnest money upon signing that is forfeitable if the buyer does not obtain regulatory approval. Choose an appropriate drop-dead date for the transaction. Although this date should be realistic, it should also incentivize the buyer to move quickly. We have seen sellers offer buyers options to pay for extensions. The contract should also require the buyer to file the regulatory application promptly following signing and to keep the selling bank well informed about the regulatory approval process.

While a transaction with a non-traditional buyer may be more challenging, under the right circumstances it can present an appealing alternative for a bank looking to maximize its sale price in a cash transaction.

Six Priorities for Successful Post-Merger Integration

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Is your bank properly resourced for an efficient and effective post-merger integration?

Most banks head into post-merger integration with long to-do lists but find they are not equipped with the people, processes and technology integral to achieving valuable post-close results. Managing data, applications, and infrastructure to integrate the target company to drive the return your institution is expecting is critical to the merger’s success.

Depending on the scope and scale of each transaction, the first 120 days can vary greatly. Boards and executives should keep these six priorities in mind when planning the days following the merger for a smoother transition to full integration. A well-executed and communicated plan avoids delays, unnecessary costs and long-term unfavorable consequences.

Document everything, assume nothing. Memorialize the value creation strategy. What is the integration approach? Where is the value? And what’s the time frame to realize this value? When a bank defines these goals, it allows the integration team to set the right priorities. Communicate it and then communicate it again, and again.

Prioritize consistent communication between key players. The right hand needs to know what the left hand is doing. That does not mean constant meetings between every member of the integration team, but the moving pieces — for example, the merger and acquisition leaders, operations and the finance team — must regularly sync. Boards need to set an expectation for communication cadence early.

Agree on the integration approach. Is this acquisition an absorption, holding, value creation or integration? Agreeing on what the end game looks like creates a solid, common vision and strategy, quiets the noise around non-priorities for the near term and universally defines what success looks like in zero to 90 days, 90 to 120 days and beyond.

Realistically assess team skills and what’s missing. In most banks, everyone on the integration team has a day job and few have the experience or bandwidth to handle onetime tasks and niche elements of M&A, including core system conversions. For most banks, this may be the first time they’ve been through the process, or the last deal was years ago. If your institution doesn’t have time for training, consider contracting outside talent that regularly performs these types of transactions to handle your institution’s integration efficiently.

Core system conversion planning. Core system conversion readiness and availability of vendors is a key part of the post-integration plan. This component alone could demand a separate team of bank personnel from both organizations. Use this time to review your technology vendor contracts.

Understand (and respect) the culture. Every transaction will affect people: employees, customers, shareholders, and vendors. Recognize the impact, plan for it and communicate what you know when you know it. Focus on the value creation for each audience.

As early as possible, rightsize the project team with a trusted advisor that understands the nuances of the banking industry, has nimble processes, a broad range of knowledge and expertise, and most importantly — the ability to execute.

The information contained herein is general in nature and is not intended, and should not be construed, as legal, accounting, investment, or tax advice or opinion provided by CliftonLarsonAllen LLP (CliftonLarsonAllen) to the reader. CLA (CliftonLarsonAllen LLP) is an independent network member of CLA Global. See CLAglobal.com/disclaimer. Investment advisory services are offered through CliftonLarsonAllen Wealth Advisors, LLC, an SEC-registered investment advisor.