Now’s the Time to Identify Takeover Targets


Consolidation in the banking industry has ground almost to a halt. Stock prices have been tanking and few buyers or sellers seem interested in courting in this environment. But that might actually be a mistake, explains Steven Hovde, the founder, CEO and president of The Hovde Group, which provides investment banking, capital markets and financial advisory services focused exclusively on the banking and thrift industry. He speaks with Bank Director about what factors could change the merger environment going forward, and why bankers should be thinking about deals now.

Lots of people thought there would have been more mergers and acquisitions in the banking industry by now, but there hasn’t been. Why?

The drought in M&A activity is largely due to the remaining economic uncertainty and the inability of banks to grow revenues as a result. Furthermore, we’ve seen heightened uneasiness among investors due to the U.S.’s tumultuous political climate, as witnessed by the debt ceiling drama and the Federal Reserve’s several failed attempts to spur job growth through massive rounds of government stimulus. On top of these domestic issues, the European debt crisis has further increased investor anxiety. As long as the credit environment remains uncertain, M&A isn’t going to pick up to any significant degree.

What deals are getting done and what trends do you see there?

Deals are still getting done where the bank is small enough that the buyer can understand the loan portfolio and all potential credit issues. There have been a few larger deals, but that is not the norm. Bank recapitalizations will continue, assuming investors can get comfortable with the banks’ specific credit risks. However, most recapitalizations are of banks that have no option but to raise capital or risk failure, and are being done on terms that dilute existing shareholders down to a de minimis pro forma ownership.

What factors do you think would encourage more M&A?

The housing market must bottom out, or at least stabilize, for an extended period of time for bank M&A to return substantially. Until housing prices bottom, the overall economy will be troubled and loan portfolios will be scrutinized, particularly by buyers. Furthermore, because of economic and housing market uncertainty, the buyer’s credit marks, writing down the value of assets to fair market value, generally are too deep to negotiate a mutually agreeable transaction in today’s environment. A stable housing market—and ideally one in which housing values begin to increase—will break the dam for a gigantic M&A wave. However, with so many foreclosures in the pipeline and the uncertain debt markets in the U.S. and Europe, housing is unlikely to recover in the near-term.

What will be the impact of this environment on smaller banks, say below $500 million in assets?

Heightened regulation (e.g., the Dodd-Frank Act) will negatively impact banks and translate into reduced fees, higher expenses and reduced earnings for many community banks. Smaller banks, in particular, do not have the scale to absorb higher operating expenses and cannot generate sizable revenues from fee-based businesses like their larger brethren. Furthermore, small banks’ loan market shares have dropped, their balance sheets have become more liquid and their margins are shrinking. These trends have become so pronounced that even regulators have suggested many community banks will not survive the next few years.

What should banks keep in mind before they go down the M&A path?

Banks considering a merger or sale should understand their universe of potential buyers. Today’s operating environment is having the same negative impact on all community banks. The next M&A wave will come quickly with sellers flooding the market, ultimately resulting in a buyer’s market. Knowing the buyers for a particular bank will give bankers a leg up on timing the next wave. We often prepare our clients for sale well before they go to market. Knowing the buyer universe assists in the decision-making process. As many of today’s banks would attest, there is nothing worse than missing the market.

 

How to Avoid Minefields in a Merger or Acquisition


With hundreds of bank failures since the financial crisis began and many mergers and acquisitions taking place in an environment of financial and regulatory stress, Commerce Street Capital Managing Director Tom Lykos responds to written questions related to M&A in the face of shareholder activism and heightened judicial scrutiny.

Can you say a little about the regulatory and financial environment and how that is impacting banks?

The increased regulatory scrutiny that began with the crisis of 2008 has only been heightened by the increased regulatory burdens of the Dodd-Frank Act. However, there is a tension between the fiduciary duties owed to shareholders and the obligations directors owe to the FDIC and their primary regulator. At times, the director is caught between the need to accede to the “requests” and directives of regulators while vigorously advocating and advancing the interests of shareholders where the burdens of compliance seem excessive and adversely affect profitability. In such situations, engaging qualified and independent financial and legal advisors is justified given the nature, complexity and immediacy of the issues confronting management and directors. Reliance upon their advice is advisable given that the FDIC alleged, in its demand for payment of civil damages sought from certain officers and directors of BankUnited FSB in Florida, that they failed to heed the warnings and/or recommendations of bank consultants prior to the bank’s 2009 failure. 

How should bank directors approach M&A in the current environment?

In general, it is fair to state that the old standards still apply. However, the application of these standards has been more rigorous with regard to corporate governance in the context of both evaluating a bank’s strategic direction in general and especially in M&A transactions.  Officers and directors do not necessarily have to prove they received the “highest” or “best” price. Rather, they are charged with the duty of following a course or a process that leads to a reasonable decision, not a perfect decision.  In the context of a merger, an independent fairness opinion increases the probability that a board’s decisions will be protected by the business judgment rule and may also help facilitate shareholder approval of a proposed transaction.

If the old standards still apply, then how have the burdens on directors changed?

Although the standards have not changed, there is a higher level of scrutiny on directors now than at any time in the recent past. Increased regulatory oversight combined with increased shareholder activism has resulted in a corresponding increase in judicial scrutiny of the reasonableness of directors’ actions. The level of scrutiny is heightened in situations where an institution is not adequately capitalized, financial performance has lagged and shareholders have concerns about the bank’s strategic direction and the strategic options proposed by management. With regards to situations where subpar performance has led to shareholder activism, the creation of a special committee of the board and retention of an advisor to present strategic options are appropriate responses to address shareholder concerns. Without sounding alarmist, it may be that it is no longer enough for directors to satisfy their obligations to shareholders by negotiating a premium, hiring a financial advisor and obtaining a fairness opinion for a sale or acquisition. The courts have demonstrated an increased willingness to look behind the conclusions of a fairness opinion and board deliberations to determine if a transaction is fair from a financial point of view.

Can you give me an example?

Directors can look to recent court decisions to discern the inquiries relevant to appropriate director conduct. These include: Were the conflicts of interest adequately addressed and disclosed to shareholders, including those that may have unduly influenced directors, management and the financial advisor in the exercise of their judgment and discretion? Who took the lead in negotiating the transaction and what were their financial incentives for doing so? Was the process designed and implemented in a way intended to maximize shareholder value? Were there terms in the merger agreement and “deal protection devices” that were excessive or coercive in the context of the specific transaction? Was there adequate input from disinterested and independent directors? Was the fairness opinion truly independent or was the advisor’s fee contingent on a successful transaction, creating conflicts or “perverse incentives?” In short, both the courts and shareholders are focusing on the events and circumstances that lead to a transaction; the board process in evaluating a transaction (whether accepted or rejected); deal protection devices that may discourage or preclude the consideration of other offers; and the existence and disclosure of apparent or actual conflicts of interest among officers, directors and advisors that might impair their independent judgment.

Watch out: Federal Reserve Begins Systemic Reviews of Pending Acquisitions


risk-magnify-article.jpgAt first blush, it might seem strange that the Federal Reserve would be scrutinizing Capital One Financial Corp.’s announced $9 billion acquisition of ING Groep NV’s U.S.-based online banking unit to gauge whether it poses a systemic risk to the financial system. Capital One focuses primarily on retail businesses including credit cards and branch banking, and the operation that it’s acquiring from Dutch banking giant ING is an Internet bank. And when most people think of activities that might entail some element of systemic risk, they probably think of large trading or derivative operations—not consumer banking. 

The Dodd-Frank Act now requires the Fed to review bank mergers to determine whether they pose a systemic risk, so to a certain extent, its review of the Capital One/ING deal might turn out to be a pro forma exercise. Brian F. Gardner, a senior vice president and Washington-based government affairs analyst for Keefe Bruyette & Woods Inc., points out that the combined entity would be “pretty plain vanilla. It won’t be derivatives intensive. It won’t be capital markets intensive.”

“I think [the Fed is] serious about systemic risk, but I don’t think this is a good test case for [the systemic review],” Gardner adds. “I think the deal will go through with few objections from the Fed.”

It will probably take some time before acquirers and their financial and legal advisors understand fully what the Fed is looking for when it does a systemic review of a pending acquisition. Bankers certainly understand the concept of systemic risk including size, inter-connectedness and counterparty risk, to name a few its elements. But as Gardner points out, “It’s a term of art, not a term of science. There’s no clear, bright line definition.”

A recent memo from Wachtell, Lipton, Rosen & Katz, a New York-based law firm with a large M&A practice, does shed some light on what the Fed will be looking at when it performs a systemic merger review. 

According to Wachtell, “(T)he Federal Reserve is focusing on the availability of substitute providers of critical financial services and the interconnectedness of the company post-acquisition and seeking information about each party’s involvement in providing numerous wholesale and institutional (and some consumer) financial services, including repo funding, prime brokerage, underwriting of equity or debt or asset-backed securities, clearing and settlement, asset custody, corporate trust, credit cards and mortgage servicing. The Federal Reserve is also seeking information about market shares and specific competitors in these markets, as well as the dollar volume of overlapping activities. In addition, they are requesting information about each party’s three highest positive and three highest negative counterparty exposures, including information about any collateral or hedges.”

These are some of the things the Fed will be looking at during its systemic reviews, but is there a formula or methodology it will use to decide that one acquisition poses no systemic threat while another one does? Gardner says that even if it does have a specific methodology in mind, he doesn’t expect the Fed to articulate it for the benefit of the M&A market. 

“That preserves as much flexibility for them as possible,” he says. And while that ambiguity leaves potential bank acquirers in large, complex transactions in the dark about what to expect, “Ambiguity is the ally of the regulator.”

What is Rick Fairbank’s Endgame?


credit-cards.jpgCapital One Corp. CEO Rich Fairbank is a smart guy, but I think he needs to work on his timing. I mean really, who announces a major credit card portfolio acquisition on the same day that the Dow Jones Industrial Average drops 519.83 point – or 4.62 percent – for an 11-month low, particularly when big banks like Citigroup, Bank of America Corp. and J.P. Morgan Chase & Co. led the way down?

On August 10, Capital One announced that it was acquiring the U.S. credit card business of HSBC Holdings PLC for approximately $2.6 billion, just as global equity markets were panicking over the combination of Standard & Poor’s historic downgrading of the United States’ credit rating, deep concerns about the wobbly financial state of major European countries like Italy and France, and the distinct possibility that the U.S. economy might be slipping back into another recession.  This followed a deal announced in June, when Capital One acquired ING Direct, the U.S.-based online banking subsidiary of Dutch giant ING Groep, for $9 billion.

Of course, Capital One had been working on the HSBC deal for months – so the exact timing of the August 10 announcement wasn’t something that Fairbank had much control over. But if you know anything about Rich Fairbank you know he’s a fearless strategist who won’t hesitate to pull the trigger on an acquisition if he believes it’s the smart thing to do.

I wrote a story about Capital One in the second quarter 2006 issue of Bank Director that was based on extensive interviews with Fairbank and W. Ronald Dietz, a long-time director who currently serves as chairman of the bank’s audit and risk committee. Back then, Capital One was in the early stages of transforming itself from a consumer finance company whose principal product was credit cards to something that was more along the lines of a traditional commercial bank. It had recently acquired two regional banks, New Orleans-based Hibernia Corp. and Long Island-based North Fork Bancorp., and Fairbank spent a lot of time during the interview explaining why he did that. And in the process, Fairbank also revealed a lot about the way he thinks when he thinks about strategy, and it’s interesting to look at the ING and HSBC deals in the context of what he said about strategy five years ago.

Fairbank made these points in that 2006 interview:

  • He foresaw the emergence of a bifurcated banking market in the United States where many consumer loan categories like credit cards, auto loans, home mortgages and student loans were being consolidated by large national players (think J.P. Morgan Chase in mortgages or Capital One in credit cards) that used their size and economies of scale to squeeze out community and regional banks — but where the deposit market remained under the control of those same community and regional players, which used their local connections to great competitive advantage. Fairbank concluded that Capital One had to be a factor in both markets, and so he embarked on an unusual national/local strategy that led to the Hibernia deal in 2005, the North Fork deal in 2006 and the acquisition of Chevy Chase Bank in 2008.
  • He wanted to diversify both sides of the balance sheet, but especially the liability side. In the early 2000s, Fairbank might have been more fixated on funding than anything else. Prior to its regional bank acquisitions, Capital One funded itself primarily by raising money from institutional investors in the capital markets. But the Russian bond default in 1998 had roiled the global capital markets to such an extent that finance companies like Capital One were deeply concerned about whether they would still be able to fund their operations at any cost. I got the sense that the Russian debt crisis was a seminal event for Fairbank, and he concluded that Capital One needed access to retail banking deposits – which are inherently more stable than capital markets funding – if Capital One was to survive as an independent company.
  • When he thinks about strategy, Fairbank always thinks about where the industry will be five years from now – not where it will be next year. Here’s what he had to say five years ago: “A strategy must begin with identifying where the market is going. What’s the end game and how is the company going to win? Typically companies work forward from where they are. And they think it is a bold move to change 10 percent from where they are. But when one starts from ‘This is the market, this is the end game, this is where the market is heading and this is the timing of when the market is likely to get there,’ you are faced with a very different kind of reality. It creates a much greater sense of urgency and allows the company to make bold moves from a position of strength.”

So, what observations can we make about Capital One’s most recent acquisitions in light of that 2006 interview? First, the HSBC deal would seem to signal the continued consolidation of the credit card market, and affirms Capital One as one of that industry’s major players. It might seem counter-intuitive (or, just plain dumb) to acquire another company’s credit card portfolio when we might be heading down the second leg of a double-dip recession, but Capital One is probably the most analytical company I’ve ever come across — they analyze everything! – so I assume they have factored in all of the likely economic scenarios, including a spike in loan losses if the economy does tank.

The upside? Capital One squeezes enough juice from the HSBC portfolio through cost saves and revenue enhancements that the deal is accretive to earnings in 2013, which is the company’s current projection. The answer to whether investors will support this transaction will probably come later this year or in early 2012, when the company plans on raising some $1.25 billion in fresh capital to maintain its Tier One capital level in the mid-9 percent range.

To me, the ING Direct acquisition was actually more interesting. Capital One says it will use ING’s consumer deposits to fund the HSBC credit card portfolio on an ongoing basis, and some commentators have tended to see the two deals as being linked, i.e. Capital One wouldn’t have bought ING Direct if it also wasn’t planning on acquiring the HSBC portfolio. But to me, HSBC was tactical while ING Direct was strategic. Not only did the ING Direct acquisition provide funding for the HSBC portfolio, it also diversified Capital One’s funding base into the online consumer space – and Fairbank has pursued the goal of greater funding diversification for a long time. Just as importantly, ING Direct gives Fairbank a platform that he can use to build a national online consumer bank, which is a completely different animal than a regional branch bank, and is a natural fit with Capital One’s credit card business. I think Fairbank’s endgame is to build a national consumer bank. My guess is that he has looked five years into the future and seen further consolidation of the consumer deposit market. He can try to build a national deposit franchise through additional brick-and-mortar acquisitions, but that is an expensive and time-consuming approach.  The ING Direct deal gives him another strategic option that might be faster and cheaper – and more fitting with Fairbank’s sense of urgency. 

Bank acquisitions rise in first quarter, but not by much


Top dealmakers include Sandler O’Neill & Partners, Raymond James & Associates and Keefe, Bruyette & Woods 

Top dealmakers by volume

Top dealmakers by number of deals

There weren’t a lot of fish to be had, but Sandler O’Neill & Partners took the bigger fish. With 34 total bank and thrift acquisitions worth just $2.3 billion in the first quarter, the firm’s investment bankers were the top dealmakers by volume in the first quarter, after handling the $1 billion Comerica Inc. acquisition of Sterling Bancshares, Inc., according to SNL Financial.

race-track.jpgSenior Managing Director Jimmy Dunne III of Sandler O’Neill was ranked number one with two deals worth a total $1.5 billion: He handled Comerica as well as People’s United Financial’s $489 million acquisition of Danvers Bancorp., both announced in January.

He was quickly followed by John Ziegler and Liz Jacobs, both of Sandler O’Neill & Partners, who both worked on the Comerica deal as well.

Tom Mecredy of Raymond James & Associates, Inc., and Jeff Brand and Steve Kent with Keefe, Bruyette & Woods, Inc., were the top bank deal makers by number of deals, with three deals each.

Deal volume improved in the first quarter compared to last year, with 34 deals done compared to 26 during the same quarter last year. But pricing remains lower than historic levels, with the average deal price to book value at 103.2 percent in the first quarter, down from 123.7 percent a year ago.

Last year, there were more than 170 bank mergers and acquisitions announced worth about $12 billion, compared to 296 in 2006 worth $109 billion, according to SNL.

What Is Your Bank’s Number?


The banking industry is poised for a rebound in merger and acquisition activity, which raises the fundamental question of what a bank is worth and how the board and its advisers should derive that number. The art of valuation can be mystifying and the terminology confusing. Every director at one time or another has seen industry data on values, but converting that data into a meaningful picture of a bank’s value requires an understanding of what drives value and how the process works. Understanding the valuation process can help bank directors and top managers better understand the valuation report.
 
Levels of Value 

When determining the value of your bank, you need to consider the purpose of the valuation and the type of value you need for that purpose.

controlling interest value is what an outside party would pay for ownership of the bank. It is often defined as ownership of more than 50 percent. In banking, however, control is typically the result of an acquisition or, in more recent years, a significant recapitalization.

marketable minority interest is the value of a bank’s publicly traded stock on an exchange or other over-the-counter market. A marketable minority interest can be traded without restrictions. Since it is a minority interest, the ownership level is below 50 percent or is such that the owner can’t effect changes that a controlling owner would be able to.

non-marketable minority interest does not have a readily traded market, and transferring the shares takes time and, potentially, can result in a price reduction. To determine a valuation for a non-marketable minority interest, some sort of discount for lack of marketability is applied to the marketable minority interest.

To arrive at this discount, two sources of data are often relied on. The first set of data stems from restricted stock studies. Restricted stocks are shares of public companies that are restricted from public trading under SEC Rule 144. Although they cannot be sold on the open market, they can be bought by qualified institutional investors. Restricted stock studies compare the price of restricted shares of a public company with the freely traded public market price on the same date. Price differences are attributed to liquidity. Many consider the discounts a reliable guide to discounts for the lack of marketability.

A second set of commonly used reference data for determining lack-of-marketability discounts is derived from pre-IPO stock studies. A pre-IPO transaction is one involving a private company stock prior to an initial public offering. Pre-IPO studies compare the price of the private stock transaction with the public offering price. The percentage below the public offering price at which the private transaction occurred is a proxy for the discount.

Valuation Methodologies 

There are several approaches to determining a valuation.

The income approach to valuation indicates the fair value of a bank based on the value of the cash flows that it can be expected to generate in the future. A discounted cash flow (DCF) analysis is one widely accepted method of the income approach.

The DCF technique measures intrinsic value by reference to a bank’s expected annual free cash flows. Typically, this involves the use of revenue and expense projections and other sources and uses of cash. Factors that form the basis for expected future financial performance include the bank’s historical growth rate, business plans, anticipated needs for capital, and historical and expected levels of operating profitability.

An alternative method is the market approach, where a bank is valued by comparing it to publicly traded banks as well as market transactions involving banks with similar lines of business. Factors to consider when determining the comparability of publicly traded banks include asset size, products, markets, growth patterns, relative size, earning trends, loan quality and risk characteristics.

Big Challenges, Bigger Opportunities in Bank M&A


Following our 2011 Acquire or Be Acquired conference in Arizona, Nichole Jordan, Grant Thornton LLP National Banking and Securities Industry Leader, Molly Curl, Grant Thornton Bank Regulatory National Advisory Partner, and George Mark, Grant Thornton Audit Partner and New York Financial Institutions Industry Leader, discuss the important issues facing banks today and how those are likely to help drive M&A activity over the next few years.

The issues addressed include:

  • Principal drivers of M&A activity
  • Critical post-acquisition issues
  • Effects of the Dodd-Frank Act
  • Pursuing growth in the year ahead

Download a PDF of the article.

gt-team.jpg

Profit outlook for 2013: Still hobbled


Size and location will matter

What’s the outlook for community banks for the next few years? Well, not so great. That’s the view of about 30 investment bankers, equity analysts and consultants surveyed by Atlanta attorneys Jim McAlpin and Walt Moeling of Bryan Cave recently.

McAlpin said he was struck by how similar the respondents viewed the future for banking.
 
Community banks in particular have the worst prospects for profitability, in part because a lot of them relied too heavily on commercial real estate lending. Plus, bigger banks have more diversified income sources.

outlook.jpg

“We do have some community banks that are doing very well,’’ said McAlpin. “The challenge has been the significant increase in community banks in large urban areas, where it is more difficult to compete. We believe there is going to be opportunity in suburban and rural areas (instead).”

In fact, the consistent view of the industry analysts was that banks with less than $500 million in assets will have a tough time competing anywhere outside a rural area.

“Size and scale will increasingly matter in the world of community banks,’’ the attorneys wrote in their survey summary.

The expectations for profits are more dismal the smaller the bank. The survey respondents on average expect 2013 returns on assets to be:

  • For banks under $500 million in assets: .50 to .85 percent.
  • For banks between $500 million and $1 billion in assets: .7 percent to 1 percent.
  • For banks between $1 billion and $10 billion: 1 percent to 1.25 percent.
  • For banks above $10 billion in assets: 1.25 percent to 1.3 percent.

Industry analysts also expect mergers and acquisition pricing to stay lower for years to come.

“1.5 (times) book will be the new 2.5 (times) book value of a few years ago,” Peyton Green of Sterne Agee wrote in response to the survey.

Nobody expects huge rebounds in earnings and growth, so there’s not much premium buyers will be willing to pay, analysts said.

What was the prediction for pricing in 2013?

  • Banks with less than $500 million in assets: lucky to get book value.
  • Banks with between $500 million and $1 billion in assets: 1.25 times book.
  • Banks with between $ 1 billion and $10 billion in assets: 1.25 times book to 1.5 times book.

Because of the lack of organic growth opportunities in a slow economy, bankers will focus on profitability and cutting expenses, some industry observers said. Core deposits will be significant drivers of value, the attorneys said.

“There will continue to be consolidation but viable communities will always recognize the need for a ‘local’ bank,’” the report said.

For more information, you can read the final report provided by Bryan Cave.

Where My Deals At?


Last summer, Keefe Bruyette & Wood’s released an interesting bank takeover list. It had the usual suspects — potential buyers and potential sellers — and a “surprising” third: potential buyers who could become sellers. I thought back to this report while watching a handful of videos from our annual Acquire or Be Acquired conference over the weekend. With so much discussion at AOBA centering on FDIC-assisted transactions (which we will explore in greater detail in Chicago this May), this survey came back to me as it focused on so-called open-bank consolidation, comprising potential deals that wouldn’t involve a shutdown by the FDIC first.

Quite a few presented their views on non-distressed bank mergers at our 17th annual M&A conference —  forecasting a huge wave of bank M&A driven by aging management, the need to cut expenses and boost earnings, heightened regulatory costs and more. Of course, FDIC-assisted bank transactions continue to attract strategic acquirers, and the bidding process remains competitive. So “escaping” this particular discussion at our event proved nearly impossible. Indeed, for any healthy bank, considering this type of deal as a growth strategy bears real consideration.  

Case-in-point, this short video of Ben Plotkin, Vice Chairman of Stifel Nicolaus & Co.and long-time Bank Director supporter. We asked Ben to provide his thoughts on the impact of FDIC-assisted deals on M&A activity when we were together at AOBA; take a look:

A random fact that might interest only me…

As we celebrate President’s Day today, February 22, did you know today’s federal holiday celebrates George Washington’s birthday? In fact, this is the first federal holiday to honor an American citizen — celebrated on Washington’s actual birthday in 1796 (the last full year of his presidency).

Teaming Up on FDIC-Assisted Deals


Resolution Asset Management Co. L.P. was formed in 2010 to assist healthy banks acquire failed institutions from the Federal Deposit Insurance Corp. with loss-sharing agreements where the agency provides some measure of protection against losses. A subsidiary of Cantor Fitzgerald, RAM will provide capital to support the transaction, and has a dedicated team of professionals with real estate, asset management, banking and regulatory experience that can help banks bid for failed institutions and manage the acquired assets. Recently, Bank Director talked with Managing Director Rodney A. Montag about the outlook for FDIC-assisted deals, and how the RAM structure works.

What’s the outlook for FDIC assisted deals in 2011?

The outlook is pretty good, or bad, depending how you view it. We’ve had 322 failures since the current crisis began and we are projecting an additional 300 plus failures over the next few years. Looking forward, one of the big differences will be the average size of the bank failures, which we believe will get smaller.

Has the failure rate of banks peaked or do you think the situation will continue to worsen given the industry’s on-going asset quality problems?

I think that’s more of a regulatory policy question than anything else. There is a backlog of troubled banks to deal with and they’re only closing the worst of the worst, which is to say the banks that have diminished liquidity. They seem to be focused on banks with serious liquidity issues as opposed to those banks with operational or other asset problems.

What are the greatest challenges in doing an FDIC assisted deal?

The first is the availability of capital. Even if a healthy bank has sufficient capital, most banks are in a capital preservation mode and don’t want to spend it, including for an acquisition. The second challenge is working out the good and bad assets that are acquired from the failed institution. The third is the bidding process, which is competitive whether in or outside of your marketplace.

How does Resolution Asset Management work with a participating bank?

The bank will form an operating subsidiary of which RAM will be a non-voting minority member. The bank itself will acquire the failed bank’s deposits and liabilities, while the assets of the failed bank that are covered by loss share will be transferred to the operating subsidiary at a value agreed upon by RAM and the bank. A RAM affiliate will use its real estate, valuation and asset management expertise to manage these covered assets. RAM will provide to the operating subsidiary capital necessary to support the acquisition, which is usually a non-dilutive way for the bank to raise capital. The bank will hold a preferred equity ownership position in the op-sub and all of the voting portion of the common equity. In other words, RAM is a passive investor in the operating subsidiary with no interest in the bank or holding company.

What is your exit strategy once the bank’s loss-share agreement with the FDIC has been concluded?

Our equity interest is solely in the operating subsidiary; once all the covered assets have been resolved either through liquidation or modification, the subsidiary itself will be liquidated and RAM will no longer have any equity interest. And of course we never had any ownership interest in the bank parent or the bank holding company, which is a big difference between our structure and a private equity investment in the bank.

Are there steps that a bank should be taking even before they contact RAM?

It’s important to understand that a bank has to have our structure in place before they can bid on a failed bank, though we can also participate with a bank on a transaction they have already closed upon. We spend as much time underwriting the participating bank to confirm its health for our structure as we do reviewing the failed bank. The participating bank also has to submit our structure to its primary regulator for approval, which takes added time.