As organic growth cools, could the slowdown in M&A turn around in 2024?
Roughly a third of bank executives and directors responding to Bank Director’s 2024 Bank M&A Survey, sponsored by Crowe, believe their bank is likely to acquire another institution by the end of 2024, down from 39% in 2023 and 48% in 2022.
However, with banks spending the past two years wrestling with deposit pricing and attrition, 85% point to an attractive deposit base as a top attribute of an acquisition target today, compared with 58% who said as much a year ago. That was followed by a complementary culture (58%), efficiency gains (55%) and locations in growing markets (48%).
Looking through 2024, respondents do not expect dramatic swings in their bank’s deposit rates. Forty-five percent expect deposit rates to increase by no more than 50 basis points, and 22% expect them to decline by that amount.
Focused on U.S. banks below $100 billion in assets, 201 independent directors, CEOs, chief financial officers and other senior executives responded to the survey, which examines current growth strategies, economic concerns and plans to optimize the balance sheet. The survey was conducted in September 2023.
Members of the Bank Services program have exclusive access to the full results, including breakouts by asset category and other demographic variables.
Transformational Deals Forty-one percent of respondents say their bank would be open to a merger of equals, while 34% say it would not be. Nearly a quarter are unsure. Two years ago, almost half (48%) said their bank would be open to such a transaction.
Waning Confidence In Valuations Respondents cite the pricing expectations of potential targets (71%) as a top barrier to M&A, followed by a lack of suitable targets (59%). Among potential acquirers, 35% would be willing to pay up to 1.5 times tangible book value for the right target. However, just over half of respondents would expect a minimum of 1.75 times book value in a sale. For public banks, 40% feel their bank’s stock is attractive enough to buy an institution that meets its acquisition criteria, a sharp drop from 51% who said as much last year.
Selective Sellers While a majority (61%) express no preference as to whether a potential acquirer would be a direct competitor, most would rather sell to a regional bank (65%) or community bank (60%) than to a private investor group (18%), multinational bank (12%) or credit union (9%).
Trouble On The Horizon Forty-three percent anticipate more bank failures over the next 18 months, but among those bank leaders, most do not expect to see more than 10 banks fail. A third of respondents do not anticipate any further bank failures in that time period.
Failed Bank M&A Three-quarters of bank leaders say they have not discussed the possibility of buying a failed bank, but 17% have discussed it and informed their regulator of their interest.
Sluggish Fintech Investing A large majority of respondents (79%) say their bank did not invest in or acquire a fintech firm in 2022 or 2023, consistent with last year’s survey results. Of those who did invest in a fintech company, most cite a desire to gain a better understanding of the fintech space.
These topics will be further explored at Bank Director’s Acquire or Be Acquired Conference, Jan. 28-30, 2024, in Phoenix.
Bank leaders’ enthusiasm for M&A appears muted going into 2024, but an appetite for sticky, low cost deposits could motivate some financial institutions to make a deal in the year ahead.
Bank Director’s 2024 Bank M&A Survey, sponsored by Crowe LLP, finds that 35% of bank executives and directors believe they are likely to acquire another institution by the end of 2024, down from 39% in 2023 and 48% in 2022. Eighty-five percent point to an attractive deposit base as a top attribute of an acquisition target in today’s environment, compared with 58% who said as much a year ago. That was followed by a complementary culture (58%), efficiency gains (55%) and locations in growing markets (48%).
Looking over the next five years, more than half (56%) of bank executives and directors say they are open to acquisitions. Almost a quarter plan to be active acquirers.
By and large, respondents do not expect dramatic swings in their bank’s deposit rates over the next 18 months. Forty-five percent expect deposit rates to increase by no more than 50 basis points, and 22% expect them to decline by that amount. If that holds true, that’s positive news for the industry. The Federal Reserve’s Open Market Committee raised the federal funds rate 11 times over the past 18 months, bringing it to a range of 5.25% – 5.50%. “Deposit acquisition [at] reasonable rates will be the key to profitability,” writes the independent director of a private, southwestern bank.
When asked about strategies their bank has employed to generate organic growth in 2022-23, 57% say they’ve added staff in revenue-generating areas. Forty-two percent expanded their product offering within existing business lines, and 38% added new business lines or products. The percentage who have undertaken new digital efforts to attract deposits fell from 50% in last year’s survey to 39% this year.
One respondent points out that digital channels allow customers to move money more quickly, adding, “sticky deposits are not so sticky anymore.”
Organic growth has also been tough to come by lately. Respondents cite economic uncertainty or fear of recession (56%), competition from other financial institutions (55%), and limited or sluggish loan demand (34%) as the top three obstacles to achieving organic growth in the current environment. Nearly a quarter (24%) cite staffing constraints as a growth challenge, a sentiment that was echoed in anonymous comments by survey respondents.
“The inability to attract human capital at all levels of the bank remains our largest concern going forward,” says the CEO of a midwestern bank. “I see this as our biggest obstacle to the survival of community banks going forward.”
Forty-one percent of respondents say their bank would be open to a merger of equals, while 34% say it would not be. Nearly a quarter are unsure. Two years ago, almost half (48%) said their bank would be open to such a transaction.
Waning Confidence In Valuations
Respondents cite the pricing expectations of potential targets (71%) as a top barrier to M&A, followed by a lack of suitable targets (59%). Among potential acquirers, 35% would be willing to pay up to 1.5 times tangible book value for the right target. However, just over half of respondents would expect a minimum of 1.75 times book value in a sale. For public banks, 40% feel their bank’s stock is attractive enough to buy an institution that meets its acquisition criteria, a sharp drop from 51% who said as much last year.
While a majority (61%) express no preference as to whether a potential acquirer would be a direct competitor, most would rather sell to a regional bank (65%) or community bank (60%) than to a private investor group (18%), multinational bank (12%) or credit union (9%).
Trouble On The Horizon
Forty-three percent anticipate more bank failures over the next 18 months, but among those bank leaders, most do not expect to see more than 10 banks fail. A third of respondents do not anticipate any further bank failures in that time period.
Failed Bank M&A
Three-quarters of bank leaders say they have not discussed the possibility of buying a failed bank, but 17% have discussed it and informed their regulator of their interest.
Sluggish Fintech Investing
A large majority of respondents (79%) say their bank did not invest in or acquire a fintech firm in 2022 or 2023, consistent with last year’s survey results. Of those who did invest in a fintech company, most cite a desire to gain a better understanding of the fintech space.
Bank Services members can access a deeper exploration of the 2024 Bank M&A Survey. Members can click here to view the complete results, broken out by asset category and other relevant attributes. To find out how your bank can gain access to this exclusive report, contact [email protected].
Bank Director will delve deeper into capital, M&A and technology strategies at its biggest event of the year, the Acquire or Be Acquired Conference, Jan. 28-30, 2024, in Phoenix, Arizona.
The nationwide pandemic and persistent economic uncertainty hasn’t slowed the growth of Idaho Central Credit Union.
The credit union is located in Chubbuck, Idaho, a town of 15,600 near the southeast corner, and is one of the fastest growing in the nation. It has nearly tripled in size over the last five years, mostly from organic growth, according to an analysis by CEO Advisory Group of the 50 fastest growing credit unions. It also has some of the highest earnings among credit unions — with a return on average assets of 1.6% last year — an enviable figure, even among banks.
“This is an example of a credit union that is large enough, [say] $6 billion in assets, that they can be dominant in their state and in a lot of small- and medium-sized markets,” says Glenn Christensen, president of CEO Advisory Group, which advises credit unions.
Unsurprisingly, growth and earnings often go hand in hand. Many of the nation’s fastest growing credit unions are also high earners. Size and strength matter in the world of credit unions, as larger credit unions are able to afford the technology that attract and keep members, just like banks need technology to keep customers. These institutions also are able to offer competitive rates and convenience over smaller or less-efficient institutions.
“Economies of scale are real in our industry, and required for credit unions to continue to compete,” says Christensen.
The largest credit unions, indeed, have been taking an ever-larger share of the industry. Deposits at the top 20 credit unions increased 9.5% over the last five years; institutions with below $1 billion in assets grew deposits at 2.4% on average,” says Peter Duffy, managing director at Piper Sandler & Co. who focuses on credit unions.
As of the end of 2019, only 6% of credit unions had more than $1 billion in assets, or 332 out of about 5,200. That 6% represented 70% of the industry’s total deposit shares, Duffy says. Members gravitate to these institutions because they offer what members want: digital banking, convenience and better rates on deposits and loans.
“The only ones that can consistently deliver the best rates, as well as the best technology suites, are the ones with scale,” Duffy says.
Duffy doesn’t think there’s a fixed optimal size for all credit unions. It depends on the market: A credit union in Los Angeles might need $5 billion in assets to compete effectively, while one in Nashville, Tennessee, might need $2 billion.
There are a lot of obstacles to building size and scale in the credit union industry, however. Large mergers in the space are relatively rare compared to banks — and they became even rarer during the coronavirus pandemic. Part of it is a lack of urgency around growth.
“For credit unions, since they don’t have shareholders, they aren’t looking to provide liquidity for shareholders or to get a good price,” says Christensen.
Prospective merger partners face a host of sensitive, difficult questions: Who will be in charge? Which board members will remain? What happens to the staff? What are the goals of the combined organization? What kind of change-in-control agreements are there for executives who lose their jobs?
These social issues can make deals fall apart. Perhaps the sheer difficulty of navigating credit union mergers is one contributor to the nascent trend of credit unions buying banks. A full $6.2 billion of the $27.7 billion in merged credit union assets in the last five years came from banks, Christensen says.
Institutions such as Lakeland, Florida-based MIDFLORIDA Credit Union are buying banks. In 2019, MIDFLORIDA purchased Ocala, Florida-based Community Bank & Trust of Florida, with $743 million in assets, and the Florida assets of $675 million First American Bank. The Fort Dodge, Iowa-based bank was later acquired by GreenState Credit Union in early 2020.
The $5 billion asset MIDFLORIDA was interested in an acquisition to gain more branches, as well as Community Bank & Trust’s treasury management department, which provides financial services to commercial customers.
MIDFLORIDA President Steve Moseley says it’s probably easier to buy a healthy bank than a healthy credit union. “The old saying is, ‘Everything is for sale [for the right price],’” he says. “Credit unions are not for sale.”
Still, despite the difficulties of completing mergers, the most-significant trend shaping the credit union landscape is that the nation’s numerous small institutions are going away. About 3% of credit unions disappear every year, mostly as a result of a merger, says Christensen. He projects that the current level of 5,271 credit unions with an average asset size of $335.6 million will drop to 3,903 credit unions by 2030 — with an average asset size of $1.1 billion.
CEO Advisory Credit Union Industry Consolidation Forecast
The pandemic’s economic uncertainty dropped deal-making activity down to 65 in the first half of 2020, compared to 72 during the same period in 2019 and 90 in the first half of 2018, according to S&P Global Market Intelligence. Still, Christensen and Duffy expect that figure to pick up as credit unions become more comfortable figuring out potential partners’ credit risks.
In the last five years, the fastest growing credit unions that have more than $500 million in assets have been acquirers. Based on deposits, Vibe Credit Union in Novi, Michigan, ranked the fastest growing acquirer above $500 million in assets between 2015 and 2020, according to the analysis by CEO Advisory Group. The $1 billion institution merged with Oakland County Credit Union in 2019.
Gurnee, Illinois-based Consumers Cooperative Credit Union ranked second. The $2.6 billion Consumers has done four mergers in that time, including the 2019 marriage to Andigo Credit Union in Schaumberg, Illinois. Still, much of its growth has been organic.
Canyon State Credit Union in Phoenix, which subsequently changed its name to Copper State Credit Union, and Community First Credit Union in Santa Rosa, California, were the third and fourth fastest growing acquirers in the last five years. Copper State, which has $520 million in assets, recorded a deposit growth rate of 225%. Community First , with $622 million in assets, notched 206%. The average deposit growth rate for all credit unions above $500 million in assets was 57.9%.
CEO Advisory Group Top 50 Fastest Growing Credit Unions
“A number of organizations look to build membership to build scale, so they can continue to invest,” says Rick Childs, a partner in the public accounting and consulting firm Crowe LLP.
Idaho Central is trying to do that mostly organically, becoming the sixth-fastest growing credit union above $500 million in assets. Instead of losing business during a pandemic, loans are growing — particularly mortgages and refinances — as well as auto loans.
“It’s almost counterintuitive,” says Mark Willden, the chief information officer. “Are we apprehensive? Of course we are.”
He points out that unemployment remained relatively low in Idaho, at 6.1% in September, compared to 7.9% nationally. The credit union also participated in the Small Business Administration’s Paycheck Protection Program, lending out about $200 million, which helped grow loans.
Idaho Central is also investing in technology to improve customer service. It launched a new digital account opening platform in January 2020, which allows for automated approvals and offers a way for new members to fund their accounts right away. The credit union also purchased the platform from Temenos and customized the software using an in-house team of developers, software architects and user experience designers. It purchased Salesforce.com customer relationship management software, which gives employees a full view of each member they are serving, reducing wait times and providing better service.
But like Idaho Central, many of the fastest growing institutions aren’t growing through mergers, but organically. And boy, are they growing.
Latino Community Credit Union in Durham, North Carolina, grew assets 178% over the last five years by catering to Spanish-language and immigrant communities. It funds much of that growth with grants and subordinated debt, says Christensen.
Currently, only designated low-income credit unions such as the $536.5 million asset Latino Community can raise secondary capital, such as subordinated debt. But the National Credit Union Administration finalized a rule that goes into effect January 1, 2022, permiting non-low income credit unions to issue subordinated debt to comply with another set of rules. NCUA’s impending risk-based capital requirement would require credit unions to hold total capital equal to 10% of their risk-weighted assets, according to Richard Garabedian, an attorney at Hunton Andrews Kurth. He expects that the proposed rule likely will go into effect in 2021.
Unlike banks, credit unions can’t issue stock to investors. Many institutions use earnings to fuel their growth, and the two measures are closely linked. Easing the restrictions will give them a way to raise secondary capital.
A separate analysis by Piper Sandler’s Duffy of the top 263 credit unions based on share growth, membership growth and return on average assets found that the average top performer grew members by 54% in the last six years, while all other credit unions had an average growth rate of less than 1%.
Many of the fastest growing credit unions also happen to be among the top 25 highest earners, according to a list compiled by Piper Sandler. Among them: Burton, Michigan-based ELGA Credit Union, MIDFLORIDA Credit Union, Vibe and Idaho Central. All of them had a return on average assets of more than 1.5%. That’s no accident.
Top 25 High Performing Credit Unions
Credit unions above $1 billion in assets have a median return on average assets of 0.94%, compared to 0.49% for those below $1 billion in assets. Of the top 25 credit unions with the highest return on average assets in 2019, only a handful were below $1 billion in assets, according to Duffy.
Duffy frequently talks about the divide between credit unions that have forward momentum on growth and earnings and those who do not. Those who do not are “not going to be able, and have not been able, to keep up.”
Much like the countless dystopian novels and movies released over the years, the environment today in banking begs the question of whether we’ve entered a so-called new world in the industry’s M&A domain.
Deal volume in 2018 was roughly equal to 2017 levels, though many regions in the country saw a decline. And while it’s still early in 2019, the first two months of the year have been marked by a pair of large, transformative deals: Chemical Financial Corp.’s merger with TCF Financial Corp., and BB&T Corp.’s merger with SunTrust Banks. These deals have raised hopes that more large deals will soon follow, creating a new tier of banking entities that live just below the money-center banks.
Aside from these two large deals, however, M&A volume throughout the rest of the industry is down over the first two months of the year. As you can see in the chart below, this continues a slide in deal volume that began at the tail end of 2018.
Bank Director’s 2019 Bank M&A Survey highlights a number of the factors that might impact deal volume in 2019 and beyond.
Fifty-seven percent of survey respondents indicated that organic growth is their current priority, for instance, though respondents were open to M&A opportunities. This suggests that banks are more willing to focus on market opportunities for growth, likely because bank management can more easily influence market growth than M&A. The strength of the economy, enhanced earnings as a result of tax reform, easing regulatory oversight and industry optimism in general also are likely contributing to the focus on market growth.
The traditional chasm between banks that would like to be acquirers and banks that are willing to be sellers seems to be another factor influencing banks’ preference for organic market growth. In all the surveys Crowe has performed of bank directors, there always are more buyers than sellers.
The relationship between consolidation and new bank formation also weighs on the pace of acquisitions. If the pool of potential and active acquirers remains relatively stable, the determiner is the available pool of sellers. Each year since 2008, the number of acquisitions has exceeded the number of new bank formations. The result is an overall decrease in the number of deals. It stands to reason, in turn, that this will lead to fewer deals each year as consolidation continues.
Current prices for bank stocks also have an impact on deal volume. You can see this in the following chart, which illustrates the “tailwind” impact on deal volume for publicly traded banks. Tailwind is the percentage by which a buyer’s stock valuation exceeds the deal metrics. When the percentage is high, trading price/tangible book value (TBV) exceeds the deal price/TBV and deal volume is positively affected. The positive impact sometimes is felt in the same quarter, but there can be a three-month lag.
In the beginning of 2019, bank stock prices recovered some of the declines they experienced in the latter half of last year, but they still are at a negative level overall. If bank stock prices continue to lag behind the broader market, as they have over the past year (see the chart below), deal volume likely will be affected for the remainder of the year.
It’s still too early to predict how 2019 will evolve for bank M&A. Undoubtedly there will be surprises, but it’s probably fair to assume a slightly lower level of deals for 2019 compared to 2018.
Leadership is a central aspect of banking. Not only do bank executives lead their institutions, but directors who sit on bank boards tend to be leading members of their communities.
Indeed, it’s no coincidence that the biggest and tallest buildings in many cities and towns across the country are named after banks.
That’s why leadership was one underlying theme of this year’s Bank Director’s Acquire or Be Acquired Conference held at the JW Marriott in Phoenix, Arizona.
It was the 25th anniversary of the conference, one of the marquee events in the banking industry each year.
The conference opened with a video tracing the major events in banking since 1994—a period of deregulation, consolidation and innovation.
In that time, the population of banks has been cut in half, Great Depression-era regulations have rolled back and the internet and iPhone have made it possible for three-quarters of deposit transactions at some banks to be completed from the comforts of bank customers’ own homes.
It was only fitting then to bookend the conference with some of the greatest leaders in the banking industry throughout this tumultuous time.
The first day concluded with the annual L. William Seidman CEO Panel, featuring Michael “Mick” Blodnick, the chief executive officer of Glacier Bancorp from 1998-2016, and Joe Turner, the CEO of Great Southern Bancorp since 2000.
The banks run by Blodnick and Turner have created more value than nearly all other publicly traded banks in the United States. Glacier ranks first in all-time total shareholder return—dividends plus share price appreciation—while Great Southern ranks fifth on the list.
As Blodnick and Turner explained on stage, there is no one right way to grow. Blodnick did so at Glacier through a series of 30 mergers and acquisitions, building one of the leading branch networks throughout the Rocky Mountain region.
Turner took a different approach at Great Southern. He and his father, who had run the bank from 1974 to 2000, focused instead on organic growth. They built a leading footprint in the Southwest corner of Missouri, and then, in the financial crisis, completed five FDIC-assisted transactions to spread their footprint into cities up the Missouri and Mississippi rivers.
One consequence of this approach was it enabled Great Southern to consistently decrease its outstanding share count by upwards of 40 percent since originally going public, as it never had to issue shares to buy other banks.
Asked what one thing he wanted to share with the audience, Turner talked about the importance of ignoring shortsighted stock analysts. Despite Great Southern’s extraordinary returns through the years, it has rarely if ever been “buy” rated by the analyst community.
Why not? When the economy is great and other banks are growing at a rapid clip, Great Southern tempers its growth to avoid making imprudent loans. Then when times are tough, and a pall is cast over all stocks, Great Southern surges ahead. Blodnick’s advice focused on M&A. For sellers, the goal should never be to get the last nickel, he explained. Rather, the goal should be to establish a partnership that will maximize value over time.
The conference also had a parallel track of sessions, FinXTech, focused on technology.
These sessions were often standing-room only. It was an obvious indication about what the future leaders of banking are focused on now.
Don MacDonald, the chief marketing officer of MX Technologies, took a particularly broad approach to the subject. Although his session ostensibly focused on harnessing data to increase growth and returns, he put the topic into historical perspective.
The question MacDonald was trying to answer was: How do we know if the banking industry has reached a genuine inflection point, after which the rules of the game, so to speak, have changed?
The answer to this question, MacDonald said, can be found in developing a framework for assessing change. That framework should include multiple forces in an industry, such as regulations, customer expectations and technology.
It’s only when multiple major forces experience change at or around the same time that a true strategic inflection point has been reached, explained MacDonald.
Has banking reached such a point?
MacDonald didn’t answer that question, but given the environment banks operate in right now with the growth of digital distribution channels and the ever-evolving regulatory regime, one would be excused for coming to that conclusion.
Given these two tracks—the general sessions focusing on banking and the FinXTech sessions focusing on technology—it was fitting that the final day of the conference was opened by John B. McCoy, the former CEO of Bank One, from 1984-99. McCoy hails from the notoriously innovative McCoy banking dynasty, preceded by his father and grandfather. Bank One was one of the earliest adopters of credit cards, drive-through windows and ATMs, among other things.
Furthermore, it was McCoy’s approach to acquisitions at Bank One, where he completed more than 100 deals, that helped to inform Blodnick’s approach at Glacier. Known as the “uncommon partnership,” the approach focused on buying banks, but allowing them to retain their autonomy.
The decentralized aspect of the uncommon partnership left decision-making at the local level—within the acquired banks. It allowed Bank One and Glacier to have their cake and eat it too—growing through M&A, but leaving the leadership of the individual institutions where it belongs: In their local communities. This resulted in lower customer attrition, the scourge of most deals.
One overarching lesson from Acquire or Be Acquired is that banking is about facilitating the growth of communities, and the best people to spearhead this are the ones with the most on the line—the leaders of those communities.
There was a lot of optimism among the crowd of more than 200 during the first full day of Bank Director’s 13th annual Bank Compensation & Talent Conference Tuesday, which included bank CEOs, board members and human resources executives. It was almost as if the prior day’s rains had passed and the day’s breeze and sunshine at The Ritz-Carlton, Amelia Island, lightened the mood. For instance, a full 95 percent of the audience in a poll felt that a bank can create a culture of innovation.
Here are a few takeaways from the conference to consider:
Culture is key to one’s future success. Regardless of size, bank executives and board members exert tremendous influence on the long-term culture and success of an institution. Culture manifests in various ways. It may be the board asking challenging questions. It might be figuring out the right incentive structures to encourage growth without undue risk.
Doug Kennedy, president & CEO of Bedminster, New Jersey-based Peapack-Gladstone Bank, a $4.7 billion asset bank, talked about organic growth, while Frank Leto, president & CEO of Bryn Mawr Bank Corp. in Bryn Mawr, Pennsylvania, which has $3.48 billion in assets, explained his approach to growing through a combination of organic growth and targeted acquisitions. His bank has done eight deals in nine years. Juxtaposing their leadership styles reminded the audience that there is not a one-size-fits-all approach to scaling a company.
Having talked with both Kennedy and Leto onstage and off, I’m impressed with their commitment to their teams, communities, investors and clients. Determining the right pay structure for the CEO is not a routine exercise, so I’m sure I’m not the only one apprehensive about the soon-to-be-disclosed CEO-employee pay ratio for public companies. Specifically, this Securities and Exchange Commission (SEC) rule requires companies to include in the proxy statement the median employee’s total compensation, the CEO’s total compensation and the ratio of the two.
I can see the unfortunate headlines in local markets when news comes out. Susan O’Donnell, partner with Meridian Compensation Partners, stressed the urgency for banks to begin the process of collecting relevant data and developing communication plans if they have not already started, given the rule goes into effect for proxies filed in 2018. Don Norman Jr., partner with the law firm Barack Ferrazzano Kirschbaum & Nagelberg in Chicago, worried that this new requirement may inadvertently punish those banks that hire a lot of entry-level positions, as such salaries will increase the ratio.
Another challenge ahead for banks is the need to recruit tech talent. I was a bit perplexed to see that in our audience poll, 44 percent still cite finding commercial lenders as the top recruitment challenge for their banks. I would have thought that tech talent—which received a mere 9 percent of the vote—would have dominated the poll given the accelerating pace of change driven by the digitization of financial goods and services.
Another result that surprised me? Sixty-six percent believe their bank has the right executive-level talent in place to guide the bank’s technology initiatives and implement innovative solutions throughout the organization. Given how much angst exists for the future of banking—and the supposed lack of next generation leadership, 66 percent aren’t worried about having the right people in place at all. It might be true that the current generation of banking executives will be able to lead the way in finding and recruiting new talent, but still, I wonder this may be easier said than done.
Still, I remain optimistic about the future of the banking industry as a whole. This conference has always been a meeting ground for the banking industry’s key leaders to meet, engage with one another and learn. Indeed, most of the speakers talked about culture and growth along with compensation, recruitment, training and development. Programs like these help bank officers and directors to think about the challenges ahead and how they might solve them. While sunny days will not be on every day’s outlook, I do sense a true note of optimism.
The post-recession world has created a series of new challenges for community banks, including declining margins, rising loan-to-deposit ratios and loan concentration issues. The economic climate has made it nearly impossible for banks to work through these issues through traditional means such as organic growth.
And despite what most analysts say, community banks will not find earnings relief when interest rates rise. They will instead find more trouble. Different factors influence the rate of recovery after an interest rate trough, including its duration and depth. Deposit volume and rates, existing loan portfolio half-lives, and the expected economic environment and its impact on loan demand must also be weighed.
Community bank balance sheets have been poisoned by loans that were issued in the last decade, and it will take years—not quarters, as in the past—for a normalization period to change this dynamic. Community bank CEOs and boards have limited strategic options to separate themselves from the pack and maximize relative shareholder value.
Normal organic growth will not give community banks sufficient flexibility to adjust the asset portfolio, with the potential rising costs and declining availability of deposits compounding the problem.
The only way management can substantially restructure their asset and liability base is through acquisitions. However, these M&A deals have to be structured to compliment the bank’s asset and liability strengths and weaknesses, using the proper analytics to evaluate the impact on the bank’s existing capital structure. Loan mix, portfolio maturities, fixed versus floating distribution and concentrations are just some of the factors that have to be taken into consideration in valuing both acquirer and target assets.
Properly analyzed and structured M&A transactions can be a very powerful tool in helping community banks overcome their profitability issues and other limitations. But many community banks are making mistakes when it comes to M&A.
Here are six basic rules that should be followed:
Don’t pay attention to investment bankers spouting multiples-of-book suggestions for how much a bank is worth. These change based on expected market conditions, with multiples declining in strong expected operating markets and increasing in difficult pro forma market environments. Furthermore, every bank for sale has a different value proposition for each individual buyer. This value proposition is a function of how the target’s unique asset and liability mix strengthens and weakens the acquirer’s unique asset and liability mix, as well as its eventual pro forma profitability.
Don’t focus your pre-due diligence analysis on traditional financial and operating accounting statements and extrapolated financials derived from these statements. Traditional financial statements are accounting translations of raw bank data that meet certain required reporting guidelines. While they might be an excellent summary of monthly, quarterly or annual performance, they lack the critical vintage information embedded in different layers of loans that directly affect their pro forma risk, return and maturity schedules.
Don’t wait for deals to be delivered to your doorstep, generally in the form of auctions. The probability of finding the right deal and winning the auction at a reasonable price is extremely low. The time resources that are committed to these unsuccessful and questionable bids can be easily spent in more productive directions. Instead, take a proactive approach that evaluates all banks within the acquirer’s desired geographic footprint, which can be far less time-consuming and far more effective in identifying the ideal target consistent with the bank’s own operating performance and financial strength.
Do evaluate every acquisition against the baseline of equivalent organic growth and its impact on shareholder value. Without this baseline, even a reasonably accurate estimate of impact on shareholder value is a time-wasting exercise in number crunching. Comparing the value of transactions of different sizes can only be done consistently against an equivalent organic growth baseline.
Do compartmentalize the value proposition of a target into the value of loans, value of deposits, value of existing excess/deficit capital and so on. Some of these value propositions are directly incremental to the purchase value, such as loan portfolios with their inherent pro forma yields and maturities; others indirectly contribute to value by eliminating operating constraints such as low loan-to-deposit ratios and high commercial real estate concentrations. Categories that contribute to value by eliminating operating constraints have to be evaluated in the context of the bank’s strategic plan and its ability to capitalize on these reduced constraints.
Do focus on regulatory capital adequacy, both pre-and post-acquisition, to ensure that there are no unpleasant surprises as the target is consolidated into the acquirer’s operations. A fairly meaningful portion of the purchase price can be affected negatively or positively by the target’s existing capitalization.
For most banks, organic growth comes from loans. Commercial real estate (CRE) lending is the top source for loan growth, according to the executives and board members responding to Bank Director’s 2015 Growth Strategy Survey. With financial institutions continuously looking for organic growth opportunities, Bank Director asked our program members: “How has your bank’s commercial real estate lending strategy changed or evolved for your institution in recent years?”
Here is a selection of their responses.
“Our CRE strategy remains in place in that we seek opportunities that fit within our risk appetite. We have evolved in that we are adding talent to the organization for commercial & industrial (C&I) banking as well as specialty finance. This broadens our profile and puts less dependency on CRE as the only source of commercial revenue.”
“We are going longer for term loans, focusing more on owner-occupied real estate, and doing employee lift-outs to take advantage of loan officers’ contacts.”
“Our strategies related to commercial real estate lending have evolved over the last five years. We are much more focused today on maintaining more diversity in the portfolio, and paying close attention to concentration levels in the portfolio relating to geography and purpose. We have lowered our ‘hold’ levels significantly, and tend to participate out larger levels of credit exposure to partner banks. We underwrite to stricter standards, including debt service coverage, and very rarely, if ever, approve any policy exceptions.”
“We have not really changed any of our philosophies regarding commercial real estate over the last several years. We do insist on seeing leases for new construction of strip centers that will show a minimum of 75 percent occupancy to start. Owner-occupied [real estate] requires a lower loan-to-value [ratio].”
“One thing we have not done in order to grow our CRE portfolio is compromise our underwriting standards. Two strategic things we changed is [to] raise our self-imposed lending limit, and how we aggregate relationships with similar ownership. Both of these changes provide us with a greater ability to meet the borrowing needs of commercial customers, reduce our outbound participation activity and provide growth in the portfolio.”
“The bank whose board I sit on hasn’t changed much, other than adding a new business line, quick-service franchise restaurant financing. Our focus is still on relationships, which generate core deposits.”
We hope this spirit of sharing provides insight and value to your bank’s board. If you have a question you need answered, please send your inquiries to [email protected]. We also encourage you to comment below if you would like to share how your bank’s CRE lending strategy has evolved.
Traditional banks, which are typically run by baby boomers and older Gen X’ers, are still trying to figure out the next big generation of consumers.
Sixty percent of bank CEOs and directors responding to Bank Director’s 2015 Growth Strategy Survey, which was sponsored by the Vernon Hills, Illinois-based technology firm CDW, indicate that their bank may not be ready to serve millennials, which this year surpassed baby boomers as the largest segment of the population, according to the U.S. Census Bureau. As digital use increases among an increasingly younger customer base, truly understanding and planning for the digital needs and wants of consumers seems to continue to elude bank boards: Seventy percent of bank directors admit that they don’t even use their own bank’s mobile channel.
Bank Director contacted chief executive officers, chairmen, independent directors and senior executives of U.S. banks with more than $250 million in assets, to examine industry trends regarding growth, profitability and technology. Responses were collected online and through the mail in May, June and July, from 168 bankers and board members.
Instead of millennials, banks have been finding most of their growth in loans to businesses and commercial real estate, which is their primary focus today. Loan volume was the primary driver of profitability over the past 12 months for the institutions of 88 percent of respondents, and the majority, at 82 percent, expect organic loan originations to drive future growth at their institutions over the next year. Eighty-five percent see opportunities for growth in commercial real estate lending, and 56 percent in commercial & industrial (C&I) lending. Total loans and leases for the nation’s banks grew 5.4 percent year over year, to $8.4 trillion in the first quarter 2015, according to the Federal Deposit Insurance Corp.
Despite the rise of nonbank competitors like Lending Club and Prosper in the consumer lending space, just 35 percent of respondents express concern that these startup companies will syphon loans from traditional banks. Just 6 percent see an opportunity to partner with these firms, and even fewer, 1 percent, currently partner with P2P lenders to expand their bank’s portfolio. Few respondents—13 percent—see consumer lending as a leading avenue for loan growth.
Other key findings:
Forty percent of respondents worry about potential competition from Apple. Just 18 percent indicate their bank offers Apple Pay, with 63 percent adding that they “don’t think our bank is ready” to offer the feature to their customers.
More boards are putting technology on their agendas. Forty-five percent indicate their board discusses technology at every board meeting, up 50 percent since last year’s survey. Almost half of respondents say their board has at least one member with a technology background or expertise.
More than three-quarters indicate plans to invest more in technology within their bank’s branch network.
More than 80 percent of respondents indicate that their bank’s mobile offering includes bill pay, remote deposit capture and account history. Less common are features such as peer-to-peer payments, 28 percent, or merchant discounts and deals, 9 percent, which are increasingly offered by nonbank competitors.
For 76 percent of respondents, regulatory compliance causes the greatest concern relative to the growth and profitability of their institutions, and 64 percent say the high cost of regulatory compliance had a negative impact on their bank’s profitability over the past 12 months. Low interest rates, for 70 percent, were also a key impediment to profitability.