Improving Shareholder Liquidity, Employee Performance through ESOPs


ESOP-6-18-19.pngMost banks face challenges to find, incentivize and retain their best employees in an increasing competitive market for talent. Often, smaller banks and banks structured as Subchapter S corporations have the added challenge of providing liquidity for their shareholders and founders. An employee stock ownership plan can be an excellent tool for addressing those issues.

An ESOP creates a buyer for the bank’s stock, generating liquidity for shareholders of private or thinly traded banks and providing market support for publicly traded ones. An ESOP’s buying activity can reduce shares outstanding and increase a bank’s earnings per share. It can also increase employee benefits and gives them a sense of ownership that can improve recruitment, retention and performance.

ESOPs are tax-qualified defined contribution retirement plans for employees that primarily invest in employer securities. ESOPs offer accounts to employees, similar to 401(k) retirement plans. But unlike a 401(k), employees do not contribute anything to the plan; instead, the bank makes the contribution on their behalf.

ESOPs are an excellent employee benefit and a recruitment, retention and performance tool. ESOPs do not pay taxes on an annual basis, so taxes are deferred while the stock remains in a plan. When the employee retires or takes a distribution from the plan, the value of the distribution is taxed as ordinary income. Employees also have the ability to roll over the distribution to an individual retirement account.

Employees at companies that offer an ESOP have, on average, 2.6 times more in retirement assets than employees working at companies that do not have an ESOP, according to the National Center for Employee Ownership. Additionally, companies with broad-based stock option plans experienced an increase in productivity of 20 percent to 33 percent above comparable firms after plans were implemented. Medium-sized companies saw gains at the higher end of the scale. Employee ownership is also associated with higher rates of employee retention. According to a survey by the Rutgers University’s NJ/NY Center for Employee Ownership, workers at employee-owned companies are less likely to look for other jobs and more likely to take action when co-workers are not working well.

There are a couple of different ways that banks can establish ESOPs. The simplest and most efficient is called a non-leveraged ESOP, where the bank or holding company makes a tax-deductible cash contribution. The contribution can be in stock or cash and is recorded as compensation expense. If the bank contributes cash, those funds can be used to purchase stock directly from shareholders and create liquidity and demand in the stock. However, it can take years for a non-leveraged ESOP to accumulate a significant enough position to make a meaningful difference to a bank.

The other method, called a leveraged ESOP, uses a bank’s holding company to lend money directly to the ownership plan. The holding company is required because banks are not permitted to lend directly to the ESOP or guarantee a loan made to the ESOP. The holding company can use cash on its balance sheet, borrow it from a third-party lender or guarantee a third-party loan made directly to the ESOP. The ESOP uses the funds to purchase a large block of non-issued shares from the holding company or directly from shareholders. Although leveraged ESOPs have higher costs and complexity, they can make an immediate, meaningful difference in liquidity and employee benefits. This approach also has the benefit of increasing earnings per share upfront, since the shares underlying the ESOP loan to make the purchase are not considered outstanding. However, the repurchased shares negatively impact tangible common equity and tangible book value.

An ESOP can help the right bank accomplish many of its goals and objectives. Banks should carefully review their goals and objectives with qualified professionals that know and understand both the ESOP and commercial bank industries.

12 Questions Directors Should Ask About New Bank Activities


governance-3-18-19.pngA bank’s board of directors must answer to a variety of constituencies, including shareholders, regulatory agencies, customers and employees. At times those constituencies may have competing interests or priorities. Other times, what may appear to be competing interests are actually variations of aligned interests.

One area where this is particularly true is the board’s responsibility to strike the right balance between driving revenues and ensuring the bank adheres to its risk appetite established as part of its enterprise risk management framework.

The failure to strike this proper balance can be devastating to the institution, and if widespread, could result in consequences across the entire industry, such as the 2008 financial crisis. As technology and innovation accelerate the pace of change in the banking industry, that balance will become more critical and difficult to manage. And as banks explore ways to increase profits and remain competitive, especially with respect to noninterest income, bank directors will need to remain diligent in their oversight of new bank activities.

Regulators have offered guidance to bank boards on the subject. For example, the Office of the Comptroller of the Currency (OCC) issued a bulletin in 2017 that defines “new activities” to include new, modified, and/or expanded products and services and provide guidance related to risk management systems for new activities. While it is management’s role to execute strategy and operate within the established risk appetite on a day-to-day basis, the board’s role is to oversee and evaluate management’s actions, and the board should understand the impact and risks associated with any new activities of the bank.

To exercise this responsibility, directors should challenge plans for new activities by posing the following questions to help them determine if the proper risk approach has been taken. Questions may include:

  • Does the activity align with the bank’s strategic objectives?
  • Was a thorough review of the activity conducted? If so what were the results of that review and, specifically, what new or increased risks are associated with the activity, the controls, and the residual risk the bank will be assuming?
  • Is the associated residual risk acceptable given the bank’s established risk appetite?
  • Is the bank’s infrastructure sufficient to support the new activity?
  • Are the right people in place for the activity to be successful (both the number of people required and any specific expertise)?
  • Are there any new or special incentives being offered for employees? If so, are they encouraging the correct behavior and, just as importantly, discouraging the wrong behavior?
  • What are the specific controls in place to address any risks created?
  • How will success be measured? What reporting mechanism is in place to track success?
  • Will there be any impact on current customers? Or in the case of consumers, will there be any disparate impact or unfair or deceptive acts or practices (UDAAP) implications?
  • What third parties are required for successful implementation?
  • What limits on the amount of new business (concentration limits) should be established?
  • Are the applicable regulators aware of the bank’s plans, and what is their position/guidance?

These threshold questions will assist directors in becoming fully informed about the proposed new activities, and the answers should encourage follow up questions and discussions. For example, if third parties are necessary, then the focus would shift to the bank’s vendor management policies and procedures. Discussions around these questions should be properly documented in the meeting minutes to evidence the debate and decision-making that should be necessary steps in approving any new bank activity.

If these questions had been posed by every bank board contemplating the subprime lending business as a new activity, it may have averted the challenges faced by individual banks during the financial crisis and lessened the impact on the entire industry.

In the future, if boards seek the answers to these questions, the following discussions will help ensure directors will give thoughtful consideration to new activities while properly balancing the interests of all of their constituencies.

Should 1,900 Banks Restructure After Tax Reform?


strategy-2-18-19.pngOne of the big story lines of 2018 was tax reform, which should put more money in the pockets of consumers and businesses to grow, hire, and borrow more from banks.

Shareholders of Subchapter-S banks may ask whether the benefits of Sub-S status are as meaningful in the new tax environment. Roughly 35 percent of the 5,400 banks in the U.S. are Subchapter-S corporations, and given the changes brought by the Tax Cuts and Jobs Act, some choices made under the prior tax regime should be revisited.

Prior to tax reform, the benefits of Sub-S status were apparent given the double taxation of C-Corp earnings with its corporate tax rate of 35 percent, plus the individual dividend tax rate of 20 percent. That’s compared to the S-Corp, which only carried the individual income tax rate up to 39.5 percent.

Tax reform lowered the C-Corp tax rate to 21 percent, lowered the maximum individual rate to 37 percent, and created a potential 20 percent deduction of S-Corp pass-through earnings, all of which make the choice much more complicated.

Add complexities about how to calculate the 20 percent pass-through deduction on S-Corp earnings, the 3.8 percent net investment income tax on C-Corp dividends and some S-Corp pass-through earnings, and it becomes more challenging to decide which is best.

Here are some broad concepts to consider:

  • S-Corp shareholders are taxed on the corporation’s earnings at the individual’s tax rate. If the corporation does not pay dividends to shareholders, the individual tax is being paid before the individual receives the actual distribution. 
  • The individual tax on S-Corp earnings may be mitigated by the 20 percent pass-through deduction allowed by the IRS, but not all the rules have been written yet. 
  • A C-Corp will pay the 21 percent corporate tax, but individual tax liability is deferred until shareholders are paid dividends. The longer the deferral, the more likely a C-Corp structure could be more tax efficient.

The impact of growth, acquisitions, distributions, and capitalization requirements are interrelated and critical in determining which entity makes the most sense.

If a bank is growing quickly and distributing a large percentage of its earnings, its retained earnings may not be sufficient to maintain required capital levels and may require outside capital, especially if the bank is considering growth through acquisition. Because an S-Corp is limited in the type and number of shareholders, its access to outside capital may also be limited, often to investments by management, board, friends, family and community members.

A bank with little or no growth may be able to fully distribute its earnings and still maintain required capital levels. Depending on the impact of Internal Revenue Code Section 199A, state taxes, the 3.8 percent net investment income tax and other factors, Subchapter S status may be more tax efficient.

Section 199A permits the deduction of up to 20 percent of qualifying trade or business income and can be critical to determining whether Subchapter-S makes sense. For shareholders with income below certain thresholds, the deduction is not controversial and can have a big impact.

For shareholders with income above the thresholds, the deduction could be limited or eliminated if the business income includes specified service trade or business income, which includes investment management fees and may include trust and fiduciary fees and other non-interest income items.

S-Corp structures can be terminated at any time. If your bank is a C-Corp and considering a Subchapter S election for the 2019 calendar tax year, the election is due on or before March 15, 2019.

Given the level of complexity and amount of change brought about by the new tax legislation, it is clear that that decisions made under the old rules should be revisited.

Balancing the Relationships of Constituents


investor-1-16-19.pngOftentimes, as supporters of community banks, we can perceive an inquiring shareholder might not favor the bank remaining independent. But there are times when this perception might be warranted.

Shareholders, in the end, are still people. Though they align into different groups with different interests, people are ultimately in charge. Often, it is a misunderstanding of the role of management and the board, the bank’s role, the shareholder’s role, and the goals and objectives of each that cause distractions.

Here are several points to consider.

Management and the board
Management must understand that they work for the board. The board works for the shareholders. The amount of influence any board can have is directly correlated to its collective ownership of the company. Without a meaningful stake, outside investors will have the most say. If the board doesn’t own 100 percent of the stock, it has a fiduciary duty to the other shareholders. This seems an elementary concept, but if the board and management team don’t really understand the legal and practical implications of ownership and reporting, it can precipitate a communication breakdown and misalignment of interests.

Insiders must align independent shareholders’ interests with their own and avoid setting themselves up for a lifetime job to only serve themselves.

Transparency and communication
Banking is one of the most transparent industries in the U.S., so communicate often with your shareholders. A lack of communication and transparency leads to mistrust and misalignment of interests. If the bank is private, then a quarterly newsletter with summary financials should be included, along with book value per share and market value per share, if known or done by a third party. At minimum, book value per share should be provided.

Market for stock
If the bank is public, this is not much of an issue, but privately-held banks need a market of some kind. The bank should get a valuation once a year, and engage a third party to make a market in the stock or facilitate communication between shareholders with knowledge of last trades.

Pricing is important. If you have your private bank stock selling for tangible book or less, an enterprising shareholder may seek to put the bank in play for control value.

If the private bank stock is selling at 1.5 to 2 times tangible book value, it makes it much more difficult to put it in play, and most shareholders feel thankful for the rich minority valuation. Valuation can be very important as a strategy for independence.

Types of shareholders
When adding shareholders during a capital raise, consider their investment horizon, type, and propensity for involvement and activism. An ongoing assessment of these qualities is very important.

Generational transfers can change all these goals, and if the bank’s management and board are not prepared for these different investment goals, it can be a shock.
Private equity funds are short term, focused on internal rate of return (IRR) and controlling, or at least heavily involved, as investors. Some institutional investors are passive and long term. Some are very familiar with long-term community bank investing, and some are not.

Local, long-term community-based individuals can make wonderful investors but can present problems as well. A good investment banking advisor will categorize these diverse investor types and offering type situations, and analyze them with the bank.

Inquiring shareholders
When a shareholder asks about performance, liquidity or selling the bank, your first reaction is key to setting the tone. You should always take a meeting, listen and politely consider your response.

This will probably be a two-meeting process. Two things to make certain: Don’t bring your lawyer and investment banker to the initial meeting, and certainly don’t ignore the shareholder.

Bringing the bank’s lawyer and investment banker, and ignoring the shareholder are two responses by management teams and boards that have things to hide. Attorneys and investment bankers may provide you counsel and advice but need not participate in the initial meeting.

The bottom line
Hold an annual or semi-annual meeting at your bank to address potential shareholder issues. Frequently, too little importance is placed on all constituent groups involved in the success of the bank and its future.

The management team and the board can and should be steering toward a successful future for their bank, and doing so with satisfied shareholders.

More Banks Want To Sell For This Reason


liquidity-1-14-19.pngPeople often ask what are the main factors that are motivating banks to sell. Not surprisingly, sellers frequently cite a lack of succession planning, a lack of scale and increasing costs for technology and compliance.

But one surprising area that is becoming more influential is shareholder liquidity, now more often the primary factor we see pushing institutions to sell.

For many banks, the age of their average shareholder is approaching or exceeds 70. This leads to three primary challenges:

  • As shareholders pass away, the personal representative often needs to liquidate shares in order to settle the estate. If the issuer can’t provide a source of liquidity, the estate will “dump” the shares, sometimes at a steep discount.
  • Other shareholders are engaged in estate planning and seeking to sell shares.
  • Local shareholders are bequeathing shares to children and grandchildren spread all over the country who have no commitment to the community or desire to hold shares in the local bank.

There are also de novo banks whose investors bought in during the late 1990s and early 2000s with the promise of a 10- to 15-year time horizon. They are 20 years older and eager for a liquidity event.

There are many tools institutions can use to provide shareholders with increased liquidity, including:

1. Matching Programs. Some of our clients keep “interested purchaser” and “interested sellers” lists, in order to help match prospective buyers and sellers. This can be a simple way to help shareholders find an avenue for sale. If a shareholder asks for help in selling their shares, you can provide them with a list including the contact information of interested purchasers.

There are important considerations when administering a matching program. You will want to (1) avoid activity that would require registration with the SEC as a broker-dealer, and (2) make sure you, as the issuer, are not seen as “offering” the shares. To mitigate those risks, you should play a very limited role in any matching transaction. You should not negotiate, offer opinions, handle transaction money, or actively promote the service or solicit customers. You may, however, provide certain limited information and make shareholders aware of the service.

2. Repurchase Programs. Repurchase programs can take many forms, but the two most common are buyback programs and tender offers. With a buyback program, the board adopts a policy authorizing the company to repurchase shares within certain parameters. You may then inform shareholders of the program, but you may not actively solicit shareholders to participate in the program. Alternatively, a tender offer is an active solicitation whereby you ask a shareholder to make an investment decision in a limited amount of time. Furthermore, a tender offer is often more successful because it is “easy.” A shareholder simply needs to accept the issuer’s offer and doesn’t need to engage in negotiations with the company or other unfamiliar shareholders. Tender offers also allow the issuer to target strategic goals, such as offering redemption to small shareholders or out-of-state shareholders.

There are certain bank regulatory considerations involved with any share buyback or redemption transaction. In addition, specific securities laws and requirements apply to tender offers.

3. Transfer Services. Legislation enacted in recent years (the JOBS Act and the FAST Act) allows the use of a third-party online platform to implement certain securities transactions. By using a third-party platform, you can remain involved and offload most of the compliance risk to the vendor. Such platforms can often act as a white-labeled bulletin board for your shareholders to interact.

4. Listing. There are always the options of listing your securities over-the-counter (or OTC), on the recently-created bank-specific OTCQX, or going public and listing your shares on NASDAQ or NYSE.

To fund some of the repurchase initiatives identified above, some banks have successfully raised new capital from community members and customers, many of whom have not had the opportunity to invest in the bank. When a repurchase program is coupled with an offering, several banks have successfully “recycled” their shareholder base, buying time to execute their strategy without the added pressure of liquidity concerns.

There are a lot of options to consider, but community bank executives and boards should be aware of the increasing challenge shareholder liquidity is presenting to their peers and how to manage it proactively.

The Three M&A Virtues of M&T


merger-1-4-19.pngM&T Bank Corp.—the $117 billion asset bank holding company headquartered in Buffalo, New York—is well-known for its disciplined approach to M&A, a strategy that has served the big regional bank well through the 18 whole-bank acquisitions it has made since 1987.

Its most recent deal, which closed in November 2015, was also its biggest—the purchase of Hudson City Bancorp, a Paramus, New Jersey-based regional thrift that expanded M&T’s reach in New Jersey, Connecticut and parts of New York City, adding $37 billion in assets and $18 billion in deposits.

The well-priced deal led to M&T’s first-place tie with Phoenix, Arizona-based Western Alliance Bancorp. for the Best M&A Strategy in Bank Director’s 2019 RankingBanking study.

Given M&T’s three decades of successful deals, Bank Director interviewed M&T Chief Financial Officer Darren King to explore the bank’s philosophy around M&A. He says three values drive its M&A strategy.

The first—and perhaps most important value—is patience. Put simply, if a deal doesn’t align with M&T’s strategy, it won’t happen.

“We’ve never been a bank that’s been interested in growth just for growth’s sake,” says King. M&T is laser-focused on getting a return on the dollars invested, whether that’s for an acquisition, an investment in technology or any other investment made to grow and improve the business.

“Our job is to provide our shareholders with a better-than-average return on their investment,” says King. That focus on returns—rather than chasing growth—yields the discipline the bank needs to execute on its strategy.

Part of that patience means the bank will wait for the right partner—one that is committed to the long-term success of the deal. This is the second value that drives dealmaking at M&T.

“One of the places that helps you earn that return [on investment] is the price that you pay,” says King. Committed partners tend to hold to a more long-term view on that point. “Our hope is that anyone who is a willing partner—which is precondition for us for the combination—would like to be paid in our stock, and therefore the price [paid] isn’t necessarily a reflection of the value that would be created for both [entities’] shareholders by putting the two organizations together.” A lower price in a successful transaction will have a positive impact on M&T’s stock—which benefits the seller as a stockholder.

Having so-called skin in the game by taking stock in the transaction also represents a commitment from the seller that the acquired bank’s management team will stay on board to ensure the future success of the merged entity—and raise the value of the stock.

“They don’t want someone to sell their bank to M&T, and go away and retire,” says Brian Klock, a managing director at Keefe, Bruyette and Woods, who covers M&T. “They want to have those local managers and executives that will make a difference and be the M&T leader in that market, so they want those executives to stay around. If they take M&T stock and don’t take as big a price, that’s a commitment from the bank that’s selling to them.”

The final value for M&T is its consideration for the size and location of the target.

“We’re cautious not to go too big, because then it increases the risk,” says King. Integrating a large deal can get out of hand if a bank bites off more than it can chew. But a deal can’t be too small either, he says, because some of the risks related to integration and conversion aren’t scalable. “If you’re going to take on that risk, it needs to be worth the trip,” King says.

M&T also prefers in-market deals or locations in contiguous markets, where its brand is well known.

Outsiders may see M&T as a bank focused on price, but that’s not the case, says King. “If you look at our history, people would describe us as focused on price, and we buy troubled assets,” he says.

Economic downturns tend to yield troubled franchises with strong long-term potential. Having the discipline to focus on long-term returns—not just price—puts M&T in a position to take advantage of opportunities in the marketplace. M&T scooped up four banks—totaling more than $10 billion in assets—from late 2007 through August 2009. It gained another $10.8 billion through its acquisition of Wilmington Trust in May 2011.

It’s often said the best deal is the one you don’t make. By making deals that adhere to three key M&A virtues—patience, focusing on in-market targets that are the right size, and finding a committed partner—M&T’s disciplined approach has served it well.

The New Philosophy That’s Catching on With Banks


customer-12-21-18.pngBankers are right to be concerned that Amazon will one day emerge as a competitor in the financial services industry, but that shouldn’t stop banks from stealing a page from the ecommerce company’s playbook.

Banking is a relationships business. For ages, banks have tried to leverage that relationship to grow and maximize shareholder return.

Some of the ways they’ve done so seem antiquated now, like giving away toasters to anyone that opens a checking account. But the underlying logic remains sound.

That’s why many top banks are now starting to think more like Jeff Bezos, Amazon’s chairman and CEO.

In 1997, the year Bezos wrote his first shareholder letter, he cycled through the usual subjects, boasting about growth and maximizing the return for shareholders. But he also talked about the long game Amazon would play by eschewing even faster growth and profitability by instead focusing “relentlessly” on customers.

We have invested and will continue to invest aggressively to expand and leverage our customer base, brand, and infrastructure as we move to establish an enduring franchise,” he wrote in his inaugural letter.

Why? Because Bezos wanted Amazon to be engrained in people’s lives, far more than just the books they were getting 20-some years ago.

“Because of our emphasis on the long term, we may make decisions and weigh tradeoffs differently than some companies,” Bezos wrote, noting that Amazon’s first and foremost priority would be serving customers, not buckling under pressure from Wall Street.

Two decades later, everything Amazon does is driven by what the “divinely discontent” customer wants, which they learn through data collection and analysis. And as a result, Amazon has become an integral part of many consumers’ lives.

“I sense that the same customer empowerment phenomenon is happening broadly across everything we do at Amazon and most other industries as well. You cannot rest on your laurels in this world. Customers won’t have it,” Bezos wrote two decades later in his 2018 shareholder letter.

It’s this relentless, single-minded drive to satisfy customers that banks are beginning to adopt, especially when it comes to serving customers over digital distribution channels.

Many banks have modernized their digital offerings to attract digitally savvy customers. An ancillary benefit is that the interactions conducted over these channels generate immense amounts of valuable data. It’s be effectively using this data that banks can build out an Amazon-like experience.

Brian Moynihan, CEO of Bank of America, recently explained to Bank Director the value of that data, and also how the $2 trillion bank can leverage it to improve customers’ experience: “We know that customer better than everybody else, because we’re seeing everything they do.”

Another bank doing this is Citizens Bank, a New England-based bank with $155 billion in assets. Citizens CEO Bruce Van Saun talked his focus on customers at the Wharton Leadership Conference this summer.

This focus is behind the bank’s decision to launch its digital offshoot, Citizens Access. It has also informed how they think and obsess over—what else—data. Van Saun said it allows them to leverage it in “moments of truth” for customers that the bank knows better than anyone.

“Citizens is doing this through an intense focus on ‘customer journeys’ – transforming the way we engage with customers at critical moments so that they are compelling, differentiated, personalized and highly user-friendly. This process starts with putting the customer – not the organization – at the center.”

Sounds an awful lot like Bezos and Moynihan. It also sounds a lot like “The Law of The Customer,” a theory discussed in Stephen Denning’s book, “The Age of Agile.”

Denning discusses a “Copernican revolution” of management that puts the customer at the center, rather than the firm. Nicolas Copernicus, of course, was first with the theory the Earth revolved around the Sun, not vice versa, a blasphemous idea in the 16th century.

What that means is delivering things like delight, enthusiasm and passion instead of products or services.

This requires a cultural transformation at organizations, Denning argues, and especially at banks that have long been driven by traditional metrics.

That is where not just the CEO, but the entire C-suite, comes in.

“If the drive to delight customers comes from the CEO alone, or from the bottom alone, the firm is lost,” Denning writes.

Most banks don’t have the manpower or capital to invest in tech capabilities like the biggest banks, but many are now realizing they do have the most prized collection of data about their customers.

That data can be leveraged, and it’s data that would make Bezos even more obsessed than he already is about customers.

Twelve Steps for Successful Acquisitions


acquisition-11-21-18.pngOftentimes bankers and research analysts espouse the track records of acquisitive banks by focusing on the outcomes of transactions, not the work that went into getting them announced. As you and your board consider growing your bank franchise via purchases of, or mergers with, other banks, consider these steps as a guideline to better outcomes:

  1. Prepare your management team
    Does your team have any track record in courting, negotiating, closing and integrating a merger? If not, perhaps adding to your team is warranted.
  2. Prepare your board
    Understand what your financial goals and stress-points are, create a subcommittee to work with management on strategy, get educated about merger contracts and fiduciary obligations.
  3. Prepare your largest shareholders
    In many privately held banks there are large shareholders, families or individuals, who would have their ownership diluted if stock were used as currency to pay for another bank. It is important to get their support on your strategy as the value of their holdings will be impacted (hopefully positively) by your actions.
  4. Prepare your employees 
    While you cannot be specific about your targets until you need to broaden the “circle of trust,” let key employees know that their organization wants to grow via purchases. They will deal with the day-to-day reality of integration, get them excited that your organization is one they want to be with long-term.
  5. Prepare your counsel
    Just as some bankers focus on commercial or consumer loans, some law firms focus on regulatory matters, loan documents or corporate finance. Does your current counsel have demonstrated experience in merger processes? In addition, your counsel should help to educate your Board about the steps required to complete a transaction.
  6. Prepare the Street
    We have seen in recent months several large bank acquisitions announced where the market was unpleasantly surprised; a bank they viewed as a seller suddenly became a buyer. Some of these companies have since underperformed the broader bank market by 5 to 10 percent. If it has been several years between acquisitions, prep the market beforehand that you might resume the strategy. BB&T recently laid parameters for going back on the acquisition trail. And while their stock was down some on the news, it has since more than recovered.
  7. Prepare your IT providers 
    Most customers are lost when you close your transaction by the small annoyances that come with a systems conversion. Understand if your current core systems have additional capacity or begin to get systems in place that can grow as you grow.
  8. Prepare your regulator(s)
    Whether it is the state, the FDIC, OCC or the Fed, they generally do not like surprises. Get some soft guidance from them on their expectations for capital levels and growth rates. Before you formally announce any merger, with your counsel, give the regulators a courtesy heads-up.
  9. Prepare your rating agency
    If you are a rated bank, think about your debt holders as well as equity holders, especially if you need access to acquisition financing. Share with them the broad plan of growth and your tolerances for goodwill and other negative capital events.
  10. Prepare your financing sources
    Do you have a line-of-credit in place at the holding company that could be drawn to finance the cash portion of acquisition consideration? Have you demonstrated that you can fund in the senior or subordinated debt markets, perhaps by pre-funding capital? Are there large shareholders willing to commit more equity to your strategy?
  11. Prepare your targets
    If the Street does not know, and your shareholders do not know, and your bankers and lawyers do not know, then the targets you might have in mind also will not know you are a buyer. Courting another CEO is a time-consuming process, but completely necessary and should be started 12-18 months before you are in the position to pull the trigger. Your goal is to be on their “A” list of calls, and have the chance to compete, either exclusively or in a controlled auction process.
  12. Prepare to walk away 
    After you have done all this work, it is easy to get “deal fever” when that first process comes along. Sometimes you need to recognize it is a trial run for the real thing and be prepared to pack your bags and go home. The best deal most companies have ever done is the one they didn’t do.

Three Lessons for Bankers From Warren Buffett


strategy-11-16-18.pngIt’s reasonable to argue that the greatest banker in the United States today isn’t a banker at all—he’s an insurance guy.

You might have heard of him.

Warren Buffett.

As the chairman and CEO of Berkshire Hathaway, an insurance-focused conglomerate based in Omaha, Nebraska, Buffett oversees one of the largest portfolios of bank investments in the country.

Berkshire owns major stakes in a Who’s Who list of historically high-performing banks:

  • 9.9 percent of Wells Fargo & Co. 
  • 6.8 percent of Bank of America Corp.
  • 6.3 percent of U.S. Bancorp
  • 5.3 percent of The Bank of New York Mellon Corporation
  • 3.7 percent of M&T Bank Corp.

That Buffett made such substantial investments in banks isn’t a coincidence.

If there are two things he appreciates at a visceral level, owing to his experience in insurance, it’s leverage and cycles—the same two qualities that make banking so unique.

This is why it’s worth listening to Buffett when he opines on banking, as he often does in his annual letters and media interviews.

This is from his 1991 shareholder letter:

“When assets are 20 times equity—a common ratio in [the bank] industry—mistakes that involve only a small portion of assets can destroy a major portion of equity. And mistakes have been the rule rather than the exception at many major banks. Most have resulted from a managerial failing that we described last year when discussing the ‘institutional imperative:’ the tendency of executives to mindlessly imitate the behavior of their peers, no matter how foolish it may be to do so.”

Buffett is referring to the havoc wreaked on banks during a pronounced downturn in commercial real estate in the early 1990s, when Berkshire bought 10 percent of Wells Fargo.

His point is that it’s critical for bankers to maintain discipline, especially when all of those around you are not.

Another thing Buffett talks about a lot is competitive advantage.

Here he is in a 2009 interview with Fortune:

“If you’re the low-cost producer in any business—and money is your raw material in banking—you’ve got a hell of an edge. If you have a half-point edge . . . half a point on $1 trillion is $5 billion a year.”

And here‘s a selection from his 1987 shareholder letter flushing out the idea more fully, though in the context of the insurance industry, which faces nearly identical competitive dynamics to banking:

“The insurance industry is cursed with a set of dismal economic characteristics that make for a poor long-term outlook: hundreds of competitors, ease of entry, and a product that cannot be differentiated in any meaningful way. In such a commodity-like business, only a very low-cost operator or someone operating in a protected, and usually small, niche can sustain high profitability levels.”

One nuance about efficiency in banking is it doesn’t just boost profitability directly by freeing up more revenue to fall to the bottom line; equally important is its indirect effect.

This is a point U.S. Bancorp’s chairman and CEO Andy Cecere made in a recent, albeit unrelated, interview about the bank with Bank Director.

Efficient banks needn’t stretch on credit quality to generate satisfactory returns, which reduces loan losses at the bottom of the credit cycle, Cecere says. And as a corollary, efficient banks can compete more aggressively for the most creditworthy customers, further limiting credit losses in tough times.

It isn’t a coincidence, in turn, that U.S. Bancorp has consistently been one of the industry’s most efficient banks and disciplined underwriters since its transformative merger nearly two decades ago.

And while neither Buffett nor his philosophy came up during the interview with Cecere, Berkshire Hathaway is one of U.S. Bancorp’s biggest shareholders.

A final lesson about banking that can be gleaned from Buffett involves his approach to mergers and acquisitions.

Buffett has said repeatedly in the past that he’d rather pay a fair price for a wonderful company than a wonderful price for a fair company. Also, all things being equal, Buffett has always preferred for existing management to stay and continue on their path of success.

“Because leverage of 20:1 magnifies the effects of managerial strengths and weaknesses, we have no interest in purchasing shares of a poorly-managed bank at a ‘cheap’ price. Instead, our only interest is in buying into well-managed banks at fair prices.”

It’s a style reminiscent of the uncommon partnership approach to mergers and acquisitions used by John B. McCoy, who dined annually with Buffett, to transform the former Bank One from the third largest bank in Columbus, Ohio, into the sixth largest bank in the country, before later merging into JPMorgan Chase & Co.

In short, although it’s true that most people don’t think of Buffett as a banker, that doesn’t mean bankers can’t learn a lot from his observations on the industry.

How To Prepare Compensation Plans For An IPO


IPO-11-5-18.pngThe decision to take your bank public will set the course of your company for years to come. There are several critical steps to prepare your compensation program before the IPO and before your bank is a public company.

Steps to prepare for the IPO

1. Assemble Your Compensation Team
Determine the team focused on compensation matters. If you have employees with IPO experience and compensation plans, they could be a key asset. Similarly, if you have employees without IPO experience but have public company experience, they could be a key team member as well.

2. Create Your IPO-Related Task List
Your bank may have implemented many compensation and governance related items already, but they should be reviewed for their appropriateness for a public company.

Key tasks required prior to the IPO will vary, however, here is a list of compensation tasks on every pre-IPO list.

  • Develop an executive compensation philosophy and key objectives – What is your bank’s strategy? Where do you target compensation? Is your pay aligned with performance? What are the objectives of your compensation program? What message do you want to send to shareholders? Craft overarching guidelines to support the process going forward.
  • Evaluate and establish appropriate executive and director compensation levels – Prior to the IPO, your company will have to disclose its executive and director compensation. You want to be sure your compensation programs are reasonable, competitive, and based on peer group data. Establishing a suitable peer group and incorporating the data into your process is key.
  • Equity plan considerations – Will a new equity plan be required, and when will you need shareholder approval? How will you determine the share pool so long-term incentive and equity grant needs can be met for three to five years? Have you evaluated the shareholder advisory firms’ current standards to receive favorable support? Avoid any pitfalls that would result in a “no” vote recommendation.

    If the company is considering one-time IPO-related equity grants, evaluate these in light of market trends, shareholder expectations, retention concerns, financial impact to the company and dilution. Many institutions consider sizeable one-time grants a front-loaded award, and decide to wait before awarding additional equity. Such decisions are based on share pool impact, financial implications, and size of the one-time grants. Carefully determine the value of these awards to minimize risks of unfavorable optics and legal actions.

  • Design ongoing annual and long-term incentive plans – As a public company, it is important to have annual and long-term incentive plans that align pay and performance, are competitive, consistent with company objectives and provide an appropriate mix of pay. As new incentive plans are designed, know that plan details will be disclosed in future public filings. Private banks are accustomed to implementing plans that are regulatory compliant and competitive, but public disclosure has not been required.
  • Implement executive agreements – In many cases, new employment and change-in-control agreements are put in place, often the case even if similar agreements were in effect before the IPO. Several details, including the terms, are subject to public disclosure. Shareholder advisory firms take issue with certain terms and, and having them can automatically result in ‘no’ vote for Management Say on Pay and the re-election of the board’s compensation committee. It is critical to be aware of these pitfalls and avoid them whenever possible.

3. Determine appropriate technical and governance actions
There are key technical and governance issues to evaluate. Some items are required while others are not. Many are considered best practices and important to achieving strong governance. Some of the key items in this category include:

  • Drafting of the SEC required filings including the CD&A (Compensation Discussion and Analysis), compensation tables and other requirements. Reporting errors and omissions can delay the IPO.
  • Determining company stock ownership guidelines – Many new public banks do not adopt stock ownership guidelines immediately, however, if one-time equity grants are awarded, adopting such guidelines immediately sets the parameters for holding these shares. Determine who will be covered by the guidelines (e.g., executives, Section 16 officers, non-employee directors), what the required holdings are, the timeframe permitted, and other terms.
  • Drafting the Compensation Committee Charter – A charter establishes the role and responsibilities of the committee, how it will interact with the board and management, and its ability to engage outside advisors. The charter is typically published on the company’s website.

4. Create a compensation committee calendar after the IPO
Once the IPO is completed, it is important for the compensation committee to focus on its new role, responsibilities and annual tasks. Setting up a calendar of activities supports effective management and should include all areas of committee oversight.

Taking your bank public can be a very exciting endeavor. Do not underestimate the number of new issues management, the compensation committee and the board will have to become familiar with to complete a successful IPO and operate a public company. Being organized, having the right knowledge and support and a flexible timeline will be great tools to help your organization get through this process.