Sellers: Be Vigilant About Stock in a Deal

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bank-stock-11-10-17.pngThrough the first nine months of 2017, the pace of bank merger and acquisitions has been up slightly from prior years in terms of the number of deals, and the strong performance of bank stocks since the U.S. Presidential election—the KBW Nasdaq Bank Index is up almost 40 percent—has led to an increase in deal prices for bank sellers in 2017. Price to tangible book value for all deals through Sept. 30, 2017, is up approximately 24 percent compared to the same nine-month period in 2016. Although sellers are happy about rising deal prices and bank stocks trading at high levels, they should consider how to protect the value of a deal in an all- or mostly-stock transaction negotiated in the period after the announcement and beyond the deal closing. Here are three considerations for boards and management teams.

1. Use a stock collar.
A stock collar allows the selling institution to walk away from the transaction without penalty, given a change in the buyer’s stock price. A double trigger often is required, meaning an agreed-upon decline in the buyer’s stock price along with a percentage deviation from a set market index. A 15 to 20 percent trigger often is used. The seller may require that a cap be used if a collar is requested. A cap would act in a similar manner as a collar and provide the buyer with the chance to walk away or renegotiate the number of shares should the buyer’s stock increase 15 or 20 percent from the announcement date. While collars and caps often are symmetrical, they do not need to be, and a higher cap percentage can be negotiated. The need for a collar tends to be driven by the buyer’s recent stock trends and financial performance.

2. Consider trading volumes and liquidity in your deliberations.
In an all-stock or a combination stock and cash deal, the seller makes a significant investment for their shareholders in the stock of the buyer. For many shareholders, this represents a significant opportunity for liquidity and wealth diversification. But these goals can be thwarted if the buyer’s stock is not liquid or doesn’t trade in enough daily volume to absorb the shares without detrimental impact. The table below indicates some of the volume and pricing differences between exchanges. The total number of shares to be issued in a transaction should be considered in comparison to the number of shares that trade on a weekly basis.

Exchange Avg Weekly Volume/Shares Outstanding (%) Number of Banks Median Price/LTM Core EPS (x) Median Price/Tangible Book (%) Median Dividend Yield (%)
Grey Mkt 0.00 8 13.60 92.38 2.07
OTC Pink 0.07 433 15.02 109.55 1.79
OTCQB 0.14 36 15.34 130.59 2.00
OTCQX 0.20 76 16.06 126.04 2.00
NASDAQ 1.18 344 19.35 184.02 1.69
NYSE MKT 0.98 6 18.88 197.00 2.10
NYSE 3.10 51 16.40 197.75 1.99

Source: S&P Global Market Intelligence as of Sept. 30, 2017
LTM: Last 12 months

3. Request reverse due diligence.
The larger a seller is in comparison to the buyer and the more stock a seller is asked to take, the more there is a need for reverse due diligence. Boards and management should require the opportunity to dig into the books and records of the buyer, when appropriate, to make sure the stock investment will provide the returns and values promised by the buyer. However, the request for reverse due diligence may be denied if the transaction is fairly small in scale for the buyer or only token amounts of stock are offered.

Reverse due diligence tends to be abbreviated compared to typical due diligence, and it’s more focused on the items that can materially affect stock price. Reverse due diligence tends to focus on items such as earnings and credit performance, regulatory issues that the risk committee is monitoring, pending litigation or other potential unrecorded liabilities, review of board and committee minutes, and dialogue around future performance and initiatives. Also, sellers should review a buyer’s stock characteristics, including reading equity analyst reports, transcripts of earnings calls, conference presentations and other public sources of information that could help to develop a holistic view of how the market might react to the transaction once it’s announced.

While no one can predict what will happen with stock prices over the next 12 months, it does seem that many believe the current run-up in bank stock prices is the result of the general election, the Federal Reserve’s increase in interest rates and expected additional rate increases. Stocks are trading at high levels, but bank sellers still need to be cautious about which stock they take in a deal.

What Makes Activist Investors Go After Banks

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activism-11-6-17.pngShareholders of public companies pushing to nominate activists in the boardroom are becoming more common. Boards of directors aren’t necessarily keen on the idea, although it’s becoming frequent enough that attitudes among board directors are becoming more accepting as they become accustomed to it.

Proxy Access Is Changing Relationships Between Directors and Shareholders
Board directors and shareholders clearly have different motives and perspectives about the demographics of board seats, especially when it comes to their views on proxy access.

Some of the larger public companies use a proxy access system. Companies that use the proxy access system typically have a governance committee or nominating committee that recruits and vets board candidates to fill the slots of board directors whose terms have ended. The board secretary prepares a proxy card with a listing of board director nominees and mails it out to the shareholders. Most share classes offer shareholders one vote per share. Shareholders can then vote for candidates on the slate by proxy or in person at the annual shareholder’s meeting, or write in a candidate of their own choosing. Activist shareholders and large shareholders favor the proxy access system because directors represent their interests and proxy access gives them a strong say in the choice of board directors.

The proxy access system is not as popular with directors as it is with investors. Board directors assess the expertise, talents, diversity and independence of boards when forming the voting slate. Nominating committees feel that they know what the board needs to help the company progress, so they should be able to select the nominees with little or no interference from shareholders.

Activism May Potentially Disrupt the Integrity of Corporate Governance
As activism begins to invade boardrooms, many are questioning other longstanding principles of good corporate governance and whether they still have meaning in today’s financial arena. For example, directors have typically had board terms that are staggered. The reason for this is to maintain some sense of tenure, history and experience on the board. In today’s climate, groups of formidable investors believe that directors should be elected every year. This approach gives shareholders the right to clean house when profit margins are lagging.

In recent decades, it has been common for directors to serve on multiple boards. Changes in the financial industry call into question whether directors who sit on many boards can truly meet the time constraints to effectively strategize and comply with the growing set of regulations. Weak boards create a climate that is ripe for activists to gain control. Large companies are prime targets for activists when they have large boards with weak skill sets and overly long-term appointments.

Procter & Gamble Is the Largest Company to Face a Proxy Fight
Procter & Gamble is one such large company that is facing the possible intrusion of an activist shareholder. Nelson Peltz is the CEO and founder of Trian Fund Management. With 3.3 billion P&G shares, Trian is one of Procter & Gamble’s largest shareholders. Trian has been dissatisfied with Procter & Gamble’s repeated poor returns. Their solution is to nominate and elect Nelson Peltz to the board of directors. As Peltz has a reputation for being a billionaire activist, the P&G board is justifiably concerned.

Trian cites many reasons for putting an activist on the board. In addition to disappointing shareholder returns, Procter & Gamble’s market share is deteriorating, and while they’ve cut some costs, the cost of bureaucracy is excessive.
Trian says that the culture of Procter & Gamble’s board is highly resistant to change, so it’s no surprise that the pressure is making them uneasy. Trian shareholders have given the board chances to improve results in the past, but their strategies have been unsuccessful. Now, Trian is insisting on the addition of a financially motivated, independent director, and they’ve chosen Peltz. Trian shareholders are not being completely unreasonable. They are offering to reappoint whichever director loses his or her board seat, once Peltz gets appointed.

Defending Against Activists
No board is exempt from the risk of a proxy fight, especially when earnings reports are not showing good results. The best defense against activism is to work at keeping performance metrics high. Companies experiencing a downturn for any reason would do well to spend time on researching which activists may have their eyes on a board seat. Knowing who is interested in joining the board will help directors anticipate what the activist wants to change and have some plans in place if a proxy fight looks imminent.

Facing Strategic Anxiety Head On

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Banks need to be more agile to face the challenges in today’s marketplace, and boards and management teams need to focus on strategy more frequently. Brian Stephens of KPMG outlines the strategic issues impacting banks and how they should be addressed by bank leaders.

  • How Shareholder Expectations Have Changed
  • Questions to Ask About the Customer Experience
  • A New Approach to Strategic Planning

Innovation Spotlight: Citizens Bank of Edmond

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citizens-bank.png

Castilla-Jill.pngJill Castilla, President, CEO and Vice Chairman
Citizens Bank of Edmond is a $252 million asset community bank with a rich history spanning 116 years. In 2009, the bank transformed its operations by making critical investments in technology instead of branches. At the helm of this resurgence is Jill Castilla, president, CEO and vice chairman, and also a fourth generation leader and banker at Citizens Bank of Edmond. Castilla is known as an active user of social media, turning critics into brand advocates by staying transparent about changes at the bank and consistently engaging the community for its feedback.

What technology does Citizens Bank of Edmond utilize that youwouldn’t expect at a small community bank?
We strive to be at the forefront of technology to ensure that the bank is relevant today and is positioned to be relevant 116 years from now. We’ve embraced the concept of remote banking: our retail team uses secure Wi-Fi to connect remotely to TellerCapture (a system that enables the imaging and posting of checks at the teller window) and our cash recycler. In 2013, we developed an interactive teller at our ATMs, making us the first bank in Oklahoma to deploy this technology.

One of the biggest changes under your leadership was reducingthe number of branches in the community to just one core branch. As you were conceptualizing this renovation, what technological improvements were a priority?What type of research did you undertake?
We knew we wanted to make Citizens Bank comfortable, approachable and accessible with all of our staff located on the first floor. We also invested in technology infrastructure to handle mobile workstations and utilize a range of products including highly advanced touchscreen kiosks. The bank has collaborative workspaces that allow our team to work easily together in groups or for the community to gather informally. We provide public Wi-Fi for our customers and secure Wi-Fi for our team. Inspiration for our newly renovated lobby sprung from visits to numerous progressive banks across the country as well as hospitality industries, such as hotels and restaurants.

One-third of your bank is owned by the employees. How does that ownership help drive the innovation strategy?
It’s the entrepreneurial spirit. Our team knows that to remain independent for another 116 years we have to stay relevant to our customers and team members. Rewards for employment at Citizens Bank reach far beyond a paycheck—it’s building a legacy that’s accomplished through having premier products, services and customer relationships. It’s about standing the test of time, and improving and maintaining a high level of efficiency in everything we do. Ownership increases peer accountability, and the way we have collaborative work stations allows for the sharpening of the saw. Ideas don’t result from a bureaucratic process, but from teams collaborating to be the best for our customers, shareholders and community.

Should the Wells Fargo Board Resign?

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resign-5-5-17.pngWhat’s the minimum percentage of votes a director should get at the company’s annual shareholder meeting?

At San Francisco-based Wells Fargo & Co.’s recent shareholder meeting held April 25 in Ponte Vedra, Florida, nine of the 15 directors won re-election with less than 75 percent of the vote, even though there were no other candidates. Three of them plus the current chairman, Stephen Sanger, won with less than 60 percent of the vote, following last year’s revelation that thousands of employees had sold customers more than 2 million unauthorized accounts over several years to meet aggressive corporate sales goals. Then-CEO John Stumpf lost his job, and as did Carrie Tolstedt, the head of retail banking.

The question now is whether directors will lose their jobs as well. Sanger acknowledged that the vote last month wasn’t exactly a home run for the board.

“Wells Fargo stockholders today have sent the entire board a clear message of dissatisfaction,’’ he wrote in a statement. “Let me assure you that the board has heard the message, and we recognize there is still a great deal of work to do to rebuild the trust of stockholders, customers and employees.”

There was no word on whether Sanger intends to step down soon, but he did tell reporters after the meeting that he and five other directors would retire during the next four years when they reach the board’s mandatory retirement age of 72. Sanger turned 71 in March.

Directors on other bank boards have taken the hint when shareholder votes showed a loss of confidence. Following JPMorgan Chase & Co.’s London whale trading scandal, two directors stepped down in 2013.

Receiving less than 80 percent of the vote in a no-contest election is a pretty clear sign of discontent, says Charles Elson, a professor of finance at the University of Delaware and the director of the John L. Weinberg Center for Corporate Governance. (He also happens to be a Wells Fargo shareholder.) Most directors garner more than 90 percent of shareholder votes, he adds.

Some of Wells Fargo directors could barely get support from half the shareholders. “The vote is significant,’’ Elson says. “It’s probably time to refresh that board.”

The board’s own conduct may have raised further questions about whether members were fit to meet their responsibilities. A report compiled by Shearman & Sterling LLP, a law firm working for the board, said in April that the board wasn’t aware of how many employees had been fired for sales-related practices until 2016.

The Los Angeles Times first reported on the extent of the problem in 2013 in a series of investigative stories. In 2015, the city of Los Angeles filed a lawsuit against Wells Fargo related to the practices. [For more on how “Wells Fargo Bungled Its Cross-Sell Crisis,” see Bank Director’s first quarter magazine.]

“Sales practices were not identified to the board as a noteworthy risk until 2014,’’ the board’s investigation found. “By early 2015, management reported that corrective action was working. Throughout 2015 and 2016, the board was regularly engaged on the issue; however, management reports did not accurately convey the scope of the problem. The board only learned that approximately 5,300 employees had been terminated for sales practices violations through the September 2016 settlements with the Los Angeles City Attorney, the [Office of the Comptroller of the Currency] and the [Consumer Financial Protection Bureau].”

The report blames senior management, such as former CEO John Stumpf, a decentralized organizational structure and a culture of deference to the business units for missed opportunities in handling the problems sooner.

But the report also notes that the board could have handled things differently, by centralizing the risk function sooner than it did, for example. A decentralized risk framework meant the company’s chief risk officer was reduced to cajoling the heads of the different business units for information, each of whom had their own chief risk officers reporting to them. Also, the board could have required more detail from management.

Wells Fargo has lost unquantifiable sums in reputational costs and damage to its brand. It has paid about $185 million in settlements with regulators and recently paid out $142 million in a class action settlement with customers. It still is grappling with the loss of new customer accounts.

At this point, a board refresh—starting with the directors who polled less than 60 percent of the shareholder vote—might be the right signal to send.

What Directors Can Learn From Stalled M&A Transactions

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transaction-4-20-17.pngBank mergers and acquisition (M&A) announcements are no longer a rarity, with more deal announcements coming every month. But for every successful transaction, another 10 transactions have died or stalled. And sometimes these are the deals that can be most educational for community bankers who want to get into the M&A market. For instance, the following five issues are hampering many would-be deals:

1. Many banks have organically grown themselves out of the M&A market due to concentration issues. One of the most overlooked consequences of aggressive organic growth in a low-rate environment is now becoming clear. Most high-growth banks focused on commercial real estate loans (particularly in urban and suburban markets) have maxed out their concentration levels relative to capital, based on regulatory thresholds. In these cases, regulators will hold pending deals hostage unless the acquiring bank agrees to inject more capital. It’s been reported that New York Community Bank’s failed acquisition of Astoria Financial is an example of high concentrations of real estate loans undoing a deal. One thing that helps: Meet with regulators far earlier in the deal process to check their temperature.

2. Buyer beware: the mortgage banks are coming to market. There are many small banks that depend too heavily on their mortgage business to drive earnings. In some cases, the core bank would not even be profitable without its mortgage arm. As a result of the historically low and prolonged rate environment, mortgage companies have been doing well, particularly with refinancings booming in 2011 and 2012, and home purchases picking up in the years since. However, now that we are transitioning to a new environment with rising interest rates, the situation may change.

Most executives and investors in banks with mortgage companies understand this and are looking to exit. The problem is they want their banks to be valued on their recent earnings. But a buyer is not buying a bank’s recent earnings, it is buying its future earnings. In a rising rate environment, refinancing can dry up, and home purchases won’t be able to make up the difference. Smaller banks with mortgage operations tend to be more heavily skewed toward refinancing than other banks, making them even more vulnerable. As a result, their valuations can be grossly overstated, if these issues are not recognized. When negotiating with such a bank, focus on what percentage of a small bank’s business is refinancing versus home purchases, and what percentage of the cost structure is fixed versus variable. Mortgage bankers also are often cut from a different cloth than commercial bankers, so cultural fit should be scrutinized.

3. A deal that appears to be expensive from a price-to-tangible book value perspective is not as expensive as it appears. Most bank acquisitions are structured as a stock purchase of the holding company’s equity. However, in the vast majority of cases, the only true asset acquired is the subsidiary bank. But there is a big difference between the target holding company’s capital structure and the subsidiary’s capital structure, which too many acquirers are ignoring. Acquisitive banks need to educate their investors on the value of such things as inexpensive trust-preferred securities (TruPS) and debt that may be on the holding company’s books. By assuming TruPS and debt, you are essentially purchasing bank capital at tangible book value. Banks must find hidden value by analyzing in detail the differing capital structures between a target’s parent company and its bank subsidiary.

4. Acquiring a bank with equity can introduce control issues. One problem associated with using equity as a currency for the buyer is the selling bank’s shareholders could own a meaningful percentage of the equity in the buyer. This is far less of an issue if the selling bank’s shares are widely held. However, many community banks, particularly on the small side, are controlled by a single shareholder or family. As a result, this single shareholder could become the largest shareholder in the buyer after the deal, especially if he or she is receiving a significant portion of the purchase consideration in stock. The normal playbook is for this shareholder to agree to certain restrictions related to voting, selling of shares in the open market, and other restrictions.

5. Look for more creative transactions that solve problems. Many banks are struggling with financial issues such as concentration issues, high loan-to-deposit ratios and a compressing net interest margin. Acquisition targets that alleviate these problems may not make immediate sense from a strategic perspective. The targets may not be geographically perfect, perhaps they aren’t adjacent to the acquirer’s footprint, or maybe they’re unattractive from a macroeconomic perspective. However, for the reasons previously mentioned, these targets may actually have premium value to the acquirer. It goes without saying that the acquiring bank’s management must come up with an operational plan to manage execution risk, but these outside-the-box deals often create the most value and lead to cutting-edge strategies that fetch higher premiums from investors in the long term.

Banks Make Changes Following Wells Fargo Crisis

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incentive-12-16-16.pngIt seems almost everyone with a bank account knows the story: a relatively small group of people within a large organization committed fraud by opening unapproved customer accounts in order to earn performance bonuses under a production-based incentive plan. The scandal badly bruised the bank’s stellar reputation, forced the CEO to step down, and resulted in a significant loss of shareholder value, before the election turned the tide for many bank stocks.

It has also prompted a widespread industry examination of retail incentive practices. Whether it is through the OCC’s horizontal review of sales and marketing practices or board requests at smaller community banks, the industry is taking a look at both the cultural aspects of sales expectations and the design and controls of the programs themselves.

In November 2016, Pearl Meyer conducted a survey of actions banks are taking to address the potential issues uncovered by the scandal. This study included 57 respondents representing both small and large institutions across the country. The key outcomes indicate that four out of five banks have had an internal or external inquiry regarding their retail incentive plan practices. Most banks are unlikely to make significant changes to their retail incentive plan design and instead are focusing on communication and training as well as enhanced documentation, controls and monitoring.

The aftermath of the Wells Fargo scandal will be that banks are expected to examine their retail incentive programs and the controls supporting them. To that end, we believe there are five questions that banks should ask and answer with respect to their retail incentive programs.

What does our plan reward? About half of respondents to our bank survey indicated using volume metrics and cross-selling metrics (55 percent and 47 percent respectively), which have been criticized as a part of the scandal. However, few are planning to discontinue these metrics (6 percent to discontinue volume and 4 percent to discontinue cross-selling). Use of either metric may put additional pressure on banks to demonstrate how their controls and administrative procedures curtail fraud or misconduct.

Approximately 70 percent of respondents use growth metrics and 34 percent use profitability or revenue, which are much more difficult to manipulate. Nearly one-third have a discretionary component for branch or individual performance that can help reinforce positive behaviors and “right size” awards.

How is our plan monitored? Participants received inquiries from executive management (72 percent) and their boards (51 percent) who may be unfamiliar with the specific details of the retail incentive programs. Banks are addressing the additional oversight through increased monitoring and controls (46 percent) and greater reporting to senior management or the board (42 percent). Reporting elements need to remedy the fact that boards have a responsibility to ensure the bank’s incentive compensation arrangements do not encourage inappropriate risk. Directors often have no visibility into retail incentive plans, have no easy way to quickly understand the impact, do not know what their rights or authority are in understanding, determining, and remedying the risk, and have no plan for how to react. These issues need to be addressed to appropriately monitor the risk.

Are our expectations reasonable? The last element of reporting—how many employees are meeting performance goals—can identify unreasonable expectations or flag the need for better training or management. Collecting performance data over time to see trends in performance, expectations and payouts may also prove useful.

What are our customers experiencing? More than a quarter of respondents indicated that they will develop or enhance their customer complaint process. The process should not only handle specific complaints but also aggregate the complaint types to identify systematic breakdowns in the customer experience.

Are we staying true to our values? Critics have indicated that perhaps the largest failing at Wells Fargo was an environment where branch staff feared that nonperformance would result in job loss. Monitoring of employee satisfaction by business line and mechanisms to provide feedback without repercussions can help identify problems before they escalate.

Given the large-scale publicity of the Wells Fargo scandal, someone—customers, employees, regulators, or shareholders—will likely ask how your retail incentive program is different and what you have done to protect against fraud or misconduct. Accordingly, banks should conduct an assessment of retail incentive plan designs, risks and controls, as well as gain a better understanding of the branch sales culture and leadership.

Good Corporate Governance Starts With the Articles and Bylaws

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governance-11-14-16.pngJust as a good diet and regular exercise contribute to a healthy lifestyle, good corporate governance and board oversight often serve as the foundation for the health and stability of any corporate organization. Corporate governance is often a difficult concept to nail down. In the highly regulated banking industry, the importance of good corporate governance practices is significantly amplified due to the additional layer of regulatory risk that may not affect businesses in other industries.

Although good corporate governance is often associated with maintaining certain policies and procedures, such as guidelines, codes of conduct, committee charters, shareholder agreements and intercompany and tax sharing agreements, we routinely encounter financial institutions that ignore or overlook one of the most fundamental aspects of corporate governance: the articles of incorporation and bylaws. In fact, we experience many situations in which financial institutions have articles and bylaws that are significantly outdated and have not been revised to comply with current laws, regulations and other corporate best practices. Failure to keep these governing documents current can not only raises legal and regulatory concerns, but oftentimes compromises the ability of the management team to protect and preserve the interests of its shareholders.

A comprehensive review of the articles and bylaws is recommended, particularly if you have not conducted such a review in the past. Set forth below is a summary of certain terms and provisions that may be of particular interest to your management and board of directors.

Compliance With State Corporate Laws
State corporate laws provide the basic foundation for the conduct of business of most banks and bank holding companies. Over time, these state corporate laws are revised or replaced with more modern corporate statutes. Although the corporate laws may evolve over time, many financial institutions fail to adapt their articles and bylaws to conform to these changes. In many cases, we encounter articles and bylaws that reference outdated and repealed laws and statutes that could lead to questionable legal interpretations and uncertainty in many critical situations.

Limitation of Personal Liability and Indemnification of Directors and Officers
Most state corporate laws have provisions that permit a corporation to limit the personal liability of, and/or provide indemnification to, directors and officers pursuant to provisions in its articles or bylaws. Typically, the ability to limit liability and provide indemnification to directors and officers is eliminated in certain situations such as a breach of fiduciary duty or intentional misconduct. However, we routinely experience situations in which the limitation of liability and indemnification are either not addressed by the articles or bylaws or contain provisions that may not fully protect the interests of the management team.

Electronic Communications
As technology continues to evolve, many state corporate statutes have been revised to permit certain shareholder and director communications, such as notices of shareholder and director meetings, to be delivered in electronic format. Despite these statutory revisions, if your institution’s articles and bylaws require physical delivery of these notices, you might not be able to take advantage of these newer and less costly forms of communication.

Uncertificated Shares
As financial institutions continue to consolidate and increase their shareholder base, the use of third-party transfer agents is becoming more prevalent for the management of stock transfer records. Most transfer agents have implemented uncertificated book-entry systems as a means of recording stock ownership, which eliminates the need for physical stock certificates. However, it is not uncommon for the articles and bylaws to specifically require the issuance of physical stock certificates to their shareholders. Obviously, these provisions must be revised before implementing an uncertificated stock program.

In addition to the specific matters addressed above, some other important areas to consider when reviewing your articles and bylaws include the shareholders’ ability to call special meetings, the process for including shareholder proposals at annual or special meetings, the implementation of a classified board of directors, the process for the removal of directors, mandatory retirement age for directors, shareholder vote by written consent and a supermajority vote standard for certain article and bylaw amendments, such as limitation of liability and indemnification.

A review of your institution’s articles and bylaws is only one component of the broader corporate governance umbrella, but it is one of the more important and fundamental aspects of your board’s corporate governance responsibilities. Routine maintenance of these fundamental corporate documents will be a good start towards enhancing your institution’s overall corporate governance structure.

Six Tips for Negotiating a Successful M&A Transaction

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merger-transaction-11-11-16.pngWhat aspect of a deal is critical to the success of an acquisition? While many in the banking industry may point to features like pricing and culture, which are certainly important, the devil is in the details. How do you protect your institution if the other party walks away from the deal? Will you have the personnel in place to ensure a successful transition? These six areas indicate where boards and management teams of buyers and sellers will want to focus their initial attention.

1. A detailed letter of intent really helps.
Putting the time in on the front-end to negotiate a detailed letter of intent (LOI) is in the best interest of buyers and sellers. The LOI is a preliminary document, and it is best to resolve any important issues at this stage. If a seller insists on a term that a buyer cannot accept, it is far better to know that before time is wasted and significant expenses are incurred while negotiating a definitive agreement. If the only substantive term in an LOI is the purchase price, then all of the other issues must be resolved among lawyers negotiating the definitive agreement.

2. Do not overlook the importance of due diligence.
The representations made in a definitive agreement supplement—but do not replace—each party’s due diligence investigation. Some important facts about a seller will fall outside the scope of the representations made in the definitive agreement. For example, the seller will disclose any actual and potential litigation against itself, but is not required to reveal litigation against its customers. If the seller’s biggest customer is facing a sizable judgment that could negatively affect its ability to repay its loans, a buyer will have to conduct detailed due diligence to uncover this fact. Further, due diligence is not just for buyers. The seller needs to critically examine the buyer if shareholders are taking the buyer’s stock in the transaction.

3. Be thoughtful about drop dead dates.
A drop dead date is the date on which a deal must close before either party can terminate the definitive agreement without incurring a penalty. Calculating the correct drop dead date is more art than science when balancing the number of actions that must be taken pre-closing—especially regulatory and shareholder approval—with the parties’ desire to get the deal closed as soon as possible. At the same time, an agreement with a short time period between signing and the drop dead date encourages the parties to take the necessary pre-closing actions expeditiously. Striking the proper balance between these two competing factors is key. In the event of a contested application, the time required to receive regulatory approval will be at least twice as long as expected.

4. Be prepared to negotiate termination and related fees.
Termination fees, which are paid by a seller to the buyer if the seller accepts an unsolicited superior proposal from a third party, are common, but the amount of the fee, and the triggers for paying it, are frequently negotiated. Expense reimbursement provisions payable to the nonterminating party are perhaps equally common, in terms of prevalence and contention of the amount. Far less common are termination fees to be paid by the buyer to the seller if the buyer terminates the transaction. These reverse termination fees are generally resisted but can be appropriate in certain circumstances, such as situations where the buyer must obtain shareholder approval for the transaction.

5. Consider the treatment of critical employees.
Buying a bank is obviously more than buying loans and deposits. Integrating the seller’s employees is critical to a successful transaction. Buyers should consider establishing a retention bonus pool to ensure that critical employees remain with the combined enterprise after the transaction (and at least through conversion). A critical employee may not be obvious—frequently they are the unsung backroom employees who keep things running smoothly—and doing right by them will help ensure a successful integration.

6. Be aware of board dynamics.
It’s relatively common for the CEO and CFO to negotiate the sale of their bank and for the deal to include a meaningful pay package for the two of them. The deal is presented to the board and, right or wrong, the board is highly skeptical of the agreement that the executives cut. In this instance, the board’s advisers can help the directors clearly assess the merits of the transaction without the distraction of potentially questionable motivations.  

Are Your Owners Violating the Change in Bank Control Act?

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Change-in-Control-10-18-16.pngMore people probably violate the Change in Bank Control Act (CBCA) than any other banking statute, as it is complicated and easy to do. But knowing the law and helping your shareholders keep up with their ownership filings is important. The law requires regulatory approvals before a person or group of persons “acting in concert” may take actions to directly or indirectly “control” a bank or savings association. Consequently, the CBCA impacts both bank and thrift holding companies and, with minor variations, all of the federal regulators have implementing regulations for the CBCA. Although the focus of this article is the Federal Reserve Board regulations regarding changes in control of bank holding companies, it is fair to say that given the intricacy of control determinations, the CBCA is likely one of the most inadvertently violated banking statutes currently on the books. The inadvertent CBCA violations often occur because of the presumption that certain groups are “acting in concert,” and the application of the CBCA requirements to these groups.

The CBCA requires that any person or groups of persons “acting in concert” must file change in bank control notices with the applicable federal regulator if the individual or group reaches an ownership level of 25 percent or more of any class of voting securities of an institution. The definition of “person” under the CBCA is very broad and includes individuals, corporations, partnerships, trusts, associations and other forms of business entities. Acting in concert is defined as knowing participation in a joint activity or parallel action towards a common goal of acquiring control of a bank or bank holding company, whether or not pursuant to an express agreement.

There is a rebuttable presumption that an acquisition of voting securities of a bank holding company is the acquisition of control under the CBCA, requiring a notice filing, if, immediately after the transaction, the acquiring person or persons acting in concert will control 10 percent or more of any class of voting securities of the institution, and if the institution has registered securities under the Securities Exchange Act of 1934 or if no other person will own, control, or hold the power to vote a greater percentage of that class of voting securities immediately after the transaction.

In determining whether persons are engaging in concerted action, there is a rebuttable presumption that the following groups are acting in concert:

  • A company and any controlling shareholder, partner, trustee, or management official of the company, if both the company and the person own voting securities of the institution;
  • An individual and the individual’s immediate family, which includes a person’s father, mother, stepfather, stepmother, brother, sister, stepbrother, stepsister, son, daughter, stepson, stepdaughter, grandparent, grandson, granddaughter, father-in-law, mother-in-law, brother-in-law, sister-in-law, son-in-law, daughter-in-law, the spouse of any of the foregoing, and the person’s spouse;
  • Companies under common control;
  • Persons that are parties to any agreement, contract, understanding, relationship, or other arrangement, whether written or otherwise, regarding the acquisition, voting, or transfer of control of voting securities of an institution, other than through certain types of a revocable proxy;
  • Persons that have made, or propose to make, a joint filing under certain sections of the Securities Exchange Act of 1934; and
  • A person and any trust for which the person serves as trustee.

With respect to inadvertent CBCA violations, the most likely “acting in concert” scenario is the consolidation of voting securities held by an individual and the individual’s “immediate family” members. To the extent a family group owns at least 10 percent of a bank holding company, a new notice filing may be required any time the family group or ownership mix changes. Violations of the CBCA are inadvertently committed literally all the time by family groups as ownership is realigned at death, through estate planning or gifting, as minors age into formal ownership stakes and by birth or marriage.

Although the burden of obtaining regulatory approval is on the person or group of persons acquiring control, not the institution, the issue has recently been arising with great frequency when bank holding companies seek to acquire other institutions. As part of the review process, the Federal Reserve has requested current shareholder lists to compare them to prior control determinations made by the Federal Reserve. If a review of the shareholder list indicates changes, even intra-family changes, in the control group, the Federal Reserve may require that a new notice be filed.

Although at least in the family context, CBCA issues are generally easily resolved by filing an after-the-fact corrective notice, reviewing your bank holding company shareholder lists for technical changes in family group ownership may prevent a holdup down the line as you seek approval for future expansion.