4 Critical Success Factors for Bank M&A in 2023

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

What Drives Success in Banking?

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As a founder and managing principal at Castle Creek Capital, a private equity firm that invests in community banks, John Eggemeyer has a unique perch from which to observe what’s going on in banking.

The San Diego-based firm has approximately $900 million under management, and usually has between 20 to 25 banks in its investment portfolio at any given time, according to Eggemeyer.

“We have the opportunity to look at a lot of different ideas,” he says. “I don’t consider myself to be an originator of any particularly interesting ideas, but I am an observer of a lot of interesting ideas that other people have worked with and made success of — or not made success of.”

Eggemeyer may be selling himself a little short. Prior to starting Castle Creek in 1990, he spent nearly two decades as a senior executive for several large U.S. banks. He also sits on the boards of many of those portfolio companies, and that combined experience gives him a very strong sense of what drives success in banking.

Eggemeyer will moderate a panel discussion at Bank Director’s upcoming Acquire or Be Acquired Conference focusing on subtle trends that bankers need to be talking about. The conference runs Jan. 30-Feb. 1, 2022, at the JW Marriott Desert Ridge Resort and Spa in Phoenix.

In today’s banking market, Eggemeyer believes that success begins with the customer. Period. End of sentence.

“It’s critical that you understand who your customer is and what your customer wants,” he says. “I think we’ve learned from the fintech community that they have segmented the customer [base] and identified very clearly the customer that they’re going after. And they have built their service model around the needs and wants of their customer group. And I think that has been harder for banks to actually do from an intellectual standpoint.”

Increasingly, success in banking is also a matter of scale. Not necessarily scale in the size of the organization, but scale in product lines or customers. “The businesses that have the greatest value, and the customer segments that offer the greatest value, are those that are the most scalable,” Eggemeyer says. “And again, I think in the fintech world, they have figured out how to apply technology to the needs and wants of the segment that they’ve gone after, and that has allowed their businesses greater scalability. … Businesses that are the most scalable offer the greatest opportunities for generating incremental returns.”

A cynic might argue that applying technology to scalable customer segments is fintech’s game, not banking’s. But Eggemeyer disagrees. “I’m not sure that fintechs are better positioned to apply technology to financial services than our banks,” he says. “So much of the technology that one would apply either operationally or in serving the customer is available off the shelf. You just have to be committed to making that transition.”

A third driver of success is talent; Eggemeyer says there is “an acute shortage of highly skilled trained executives” in the banking industry today. Talent and institutional knowledge has left as the bank space as the industry has gone through a number of difficult economic periods, he says, and banks managed their expense base in part by shortchanging the training and development of younger employees.

“I’ve watched this over a lot of cycles having spent over 50 years in the business. The great era of training in the bank industry was pre-1986,” he says. “And [since] that period of time, we have successfully downsized our investment in the development of people. And I think now we’re facing that challenge.”

In 1968, Eggemeyer was hired by the First National Bank of Chicago while still pursuing his undergraduate degree at Northwestern University. The bank had a program that hired up to 10 undergraduates a year for an extensive training program, then put them through an MBA program — in Eggemeyer’s case, at the University of Chicago. He spent 10 years working for the bank and was never in the same position for more than two years. That experience provided him with a very broad introduction to the industry.

The U.S. economy has changed greatly since the late 1960s. Graduates from top MBA programs today have many more options to choose from if they’re interested in a career in finance, including investment banking and private equity.

“It’s much harder for banks to compete for that level of talent,” Eggemeyer says. “And I don’t think there’s anything that you can do about that, other than look harder for the talented people who are not necessarily aspiring to [work in] private equity. And they may come from less traditional backgrounds, unlike the program that I went through at the First National Bank of Chicago. I just don’t see that happening very much in banking today.”

Pat Summitt’s Model on Talent Development

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talent-1-16-19.pngWith unemployment at its lowest point since 1969, the competition for top talent is as fierce as it has been in years.

While many experienced banking professionals know well that the industry offers challenges, rewards and opportunities, many millennials and Gen Z’ers remain reluctant to pursue a career in banking.

The high-performing banks of the future will be those that can translate those benefits to attract, develop, reward and retain top talent. There are two places your bank can start this process.

Banks already provide strong salaries, bonus opportunities, health-care coverage and retirement plans. The challenge the industry now faces is how to make the banking industry more attractive to today’s generation of younger recruits.

What a bank should consider includes flexible work hours, the ability to work remotely and cross-training. If the bank can demonstrate a track record and policy of promoting from within, the job opportunity will be even more attractive to a potential hire.
Another recruiting tool we have often used successfully, particularly for younger individuals, is a deferred compensation program designed to help pay down student loans, with vesting provisions that encourage continued employment at the bank.

But once you acquire top talent, how do you develop them as future leaders?

First, an ongoing coaching and mentoring program is critical.

Pat Summitt, the legendary University of Tennessee women’s basketball coach who won more games than any other NCAA Division I women’s coach, recruited talented players.

Once they joined the team, she delivered an individualized plan to improve each player’s weaker areas. She also provided regular feedback and monitoring. This method of coaching and mentoring led to 1,098 career victories and Hall of Fame success as a coach and leader. So, how can Summitt’s approach help your bank?

When developing the bank’s future senior management, the board and the CEO should ensure they agree on both the long-term strategic plan and the necessary skills to execute that plan.

They should then identify the internal candidates best suited to develop and provide them with opportunities for growth. It is important the bank develop a culture of honest assessment of strengths and weaknesses, and provide ongoing mentoring and feedback.

Even with top talent, it is unlikely that Summitt would have achieved the success she did had she provided her players with feedback only once a year.

In addition to an ongoing assessment and coaching program, the bank should discuss a career path for potential leaders, and the company should provide the necessary training and cross training, when feasible, to allow promising employees to learn each facet of the bank’s operations. Thorough training programs can be very attractive in recruitment and are invaluable to the development of a leader.

Once the bank has invested in developing up-and-coming leaders, rewarding them appropriately and incenting them to remain with your bank is critical. No doubt, your competitors will recognize the strong leaders you are developing and actively recruit your talent, requiring your bank to maintain not just competitive salaries, but methods of keeping your compensation programs unique and desirable.

An example is a nonqualified deferred compensation plan that pays in-service distributions at the end of certain periods, such as three- or five-year time frames. This type of plan typically would include performance-based compensation tied to specified goals.

Additional amounts can be credited to the deferred compensation account and distributed at the end of a longer period (such as 10 years), providing even more incentive to stay with the bank.

If the individual terminates before the applicable distribution period(s), undistributed funds can be allocated to hire a talented replacement or credited back to the bank’s income.

We have found these flexible deferred compensation arrangements, when combined with other tools, to be helpful in recruiting, developing and keeping top talent.

An active career development program bolstered with proper financial incentives can help ensure your bank has the right leaders for the future.

How Bananas and Tech Firms Can Help Tackle the Talent Challenge

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management-11-8-18.pngAll bank executives and directors say that recruiting, retaining and properly incentivizing top talent is a priority, but it’s the banks that truly excel at this that are able to separate themselves on the competitive playing field.

How to tackle the talent challenge was the theme of Bank Director’s 2018 Bank Compensation and Talent Conference, hosted this week at the Four Seasons Resort and Club at Las Colinas in Dallas, Texas.

The first day of the conference laid the groundwork by introducing the conventional techniques used today by human resources professionals throughout the bank industry.

On Monday morning, before the formal beginning of the conference, attendees participated in a half-day workshop, presided over by a panel of experts from Compensation Advisory Partners and Kilpatrick Townsend & Stockton LLP. The topics covered a broad range of issues, from common executive compensation challenges, to strategies for promoting diversity and inclusion, to tools that can be used to properly align pay and performance.

The second day of the conference built on this, in part through a pair of audience surveys.

In one survey, nearly a third (31 percent) of attendees said managing rising compensation and benefit costs is their top compensation challenge for 2019, more than half (56 percent) said they’ve raised wages to better compete for talent and in response to last year’s tax cut, and nearly three-quarters (70 percent) said they’ve expanded their internal training programs to develop young leaders.

These statistics were borne out with anecdotes. Beth Bauman, the head of human resources at Bank of Butterfield, an $11 billion bank based in Bermuda, talked about implementing a talent management program to help guide and groom the bank’s younger employees. And human resources officers from Cadence Bancorporation and Union Bankshares discussed the challenges of merging compensation cultures after an acquisition.

The final day of the conference delved into less conventional approaches to talent management.

The day started with an anecdote from Bank Director’s CEO, Al Dominick, about an Asian grocery store chain that figured out a new way to sell bananas. Instead of selling them in traditional, equally ripe bunches, the chain sold bananas in packages of five, with each banana at a different stage of ripeness. As a result, the bananas ripen in stages over a period of a week, not all at the same time.

The anecdote illustrates how approaching an issue in a creative way can result in an unconventional yet effective solution.

The first presenter on stage on Wednesday, Jason Mars, came not from a bank, but rather from a fintech company. Mars is the founder and CEO of Clinc, a company focused on bridging the gap between research on conversational artificial intelligence and its application for enterprises.

“My No. 1 criterion for hiring is intellectual curiosity, because that’s what drives people to do really hard stuff,” said Mars. This is more important to Mars than other, more orthodox measures, like a prospective employee’s college grade point average or even their performance in the interview process.

“Passion is another priority, and flexibility,” said Mars. “It’s about figuring out whether they will be motivated to do hard stuff because they’re passionate, curious and interested.”

And finishing out the conference was a panel of three bank CEOs from across the country, all of whom shared their respective talent and compensation strategies.

One of the more innovative philosophies came from John Holt, CEO NexBank, a rapidly growing bank based in Dallas.
A group of investors acquired control of the bank in 2004, when it had only $55 million in assets. Seven years later, a new management team was brought in to hasten its growth. One way it did so was to promise its employees a bonus equal to 100 percent of their base pay when the bank passed the $8-billion threshold, which it recently eclipsed. The strategy should serve as a retention policy as well, explained Holt, because the bonus pays out over 24 months.

NexBank also buys lunch for its employees every day, offering them a menu of multiple restaurants to order from. It pays 100 percent of their health insurance premiums. And it has added a millennial to its board of directors—the bank’s 37-year-old chief operating officer, now the CEO heir apparent.

The net result, said Holt, was the bank has fewer, better people than many of its competitors, and it faces little employee turnover, sidestepping a perennial problem in any industry.

The point is while there is no magic bullet that will solve all of a bank’s talent and compensation challenges, understanding the tried-and-true approaches to doing so, as well as the less conventional strategies used in the market today, will help banks better compete for the next generation of employees.

How To Manage Talent in a Parfait Organization

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talent-11-7-18.pngThe banking industry sits at an interesting crossroads from a talent management perspective. Demographically, many banks are layered like a parfait, with as many as four distinct generations working in the organization, each with its own set of personality traits, likes and dislikes.

The oldest generation—the baby boomer generation, now running the bank for several years—is beginning to retire in increasing numbers. The Generation X cohort, which follows the boomers, is moving into senior management, the best and brightest among them soon to rise to the CEO and CFO level, if they haven’t already.

Generation Y, otherwise known as millennials, are now far enough along in their careers to have gained some meaningful experience, and the really talented ones are identifiable to the bank. Most members of the final and largest cohort, Generation Z, are still in high school and college, although the oldest ones are entering the workforce. At 26 percent of the population, Gen Z will be a force for the next several decades.

This dramatic generational shift is forcing banks to become more proactive in how they manage their talent, particularly millennials, who will comprise a significant part of the industry’s workforce in the near future. The importance of creating opportunities for those individuals was a significant theme in day two of Bank Director’s 2018 Bank Compensation and Talent Conference, held at the Four Seasons Resort and Club at Las Colinas in Dallas, Texas.

In a session on talent management, Beth Bauman, an executive vice president and head of human resources at the Bank of Butterfield, a NYSE-listed $11 billion asset bank domiciled in Bermuda, described the situation at the bank when she joined it in 2015. Butterfield had frozen salaries and done relatively little hiring for several years as it struggled to recover from the financial crisis. So Bauman, along with senior management, has worked to bring in new talent so the bank can continue to grow.

A key element of that hiring effort has been to create a talent management program so Butterfield’s younger employees can have their careers guided, with the most talented groomed for higher positions within the bank.

Bauman sees this as a key to successfully managing the generational change occurring now throughout the industry. “Regardless of the size of your bank, you can have an effective talent management program,” she says.

Talent management has been very much on the minds of the conference attendees. In an audience survey that polled the 300-plus people who were there, 45 percent said it has become both more difficult and costly to attract and retain talented staff—a result not surprising in an economy where the unemployment rate is just 3.7 percent. Banking also has the disadvantage of not being perceived as an exciting employment opportunity for many job seekers, particularly millennials.

Sixty-one percent of the survey respondents said their bank is actively and intentionally recruiting younger employees like millennials and Gen Z’ers.

Similarly, more than 70 percent said in the last two years their bank has expanded its internal training programs to develop younger leaders within the organization.

As increasing numbers of baby boomers approach retirement (the youngest boomers are in their mid-50’s), and Gen X’ers take their place in the management hierarchy, it will create an opportunity for millennials to move up as well. Gen X’ers are the smallest of the four demographic groups at just 20 percent of the population, so the banking industry will be forced to rely disproportionately on millennials as this generational shift occurs.

This is why training programs that focus on talented younger employees in the organization are so important.

We’ve all heard the jibes about millennials’ self-absorption, or their refusal to return voicemail messages, but the fact is the oldest among them are already buying homes and raising families, and when the day comes to run the bank, they’ll need to be ready.