Preserving Franchise Value



The factors that help banks maximize value—including growth and profitability—are relatively timeless, though the importance of each value driver tend to change with the operating environment. But the way a bank pursues a sale impacts its valuation. In this video, Christopher Olsen of Olsen Palmer outlines the three ways a bank can pursue a sale. He also explains why discretion is key to preserving franchise value.

  • Factors Driving Today’s Valuations
  • The “Goldilocks” Process for Selling Banks
  • The Importance of Discretion

 

A Better Way to Value Deposit-Driven Deals


deposits-4-1-19.pngThere’s no doubt that the focus these days on acquisitions centers around deposits. When surveyed at the 2019 Acquire or Be Acquired conference, 71 percent of attendees said that a target’s deposit base was the most important factor in making the decision to acquire. This suggests that targets with excess liquidity (low loan-to-deposit ratios) will be highly valued in the market going forward.

This strategic objective is out of whack with traditional deal valuation metrics.

The two primary traditional deal metrics are tangible book value (TBV) payback period and earnings per share (EPS) accretion. Investors expect every deal to meet the benchmarks of a low TBV payback period (ideally less than three years) and be accretive to EPS, according to a presentation from Keefe Bruyette & Woods President and CEO Tom Michaud.

These are earnings-based metrics, and targets with low loan-to-deposit ratios have lower earnings because they have larger securities portfolios relative to loans. Therefore, traditional consolidation modeling will undervalue those targets with longer payback periods and lower accretion. Potential acquirers will struggle to justify competitive prices for these highly valued targets.

Why are deals that clearly create shareholder value by strengthening the buyer’s deposit base not reflected by the deal metrics du jour? Because those metrics are flawed. How can you justify a deposit-driven deal to an investor base that is focused on TBV payback and EPS accretion? By abandoning traditional valuation methods and using forward-looking, common sense analytics that capture the true value of an acquisition.

Traditional consolidation methodology projects the buyer and seller independently, then combines them with some purchase accounting and cost savings adjustments. Maybe the analyst will increase consolidated loan growth generated from the excess deposits acquired. This methodology does not capture the true value of the acquired deposits.

The intelligent acquirer should first project its own financials under realistic scenarios, given current market trends. Industry deposit growth has already begun to slow, and the big banks are taking more and more market share. If the bank were to grow loans organically, it must be determined:

  • How much of the funding would come from core deposits and how much would require brokered deposits or other borrowings like Federal Home Loan Bank advances and repurchase agreements? This change in funding mix will drive up incremental interest expense.
  • How many of the bank’s existing depositors will shift their funds from low cost checking and savings accounts to higher cost CDs to capture higher market rates? This process will increase the bank’s existing cost of funds.
  • What will happen to my deposit rates when my competitors start advertising higher rates in a desperate play to attract deposits? This will put more pressure on the bank’s existing cost of funds.
  • How many of my existing loans will reprice at higher rates and help overcome increasing funding costs? Invictus’ BankGenome™ intelligence system suggests that, while the average fixed/floating mix for all banks in the US is 60/40, the percentage of floating rate loans actually repricing at higher rates in the next 12 months is much lower because the weighted average time between loan reset dates is more than six quarters.

Standalone projections for the buyer must adequately reflect the risks inherent in the current operating environment. These risks will affect a bank’s bottom line and, therefore, shareholder value. This process will create a true baseline against which to measure the impact of the acquisition. Management must educate its investors on the flaws in legacy analytics, so they can understand a deal’s true value.

In the acquisition scenario, the bank is acquiring loan growth with existing core deposit funding attached. And if the target has excess deposits, the acquirer can deploy those funds into additional loans grown organically without the funding risks due to current market trends. The cost differential between the organic growth and acquisition scenarios creates real, tangible savings. These savings translate to higher incremental earnings from the acquisition, which alleviate TBV payback periods and EPS accretion issues. Traditional deal metrics may be used as guideposts in evaluating an acquisition, but a misguided reliance on them can obscure the true strategic and financial shareholder value created in a transaction.

Every target should be analyzed in depth, with prices customized to the acquirer’s unique balance sheet and footprint. Don’t pass on a great deal because of flawed traditional methodologies.

Bank M&A in 2019: Is It a New World?


Much like the countless dystopian novels and movies released over the years, the environment today in banking begs the question of whether we’ve entered a so-called new world in the industry’s M&A domain.

Deal volume in 2018 was roughly equal to 2017 levels, though many regions in the country saw a decline. And while it’s still early in 2019, the first two months of the year have been marked by a pair of large, transformative deals: Chemical Financial Corp.’s merger with TCF Financial Corp., and BB&T Corp.’s merger with SunTrust Banks. These deals have raised hopes that more large deals will soon follow, creating a new tier of banking entities that live just below the money-center banks.

Aside from these two large deals, however, M&A volume throughout the rest of the industry is down over the first two months of the year. As you can see in the chart below, this continues a slide in deal volume that began at the tail end of 2018.

Announced Bank Deals.png

Bank Director’s 2019 Bank M&A Survey highlights a number of the factors that might impact deal volume in 2019 and beyond.

Fifty-seven percent of survey respondents indicated that organic growth is their current priority, for instance, though respondents were open to M&A opportunities. This suggests that banks are more willing to focus on market opportunities for growth, likely because bank management can more easily influence market growth than M&A. The strength of the economy, enhanced earnings as a result of tax reform, easing regulatory oversight and industry optimism in general also are likely contributing to the focus on market growth.

The traditional chasm between banks that would like to be acquirers and banks that are willing to be sellers seems to be another factor influencing banks’ preference for organic market growth. In all the surveys Crowe has performed of bank directors, there always are more buyers than sellers.

The relationship between consolidation and new bank formation also weighs on the pace of acquisitions. If the pool of potential and active acquirers remains relatively stable, the determiner is the available pool of sellers. Each year since 2008, the number of acquisitions has exceeded the number of new bank formations. The result is an overall decrease in the number of deals. It stands to reason, in turn, that this will lead to fewer deals each year as consolidation continues.

Current prices for bank stocks also have an impact on deal volume. You can see this in the following chart, which illustrates the “tailwind” impact on deal volume for publicly traded banks. Tailwind is the percentage by which a buyer’s stock valuation exceeds the deal metrics. When the percentage is high, trading price/tangible book value (TBV) exceeds the deal price/TBV and deal volume is positively affected. The positive impact sometimes is felt in the same quarter, but there can be a three-month lag.

Deal Volume.png

In the beginning of 2019, bank stock prices recovered some of the declines they experienced in the latter half of last year, but they still are at a negative level overall. If bank stock prices continue to lag behind the broader market, as they have over the past year (see the chart below), deal volume likely will be affected for the remainder of the year.

Bank Stock Prices.png

It’s still too early to predict how 2019 will evolve for bank M&A. Undoubtedly there will be surprises, but it’s probably fair to assume a slightly lower level of deals for 2019 compared to 2018.

Fuel for More M&A in 2019



How will economic factors like today’s strong stock market and rising interest rates, along with the banking industry’s demand for core deposits, impact profitability and growth in 2019? Dory Wiley of Commerce Street Capital predicts we’ll see more deals. Find out why in this video.

  • M&A Drivers in 2019
  • What to Know About Valuations
  • Powering Future Growth
  • Headwinds Facing the Industry

Why Investors Are Still Hungry for New Bank Equity


capital-10-12-18.pngThe U.S. economy is riding high. Bank stocks, while their valuations are down somewhat from their highs at the beginning of the year, are still enjoying a nice run. For most banks that want to raise new equity capital, the window is still open.

The banking industry is already well capitalized and bank profitability remains strong. According to the Federal Deposit Insurance Corp., the industry earned $60.2 billion in the second quarter of this year, a 25 percent gain over the same period last year, thanks in no small part to the Trump tax cut, which has also helped prop up bank stock valuations. The truth is, in the current environment, banks don’t need to raise new equity just to increase their capital base—they can do that through retained earnings. The industry is awash with capital and most banks don’t necessarily need even more of it.

“The industry overall is enjoying capital accretion,” says Bill Hickey, a principal and co-head of investment banking at Sandler O’Neill + Partners. “Capital ratios industry-wide have continued to increase as banks have earned money and obviously enjoyed the benefits of tax reform. … I think the need for equity capital has lessened slightly as a result of capital ratios continuing to increase.”

Over the last few years, banks have clearly taken advantage of the opportunity to repair their balance sheets, which were ravaged during the financial crisis. According to S&P Global Market Intelligence, there were 123 bank equity offerings in 2016, which raised nearly $6 billion in capital at a median offering price that was 125 percent of tangible book value (TBV) and 52.8 percent of the most recent quarter’s earnings per share (MRQ EPS). There were 146 equity offerings in 2017 that raised nearly $7.5 billion, with offering price medians of 66.3 percent of TBV and 16.6 percent of MRQ EPS. (The industry was much less profitable in 2016 than in 2017, which explains the wide disparity between the median values for the two years.) And through Sept. 26, 2018, there were just in 66 offerings—but they have raised $7.6 billion in equity capital, with a median offering price that was 175 percent of TBV and 13.3 percent of MRQ EPS.

As the median offering prices as a percentage of TBV have gone up over the last two and a half years, while also declining as a percentage of the most recent quarter’s earnings per share—which means that institutional investors are in effect paying more and getting less from a valuation perspective—you might think investor appetite for bank equity would begin to wane. But according to Hickey, you would be wrong.

“There is a lot of money out there looking to be deployed in financial services and banks,” he says. “So there are folks who need to deploy capital—pension funds, funds specifically focused on investing in financial institutions. They have cash positions they need to deploy into investments. So there is a great demand for equity, particularly bank equity at the current time.”

Hickey says most of this new equity was raised to fuel growth, either organic growth or acquisitions. But any bank considering doing so needs to provide investors with a detailed plan for how they intend to use it. “You have to be able to articulate a strategy for the use of the capital you intend to raise,” says Hickey. “That seems obvious, but it needs to be explained quite well to the investment community so they understand how the capital is going to be deployed and have a sense of what their return possibilities are.”

And if you’re going to tap the equity market to support your strategic growth plan, make sure you raise enough the first time around. “Arguably, a company [should] raise enough money that will allow it to fund their growth for at least 18 to 24 months,” Hickey explains. “Investors don’t like it when they’re investing today and then 12 months later the same company comes back looking for more capital. Investors would [prefer] to minimize the number of offerings so they’re not diluted in the out years.”

Three Themes Are at the Top of Bankers’ Minds Right Now


risk-6-14-18.pngIf one looks at the bank industry as a whole, it’s easy to agree with Jamie Dimon, the chairman and CEO of JPMorgan Chase & Co., the nation’s biggest bank by assets, that we are in the midst of a “golden age of banking.”

This is true on multiple fronts. Dimon’s comments were directed specifically at the easing of the regulatory burden on banks, an evolution that has been going on since the change in administration at the beginning of last year. The lighter touch is most evident at the Consumer Financial Protection Bureau, which has taken a more passive approach to enforcement actions under its current acting director, Mick Mulvaney. The broadest base of regulatory relief culminated last month, when federal legislation was signed into law that eased the compliance burden on smaller banks in particular.

Banks are also reaping benefits from the cut last year in the corporate income tax rate from 35 percent down to 21 percent. The change led to a surge in profits and profitability.

These events highlight a trio of themes that emerged from this year’s Bank Audit & Risk Committees Conference hosted by Bank Director in Chicago. Each theme is unique, but the common denominator is that bank boards face an evolving landscape when it comes to the macroeconomic environment, cyber security threats and the means through which a bank can navigate this landscape.

Profitability is a point that Steve Hovde, chairman and CEO of Hovde Group, stressed in a presentation on the current and future state of banking. Banks earned a record $56 billion in the first quarter of the year, which amounted to 28 percent growth over the same quarter of 2017. And while the industry has yet to report a return on assets above 1 percent on an annual basis since the financial crisis a decade ago, the average bank eclipsed that figure in the first three months of the year.

And banks aren’t just more profitable, they’re also arguably safer, former Comptroller of the Currency Thomas Curry noted in a conversation with Bank Director magazine Editor in Chief Jack Milligan. Curry pointed to the fact that banks have more capital than they’ve had in decades.

Yet, as Hovde noted, many of these positive performance trends are not being experienced equally across the industry, with the lion’s share going to the biggest banks. The return on average assets of banks with between $10 billion and $50 billion in assets is 1.27 percent compared to 0.72 percent for banks with less than $1 billion in assets. This is also reflected in bank valuations, with big banks trading on average for more than two times tangible book value compared to 1.4 percent for smaller banks.

This gap is projected to grow with time, in part because of a second theme that coursed through conversations at this year’s Bank Audit & Risk Committees Conference: trends in technology and cyber threats, which large banks have deeper pockets to address. Of all the things that concern bank officers and directors right now, especially those tasked with audit- and risk-related duties, the need to defend against cyber threats is at the top of the list.

There are approximately 20 million hostile cyber events every day, with an estimated 200,000 of these targeted at financial institutions, noted Alex Hernandez, vice president of DefenseStorm, a cybersecurity defense firm. Seventy-three percent are perpetrated by people outside the organization compared to 28 percent by insiders. It isn’t just criminals who pose a threat, as nation-state actors are behind 12 percent of hostile cyber events, with their timing tending to coincide with elections.

The solution, Hernandez notes, is to double down on the fundamentals of cyber defense. “The most effective way to address cyber threats isn’t to focus on the latest shiny object like artificial intelligence, it’s about educating your staff and securing your network.” To this point, most threats come through unsophisticated channels, be it an email phishing scheme or malware delivered by way of a thumb drive.

One challenge in addressing these threats is simply recruiting the right expertise—not only on the bank level, but also on the board. Finding and retaining the right talent in not only information security but elsewhere was also a recurring theme. Most board members in attendance acknowledge they don’t know enough about technology to ask the right questions. But recruiting people who do is easier said than done, especially for banks in rural communities, who often try to tap into nearby metro areas for talent, or offer creative compensation plans to mitigate risk and retain younger officers.

There are certainly reasons to suggest big banks are experiencing a golden age, but smaller and mid-size banks shouldn’t use this recent change in fortune as an excuse to rest on their laurels. It remains incumbent on bank officers and directors to stay vigilant against ever-evolving cybersecurity risks and focused on recruiting the talent and designing effective governance structures to address them.

Four Drivers of Banking M&A in 2018


merger-5-28-18.pngAfter several years of false starts, 2018 may be the year that banking merger and acquisition (M&A) truly gets in gear. Financial stocks have rallied and stabilized and boosted the value of companies’ capital war chest.

Add to that new favorable policy developments easing regulatory constraints, interest rates steadily rising, the tax reform bill’s potential boost to bottom lines, loan growth projected to increase, and abundant capital is available to invest. Still, positive developments are sometimes accompanied by challenges. Deloitte’s 2018 banking and securities M&A outlook identifies four trends and drivers that are worth watching for their potential catalyzing or hindering effect on industry M&A activity.

1. Regulatory and legislative changes. Business-friendly legislation and regulatory policy changes may act as a flywheel to concurrently control and increase the M&A machine’s momentum in 2018. Of the potential regulatory changes, raising the statutory $50 billion asset thresholds for systemically important financial institutions, or SIFIs, designation and stress tests may have the most impact on M&A, especially within the ranks of $10 billion-$50 billion and $50 billion-$250 billion institutions. Higher thresholds could bring some regulatory relief around deal-making, opening the door to merger activity by small and midsized banks.

2. U.S. tax changes. Will the 2017 tax cuts be a boon for banking M&A? The outlook is encouraging, with some caveats. Banks and other financial services organizations may have more available capital but they also have numerous ways to use it: employee bonuses or raises, stock buybacks, pay down debt, increase dividends, invest in financial technology (fintech) and other operating improvements, or engage in cash-based M&A. And as of January 2018, sellers’ net operating losses (NOLs) became less attractive as an M&A trigger because, going forward, they will be applied at the new, lower 21 percent tax rate. On a positive note, while foreign banking organizations (FBOs) still face significant regulatory headwinds and some new burdens coming out of last year’s tax laws, tax reform may make U.S. banks on the margin more attractive to foreign-owned institutions looking to offset slow in-country growth and to expand their U.S. footprint where, historically, the tax rates made those investments less desirable from a post-tax earnings perspective.

3. Rising interest rates and higher valuations. Interest rates’ influence on 2018 banking M&A could be mixed: Rising rates may spawn competition in both lending and deposits, prompting an organization to rely more on organic growth and less on inorganic levers like acquisitions or alliances. Conversely, if an organization has loan origination or liquidity challenges, an acquisition could provide more stable access to deposits. Similarly, higher financial industry valuations may both grease and clog the gears of 2018 M&A.

Some banks—especially regionals and super-regionals—that have benefitted from the “Trump Bump” and have enhanced stock currency may engage in strategic deal-making to beef up their asset base, market presence, or fintech capabilities. However, those banks should remember that all valuations have gone up—while their acquisition currency may be higher so is the cost of what they want to buy. And, sellers may be hesitant in stock deals to accept perceived inflated currency. They may, as a result, seek higher deal multiples to protect their shareholders from any post-deal downside value risk.

4. The changing face of fintech. We expect that fintechs will continue to be a strategic investment area for financial services organizations of all types and sizes. Large and regional banks may look for technology assets to help improve their efficiency ratio, while smaller banks having difficulty growing their digital presence may acquire or partner with fintechs to fill critical gaps.

Regardless of their size, banks continue to struggle with diminishing brand value and reputation among certain customer segments including attracting and serving younger demographics in a manner they desire. Embracing the rapid adoption of cutting-edge financial technology, therefore, is not just a short-term means to boost revenues or eliminate cost inefficiencies; it’s a way for banks to repair and enhance their brand and value perception.

With banks likely to ride the wave of tax gains (outside of the impact on deferred tax asset values), increasing interest rates, higher valuations, and easing regulations during the first six months of 2018, they may see less need to push the inorganic lever of M&A to grow earnings. Still, with significant momentum in the system, the second half of the year could see some strategic and financial deal-making on par with or in excess of 2016. We expect larger banks to continue to acquire fintech capabilities and evaluate which businesses are core to their strategy and divesting those that no longer fit, smaller banks continuing to consolidate and private equity firms to continue to monetize remaining crisis-era investments.

Are the Ducks Quacking?


IPO-5-17-18.pngAn initial public offering isn’t the only path to listing your bank’s shares on the Nasdaq or New York Stock Exchange, and gaining greater liquidity and more efficient access to capital via the public markets.

Business First Bancshares, based in Baton Rouge, Louisiana, opted for a direct listing on the Nasdaq exchange on April 9, over the more traditional IPO. Coincidentally, this was the same route taken a few days prior—with greater fanfare and media attention—by Swedish entertainment company Spotify. A direct listing forgoes the selling of shares, and provides an instant and public price for potential buyers and sellers of a company’s stock.

Business First’s direct listing could be seen as an IPO in slow motion. The $1.2 billion asset company registered with the Securities and Exchange Commission in late 2014, ahead of its April 2015 acquisition of American Gateway Bank. Business First then completed a $66 million private capital raise in October—$60 million of which was raised from institutional investors—before acquiring MBL Bank in January. The institutional investors that invested in Business First last fall did so with the understanding that the bank would be listing soon. “We actually raised money from the same people as we would have in an IPO process,” says Chief Executive Officer Jude Melville.

Melville says his bank took this slow route so it could be flexible and take advantage of opportunities to acquire other banks, which is a part of the its long-term strategy. Also, bank stocks in 2015 and 2016 had not yet hit the peak levels the industry began to see in 2017. The number of banks that completed an IPO in 2017 more than doubled from the prior year, from eight to 19, according to data obtained from S&P Global Market Intelligence.

“The stars aligned in 2017” for bank stocks, says Jeff Davis, a managing director at Mercer Capital. The Federal Reserve continued increasing interest rates, which had a positive impact on margins for most banks. Bank M&A activity was expected to pick up, and the Trump administration has appointed regulators who are viewed as being friendlier to the industry. “There’s a saying on Wall Street: When the ducks are quacking, feed them, and institutional investors wanted bank stocks. One way to feed the ducks is to undergo an IPO,” Davis says. Bank stock valuations are still high, and so far, 2018 looks to be on track for another good year for new bank offerings, with four completed as of mid-April.

The more recent wave of bank IPOs, which had trailed off in 2015 and 2016, was largely a result of post-crisis private equity investors looking for an exit. As those investors sought liquidity, several banks opted for life as a public company rather than sell the bank. That backlog has cleared, says Davis. “It’s still a great environment for a bank to undergo an IPO,” he says. “Particularly for a bank with a good story as it relates to growth.”

The goals for Business First’s public listing are tied to the bank’s goals for growth via acquisition. Private banks can be at a disadvantage in M&A, having to rely on all-cash deals. A more liquid currency, in the form of an actively-traded stock, is attractive to potential sellers, and the markets offer better access to capital to fuel growth. Melville also believes that most potential employees would prefer to work for a public versus a private company. “Being publicly traded gives you a certain stability and credibility that I think the best employees find attractive,” he says.

Business First’s delayed listing was a result of leadership’s understanding of the seriousness of being a public bank, and the management team focused on integrating its acquisitions first to be better prepared for the listing.

“You really have to want to be a public company and make the sacrifices necessary to make that possible,” says Scott Studwell, managing director at the investment bank Stephens, who worked with Business First on its pre-public capital raise but not its direct listing. “There has to be a lot of support for doing so in the boardroom.” The direct preparation for an IPO takes four to six months, according to Studwell, but the typical bank will spend years getting its infrastructure, personnel, policies and procedures up to speed, says Lowell Harrison, a partner at Fenimore, Kay, Harrison & Ford. The law firm serves as legal counsel for Business First. Roadshows to talk up the IPO and tell the company’s story can have executives traveling across the country and even internationally.

And the bank will be subject to Wall Street’s more frequent assessment of its performance. If a bank hits a road bump, “it can be a rough go for management in terms of looking at the stock being graded by the Street every day, not to mention all the compliance costs that go with being an SEC registrant,” says Davis. All of this adds more to the management team’s plate.

Considering a public path is an important discussion for boards and management teams, and is ultimately a strategic decision that should be driven by the bank’s goals, says Harrison. “What is the problem you’re trying to solve? Do you need the capital? Are you trying to become a player in the acquisition market? Are you just simply trying to create some liquidity for your shares?” Filing an IPO, or opting for a direct listing, should check at least two of these boxes. If the bank just wants to provide liquidity to its shareholders, a listing on an over-the-counter market such as the OTCQX may achieve that goal without the additional burden on the institution.

In considering the bank’s capital needs, a private equity investor—which would allow the bank to remain private, at least in the near term—may suit the bank. Institutional investors favor short-term liquidity through the public markets, which is why Business First was able to obtain capital in that manner, given its near-term direct listing. Private equity investors are willing to invest for a longer period of time, though they will eventually seek liquidity. These investors are also more actively engaged, and may seek a board seat or rights to observe board meetings, says Studwell. But they can be a good option for a private bank that’s not ready for a public listing, or doesn’t see strategic value in it.

Though Business First’s less-common path to its public listing is one that could be replicated under the right circumstances, the majority of institutions that choose to go public are more likely to opt for a traditional IPO. “The reality is that direct listings are very rare, and it takes a unique set of circumstances for it to make sense for a company,” says Harrison. While a direct listing provides more liquidity than private ownership, be advised that the liquidity may not be as robust as seen in an IPO, which tends to capture the attention of institutional shareholders. “Usually, it’s the actual function of the IPO that helps kickstart your public market activity,” he adds. And if the bank needs an injection of capital—and determines that a public listing is the way to do it—then an IPO is the best strategic choice.

Acquire or Be Acquired Perspectives: How to Address the Social Issues of M&A


culture-5-4-18.png	Steele_Sally.pngThis is the final installment in a five-part series that examines the bank M&A market from the perspective of five attendees at Bank Director’s Acquire or Be Acquired conference, which occurred in late January at the Arizona Biltmore resort in Phoenix.

Read the perspectives of other industry leaders:
John Asbury, president and CEO of Union Bankshares
Gary Bronstein, a partner at Kilpatrick Townsend & Stockton LLP
Eugene Ludwig, founder and CEO of Promontory Financial Group
Kirk Wycoff, managing partner of Patriot Financial Partners, L.P.


It is tempting to think that last year’s tax cuts will spur deal-making in the bank industry. The cuts have driven up profits and bolstered valuations, with bank stocks trading at their highest earnings multiples since before the financial crisis. But deal volume ebbed instead of flowed last year.

“The tax reform allows potential sellers to wait longer to see how things evolve,” says Sally Steele, chairwoman of Community Bank System, Inc., an $11-billion bank based in Dewitt, New York.

Steele made this point while attending Bank Director’s 2018 Acquire or Be Acquired conference in January at the Arizona Biltmore resort in Phoenix. Her perspective on the M&A landscape is one of five that Bank Director cultivated from attendees at the event.

Whether it is prudent for a bank to sit on the sidelines as things evolve, rather than take advantage of a high valuation, is a risk—particularly when it comes to regulation. “You might have a four-year window where we have a kinder, gentler regulatory environment,” Steele notes.

All of this speaks to the axiom that banks are sold, not bought. “Folks have to come to a decision that selling is a good strategy, whatever the motivation,” says Steele.

Value plays an obvious role in this decision, but it alone is not enough. Social issues involving leadership and culture also play a major role, Steele says.

For instance, succession is a perennial topic of conversation in the industry. As leaders retire, it can be hard to find successors that are qualified to step into the void. One way to address this is to sell the bank.

There are also times when the current leadership is not a good fit, irrespective of retirement. This came up in one of Community Bank System’s recent acquisitions, where the CEO was better suited to be a commercial lender than the CEO.

Steele speaks on these issues from experience, as she has served as a director of banks that have been both buyers and sellers.

Prior to serving on the board of Community Bank System, Steele was a director of Grange National Banc Corp., a Pennsylvania-based bank that grew to $278 million in assets before selling in 2003 to her current bank.

Since then, Community Bank System has acquired seven other banks, the biggest and most recent being Merchants Bancshares, a $1.9-billion bank based in Vermont, acquired last year.

The principal motivation for buyers tends to be growth. The bank industry has consolidated every year since 1984. Prior to that, the number of banks in the country tended to grow on an annual basis. Since then, it has dropped without interruption every year.

Given this, it is easy to understand why banks are so inclined to grow. There comes a point in a consolidating industry when the law of the jungle takes hold, forcing banks to choose between eating or being eaten.

This motivation helps explain the tendency for mergers and acquisitions to impair, as opposed to improve, shareholder value. It was the imperative to grow, after all, that led banks in the prelude to the financial crisis to acquire subprime mortgage originators, as Bank of America Corporation did with Countrywide Financial and Wachovia did with Golden West.

Regardless of the numbers, however, Steele emphasizes the central role that culture plays in the acquisition process. “From a buyer’s perspective, it’s about how the combination fits,” says Steele. “Fits in a lot of different ways, not only monetarily and economically, but also the culture is huge. Bringing in the wrong culture just doesn’t work. I don’t care what anybody says, it doesn’t work.”

As the chairwoman of an acquisitive bank, this is one reason Steele attends the annual Acquire or Be Acquired conference, coming four out of the last five years.

“I’ve been through the acquisition process, and it’s a scary thing,” says Steele. “There is a lot of distrust when folks start approaching you about that kind of thing. So having rapport and thinking, ‘Oh, I met that person at the conference.’ That’s helpful. So much of it is personal. I don’t care what anybody says.”

Acquire or Be Acquired Perspectives: Two Banking Megatrends to Watch For


megatrends-4-27-18.png	Bronstein_Gary.pngThis is the fourth in a five-part series that examines the bank M&A market from the perspective of five attendees at Bank Director’s Acquire or Be Acquired conference, which occurred in late January at the Arizona Biltmore resort in Phoenix.

Read the perspectives of other industry leaders:
John Asbury, president and CEO of Union Bankshares
Eugene Ludwig, founder and CEO of Promontory Financial Group
Kirk Wycoff, managing partner of Patriot Financial Partners, L.P.


There were two industry trends at the forefront of attendees’ minds at the 2018 Acquire or Be Acquired conference hosted earlier this year by Bank Director at the Biltmore resort in Phoenix: the heating up of technology and the cooling down of M&A.

This was echoed in a conversation that Bank Director had at the conference with Gary Bronstein, a partner at Kilpatrick Townsend & Stockton LLP, who presented at the event and said that his biggest takeaways came from conversations about technology.

Bronstein is one of five perspectives Bank Director cultivated about M&A following its annual conference in late January.
The bank industry is no stranger to changes, many of which have led commentators and industry observers in the past to proclaim the death of traditional banks. Yet, there was a palatable sense among bankers in Phoenix that the evolution in technology happening right now could indeed be different.

“What does all of this actually mean?” asked Bronstein. “It’s pretty general at this point, but the demographics are changing. There’s a recognition that, once you get below a certain age range, people stop going into branches.”

The impact of this is starting to be reflected by trends in deposit growth. “I thought it was interesting to learn that, historically, the community banks typically increased their deposit bases by taking customers away from larger banks, but it appears that this trend has reversed itself,” says Bronstein. “The largest banks in the United States are now organically growing deposits even though they pay rates that are considerably lower than what community banks pay.”

Bronstein notes that brand recognition is one explanation for this. “When a young person moves to a new place and they need to open a bank account, they pick a bank with a household name,” says Bronstein. But he also believes that it could be driven by the ability of large banks to afford better technology that better appeals to younger generations.

One consequence is that banks should prioritize efforts to recruit directors with technology experience. “It’s important to have the right kind of expertise on your board,” says Bronstein. “Banks have been good about having accounting expertise on their board because, particularly for public companies, you are essentially required to have that for your audit committee. But I think equally as important today is technology expertise. It is important to make the effort to try to find it.”

Whether a bank is successful at recruiting the right expertise depends in part on location. “In rural areas this can be more difficult,” says Bronstein. “In urban areas or around urban areas, there are plenty of prospects with technology experience out there. It’s just a question of picking the right person.”

In addition to conversations about technology, Bronstein also noticed at the 2018 Acquire or Be Acquired conference that bankers seem more optimistic than at any time over the past decade. But interestingly, that optimism does not appear to be filtering through to M&A activity.

What’s causing this juxtaposition? There are few likely culprits, Bronstein notes.

The first is that there are not as many buyers in the market. “A theme at the conference was recognition on the part of people involved in bank M&A on a daily basis, including myself, that in many markets there is a limited number of buyers,” says Bronstein.

Underlying this is the perception that it is safer and simpler to grow organically. “There are some banks that have come to the conclusion that they do not want to be buyers,” says Bronstein. “They do not want to take on the risk. They do not want to do the work because it is not an effective use of their management capital.”

Another reason Bronstein offers for the underwhelming M&A market is that only a limited number of banks have currencies that are potent enough to make highly accretive acquisitions.

Many banks are trading for high multiples to their earnings, of course, but the problem is that much of the industry is in the same boat. This leaves few opportunities for banks with high valuations to realize earnings and book value accretion from the acquisition of banks with low valuations.

There’s also the simple matter of arithmetic. As the bank industry consolidates, with an average of 4 percent of banks disappearing by way of merger or acquisition each year, the number of prospective targets shrinks. And to Bronstein’s earlier point, this is a trend that is only likely to continue as community and regional banks seek the scale needed to compete against the technology offerings of the big banks.