M&A Alert for Banks: Preparing to Be a Buyer

January 27th, 2017

strategy-1-27-17.pngBefore a board and management of a bank pursue an acquisition, they should realistically assess their bank, the characteristics of the board and the shareholders, and the alternatives available.

The board and senior management should develop a strategic plan for the bank. The Federal Deposit Insurance Corporation has cited an increasing number of banks for lack of strategic planning in matters requiring board attention. The Office of the Comptroller of the Currency also has focused on strategic planning in the last few years. 

All board members must share a commitment to the strategic plan. Divisiveness in the boardroom often jeopardizes a bank’s ability to achieve its objectives.

The board has a fiduciary duty to make fully informed business decisions as to what is in the best interests of the hypothetical shareholder who is not seeking current liquidity. Management must assume the responsibility of educating the board (or bringing in consultants to do so) regarding the bank’s strengths and weaknesses, its inherent value, and the market(s) for targets. The board and senior management should meet regularly to discuss the bank’s strategic direction.

Debate in the planning process is healthy, but once the board agrees on a course of action, the board and management should speak with a united voice.

The board and management should communicate the bank’s strategic direction to shareholders. If key shareholders disagree with the direction, the board and management should arrange for such shareholders to be bought out or be comfortable that the bank need not do so. It is difficult to achieve strategic objectives if the board and key shareholders are working at cross purposes.

Evaluate Alternatives
The prospective buyer has a number of alternatives for enhancing shareholder value or multiple paths to be pursued at the same time. The board should evaluate such alternatives to identify the most attractive transaction.

Evaluate Your Prospects for Success
In embarking on bank M&A in the current environment, sellers will demand assurances that buyers can close. Here are some of the factors purchasers should consider:

  • Community Reinvestment Act and compliance ratings: Purchasers need to understand the “hot button” issues driving regulatory reviews and stay up to date. Yesterday’s focus on asset quality, anti-money laundering and Bank Secrecy Act compliance and third-party relationships have been joined by redlining, incentive compensation, concentration risk and cybersecurity, among others.
  • Capital levels: Determine whether the bank’s capital is sufficient to support an acquisition. If not, where will your bank obtain the needed funding?
  • Management: Does the purchasing bank have sufficient senior management capacity to staff the acquired bank or will target management be needed to implement the acquisition?
  • Systems and facilities: The purchasing bank’s board should evaluate whether the bank has compliance management systems and an enterprise risk management program that can scale for the acquisition.

Coming up with a good strategic plan while considering the bank’s alternatives is important for the board to discuss before embarking on an acquisition.

Negotiating the Transaction
There still may be a problem: What if there are very few targets that the bank has identified as “fits,” and none of them are in the market to sell?

Increasingly would-be buyers are willing to consider offering stock as part or all of the merger consideration. There are several drivers of this newfound willingness. First, buyers must meet increasingly challenging capital requirements. The exchange ratio in the merger may offer more attractive pricing to the buyer than issuing common equity to the market. Second, sellers have become more willing to accept private or illiquid stock as merger consideration. This may be a function of sellers’ understanding that economies of scale offer potential for greater returns on investment while enabling sellers to refrain from taking their “chips off the table” as would be the case in a cash sale. The recent run up in the stock market indexes has not yet translated into a general increase in M&A pricing. Third, a transaction that provides for a significant stock component allows for more one-on-one negotiations. Lastly, a strategic combination allows for mutuality of negotiation.

Just offering the selling shareholders stock may not be enough to convince a reluctant seller to consider a transaction. Would-be community bank buyers must recognize that there are social issues in any transaction (even when the merger consideration is cash). Accordingly, the buyer must evaluate in advance the roles of senior management of the seller, retention arrangements to proffer, severance to provide as well as bigger picture social issues such as board representation, combined institution name and headquarters.

A focus on the social issues and a willingness to put stock on the table may allow community bank buyers to continue to compete for acquisitions despite the rebounding stock market. Other competitors may be able to offer nominally more attractive pricing, but such an offer may not have better intrinsic value.

pweinstock

Peter G. Weinstock is the practice group leader of the Financial Institutions Corporate and Regulatory practice group at Hunton & Williams LLP.  Weinstock writes and speaks frequently on topics of interest to community bankers. He may be reached at (214) 468-3395 or pweinstock@hunton.com.