Five Questions That Directors Should Ask About Proposed Acquisitions

You no doubt are aware that consolidation is on the rise in the banking industry. You probably have already been assessing your strategic options as a member of a bank’s board. But what you don’t want is to be on that board that made a phenomenally bad decision where a purchase or sale is concerned. The following are some suggested questions to ask management about a proposed acquisition.

1. What impact does this deal have on shareholders?

This is a no brainer as a first question. But it’s the overarching question that includes many more to follow: Is the deal accretive to earnings? It should be, almost immediately. What are the cost savings from the deal, and how did management calculate that? How did management come to its conclusions about how the deal would add to earnings? What’s the internal rate of return? How does it impact the bank’s tangible book value? What’s the payback period on any book value dilution? Typical earn-back periods are two to four years to earn back any dilution, says Matt Veneri, managing principal and co-head of investment banking at FIG Partners LLC. Veneri thinks investors understand that rising stock prices are forcing buyers to pay higher premiums to acquire banks, and it might take longer to earn back that dilution of book value. But Gary Bronstein, an attorney at Kilpatrick Townsend & Stockton LLP, says you might be stretching it to ask investors to like a deal with an earn-back period exceeding four years. With stock prices rising and earnings improving for banks, “deals are accretive to earnings, but more often than not, they are dilutive to book value,” he says.

2. What is the rationale for doing this deal, strategic or otherwise?

In any acquisition, there is risk. You are taking on another bank’s issues if you are buying it, not to mention the costs of the transaction. You are likely paying a premium over book value to acquire another bank. “So why are you taking that risk?” asks Bronstein. Some banks feel like they need to get to a certain size to leverage costs. Some want to expand their market because they want to get into higher growth markets, Bronstein says. Those are all legitimate reasons to engage in the transaction, as long as due diligence is carefully conducted and the possible impacts of the deal are carefully considered.

3. How will this impact our bank?

One of the important considerations for the board is to address the impact of the acquisition (or acquisition strategy) on capital. Will the bank need to access the public markets to bring in additional capital, and how does that impact the financial side of the equation? What will be the cost of raising such capital? You need to try to get answers to those questions as best you can, says Veneri. If you have an all-stock transaction, you might not need to raise capital, but a significant cash component of the acquisition could change that equation. Luckily, the market has been very receptive to quality institutions that want to raise capital to make acquisitions. Also, is the bank prepared to handle the acquisition? Has the management team made acquisitions in the past, or do you need to bring in expertise from the outside? It’s important that the board assess whether the bank has adequate bench strength. Does the management team have experience doing an acquisition? A lot of banks currently doing acquisitions have established that strategy as a line of business. If the selling institution has credit issues, do you have the staff in place to address those problems? Veneri asks. Do you need to find third parties to help with due diligence or to work through problems? A lot of banks, particularly those with less than $2 billion in assets, bring in third parties to help with due diligence and loan reviews of the seller.

4. What kind of due diligence has been done?

Has there been a third-party loan review of the seller? asks Bronstein. Are you comfortable relying on your own staff to do that? Have you looked at board minutes and exam reports of the seller? Does your bank have any regulatory issues, because if so, that could really quash or significantly delay a transaction, Veneri says. What is the quality of the branches you are acquiring? What sort of risks are you taking on to your balance sheet? Are you inheriting any large shareholders or activist shareholders with the deal?

5. What are the integration challenges you will face?

This could very well be the most important consideration for your bank. Historically, integration challenges have crashed the best looking financial deals. “That historically is the difference between success and lack of success-the inability to integrate different cultures,” Bronstein says. Integrating computer systems is always a worry, but so is integrating people. Ask your management team: “Are we going to lose people who are revenue generators?” If the answer is no, what is management’s plan to make sure that doesn’t happen? Are you going to take on new board members, and if so, what effect will they have on your board’s culture and performance?