Where Have All the Buyers Gone?

The following feature appears in the third quarter 2024 edition of Bank Director magazine. It and other stories are available to magazine subscribers and members of Bank Director’s Bank Services Program. Learn more about subscribing here.

The board and management team of $74 million Lake City Federal Bank in Lake City, Minnesota, had plenty of reasons to begin pursuing a merger before its recent sale. The 90-year-old institution’s then-CEO was nearing retirement, and most of the candidates for the job wanted to work remotely from the Twin Cities, 70 miles north, or get paid more than the bank could afford. 

At the same time, the regulatory burdens and technology costs were getting too great to shoulder. When the other local bank in this picturesque Mississippi River town of 5,200 was acquired and started to introduce the latest in customer-facing technologies, any questions about the mutual bank’s long-term future felt answered. 

“That’s when the writing was on the wall,” recalls Jeff Coats, the bank’s former chief financial officer who briefly took the reins as CEO before the bank sold. “We said, ‘We truly can’t afford to compete. … We’re better off partnering with someone who has deep enough pockets to invest in those technologies.’”

Deciding to sell, it turned out, was the easy part. The search for a partner took longer than anyone expected and required Lake City Federal to cast a wide net across several states. In 2022, it agreed to merge with East Wisconsin Savings Bank, the $267 million subsidiary of Wisconsin Mutual Bancorp, located about 300 miles to the east in Kaukauna, Wisconsin, only to see the deal fall apart 13 months later when Wisconsin Mutual experienced capital issues.  

After a second round of searching, Lake City Federal finally found its match: $1 billion Forward Bank, a subsidiary of Forward Financial in Marshfield, Wisconsin. The deal was announced in January and closed in May. Today, white plastic covers draped over the bank’s signage proclaim it a “branch of Forward Bank.” 

Finding a merger partner “was a lot more difficult than anyone here thought it would be,” says Coats, who is now a Forward senior vice president. His advice to other community bankers looking for a deal today: “Be patient. It could be tougher than you think to find a partner, and everything will take a lot longer than you think or hope it will.”

Like Selling a House
For decades, it’s been an article of faith in bank boardrooms that when it comes time to sell, at least a few willing buyers — a local rival, a bank from a neighboring market, a regional institution — would step up with a palatable offer. As Lake City Federal’s odyssey illustrates, those expectations often aren’t met these days. 

Every investment banker or lawyer has a story or two of unnamed institutions whose boards and management believed a cadre of buyers would be ready to step up when the time was right, only to discover that the level of interest wasn’t nearly as great as they expected.

“Most of the deals we’re working on, it’s one or two buyers at best. And in many cases, there’s no interest at all,” says Bill Burgess, co-head of investment banking in the financial services group at Piper Sandler & Co.

For bankers and board members who put so much time and effort into their institutions, this can sting. “It’s like if you list your house and are convinced it’s worth $1 million, but when you put it on the market you don’t get any nibbles at that price,” says Christopher Olsen, managing partner at Olsen Palmer, a Washington, D.C.-based M&A advisor. 

“I’ve seen it happen, and it’s tough,” he adds. “People look like they’ve been hit by a truck” when the interest in their institutions isn’t as great as expected.

The relative dearth of buyers is especially acute in rural America, where many banks operate. It is delaying executive retirements and forcing some selling banks to make compromises and change tactics. Some are getting more creative in structuring deals to meet buyer needs. Others are sitting down with buyers such as credit unions that not long ago would have been considered taboo. 

This shortage of buyers makes efforts to prepare for a sale more important. Many bankers and boards resist thinking about selling — or don’t act for fear of spooking employees or customers — until the decision is on top of them. They don’t take the time to update credit files, tweak business models or resolve regulatory disputes, and sometimes sign long-term data processing (DP) contracts with termination fees that make deals prohibitively expensive to execute. 

M&A advisors say gussying up the bank prior to a sale by tying up loose ends, locking in key employees and ensuring that there are no surprises can boost the odds that a seller gets a good result. 

“There’s a whole category of things a bank should be doing two to five years ahead of when they might want to sell, but most don’t,” Olsen says. “They’ll wait until there’s a catalyzing event — the CEO wants to retire, the board or shareholders want liquidity — and suddenly say, ‘It’s time to sell the bank.’ By that time, it’s often too late.”

Robert Fleetwood, a partner at Barack Ferrazzano Kirschbaum & Nagelberg in Chicago, gives clients a 10-page pre-transaction checklist that includes cleaning up regulatory concerns and balance sheet issues, proactively addressing vendor contracts and tweaking the business mix.

“It’s like putting your house up for sale. You want to give the living room a fresh coat of paint and fix any plumbing problems,” Fleetwood says. “It’ll cost you some, but it can make a big difference when it comes to attracting attention and getting the kind of deal you want.”

Fewer — and Pickier — Buyers
The short-term reasons for the lack of buyers are plain enough. When deposits soared and interest rates were near zero during the Covid-19 pandemic, many banks bought bonds and then were caught with paper losses when rates jumped. Those accumulated other comprehensive income (AOCI) losses are unrealized if the bonds are held to maturity; engage in a transaction, and they become all too real. That’s made the math of many deals more challenging than in the past. 

Uncertainty over the quality of commercial real estate and other loans doesn’t help. Nor do longer regulatory approval timelines, which are making buyers more selective than ever. 

The days of an acquirer buying three, four or 10 smaller institutions in a year are past. Today, deals tend to come one at a time, with approval processes that can stretch well past a year. Most acquiring bank CEOs have a wish list of institutions they’d like a shot at and don’t want to get encumbered in a deal for an attractive bank if their top target might become available. That’s made acquirers more cautious. 

“There are deals that I would have done in the past, but I won’t do today,” says David Zalman, senior chairman and CEO of $38.8 billion Prosperity Bancshares, a historically acquisitive bank in Houston. “You have to be more selective today because they might not let you do another deal for two years.”

Olsen tells the story of a $15 billion bank that had long coveted a smaller institution in a neighboring community. When that potential target recently put itself on the market, the would-be buyer held off. 

“They said, ‘If we’re only going to get a few bullets because of the regulatory environment, we have to save them for A-plus deals,’” he recalls. “There’s a pickiness among buyers that we haven’t seen before.”

Trend or Mirage
Whether this is a blip or the start of a longer-term trend is a subject of debate. Just 100 bank deals were completed in 2023. That’s the lowest total in more than 30 years, according to figures compiled for Bank Director magazine by Piper Sandler & Co. The aggregate deal value of $4.18 billion last year was the lowest since 2009. For comparison’s sake, the industry saw 475 deals worth a combined $288.5 billion near the peak of the industry’s great M&A boom in 1998.

To many, the M&A slowdown is mostly about higher interest rates and seller expectations. “I don’t think banks are having trouble finding buyers. I think they’re having trouble finding buyers at an attractive price,” says Timothy Crane, CEO of $57.6 billion Wintrust Financial Corp., an active acquirer in Rosemont, Illinois, outside of Chicago. He attributes such impasses to “interest rate marks and challenging short-term economics.”

Others argue that the market is experiencing a more fundamental transformation, driven by earnings and numbers. The country had 4,587 banks and thrifts at the end of 2023, less than half the total 20 years earlier, according to the Federal Deposit Insurance Corp. Not only have many of the most attractive banks been acquired, there also are fewer buyers left. 

Many of the banks looking to sell are small institutions in economically stagnant markets that sometimes aren’t viewed by buyers as being worth the price or effort. The median asset size of a selling bank in 2023 was $175 million, according to an analysis by Olsen Palmer. That’s too small to move the needle for many buyers, regardless of price. 

“There are some markets where buyers just say, ‘There’s not enough growth there. We don’t have interest no matter what we might pay for it,’” says Kirk Hovde, managing principal and head of investment banking for the Hovde Group in Inverness, Illinois.

Michael Daniels, chairman and CEO of $8.4 billion Nicolet Bankshares in Green Bay, Wisconsin, says his bank usually targets the “lead local bank” in a new market and has recently passed on several deals for small institutions in slow-growth areas. “The reality is that no one is falling over themselves to buy an $85 million bank,” he says. “The costs of doing a deal are more than the accretion could ever be, even if you got rid of every expense.”

There’s also some broader discontent about the effectiveness of deals to deliver value. Stephen Scouten, a managing director and senior research analyst at Piper Sandler, says he’s noted some buyers who have been disappointed in both their returns on recent deals and the reaction of shareholders.

“There’s a growing belief that buyers never really get what they thought they would get out of a deal,” Scouten adds. “Investor appetite for M&A isn’t what it used to be.” 

Olsen argues that the industry’s ongoing evolution is simply making smaller banks less compelling to buy. “What a lot of sellers don’t appreciate yet is that the value proposition of buying a community bank is declining,” Olsen says. 

“When you layer in the costs of technology, compliance, regulation and human resources with margin compression, banks don’t make as much money as they used to,” he explains. “There’s a sense that the earnings stream for banks has been dampened almost permanently. That can make things more difficult for someone trying to sell.”

Compromises and Concessions
Such factors have led to a growing backlog of bankers looking for an exit. Many have already stayed longer than planned and are feeling antsy. Some have underinvested in systems or are struggling with AOCI issues and don’t see a way forward in the face of shrinking net interest margins and higher operating costs.

“They’re essentially looking for a buyer to fix their problems. But there’s elevated compliance risk because they haven’t spent money on the back office or don’t have the right personnel in place,” says Peter Weinstock, a partner at Hunton Andrews Kurth in Dallas. “In some cases, the buyer is willing to do that. But often it’s too much work.”

The current environment, coupled with institution-specific challenges, can force sellers to make concessions they might not want to make. Dan Bass, managing director of Performance Trust Capital Partners, says he is working with an M&A client that saw its AOCI figures worsen in the middle of a deal. 

Both sides want to move forward on the transaction, but the deal structure and math need some tweaking. “We’re trying to figure out how to take some of the risk off the table [for the buyer] by having the sellers take on the additional AOCI risk from announcement to closing,” Bass explains.

Others are casting their lots with nonbank buyers after concluding no better options exist. Selling to credit unions, once considered heresy in many banking circles, is now commonplace — especially if the seller wants cash. Credit unions often can afford a slightly higher premium because of their tax-exempt status and different rules for goodwill accounting, Bass says. In 2023, 11% of all bank acquisitions were by credit unions, according to  S&P Global Market Intelligence data. A decade earlier, the figure was less than 1%. 

Other buyers in recent years include fintech firms and less traditional banks such as community development financial institutions (CDFIs), which often receive government capital to support lending in underserved communities. In 2023, 23% of banks sold to a company other than a traditional bank or thrift, according to S&P; in 2013, the figure was 8%.

Fintech investors with banking as a service (BaaS) operations have been buying banks for their charters. “I get a call once a month from someone who wants a charter and has $30 million to $50 million in equity,” Bass says.

Jim Eckert, CEO of Anchor State Bank, the $47 million subsidiary of Anchor Bancorp. in Anchor, Illinois, was nearing retirement late last decade and struggled to come up with an exit plan. When he started 40 years ago, rural McLean County boasted 32 community banks, many of which would have made logical partners. Today, only one of those institutions remains. 

With interest in a small ag bank scant, Eckert, who owned just over half of the bank’s equity, looked further afield. One offer came from the owner of a couple of troubled mortgage lenders with shaky finances. Two more were overseas suitors who Eckert, now 75, thought wouldn’t pass regulatory muster or continue to serve his customers.

“I wanted to keep it local,” he says. “[My customers] are my friends. I wouldn’t sell to someone who would close the branch in five years.”

In 2019, the owner of an Ohio medical payments firm agreed to buy Anchor to help facilitate insurance claims disbursements. “We’re a BaaS bank now,” says Eckert, who was asked by the buyer to stay on and plans to retire soon. But the new owner also pumped capital into the bank and has committed to continue serving its ag customers.

Selling to a CDFI bank is another potential avenue. Michael Bush, former CEO of $119 million Mississippi River Bank, a two-branch shop based in Belle Chasse, Louisiana, says succession issues and increasing regulation drove his bank’s decision to sell. “My board was aging out, my shareholders were aging out, and my engine was beginning to attenuate,” he explains.

The bank attracted plenty of interest from other banks, but Bush says his shareholders wanted cash, and he thought a nontraditional acquirer would be the best bet. “I wanted to be a high-performance, plug-in engine that doesn’t compete with something [the buyer] is already doing,” Bush says.

In April, Mississippi River closed on a sale to Merchants & Marine Bancorp, a $687 million CDFI bank out of Pascagoula, Mississippi, that has the balance sheet to fuel his bank’s business model. While Merchants & Marine is a regulated bank, its government funding gave it the ability to make a stronger cash offer than a traditional bank. “They had a lot of CDFI capital to buy us with, and nothing they do competes with what we do,” Bush says. “It was a great fit for us.”

Boosting Curb Appeal
The idea of making the bank more attractive for sale isn’t revolutionary, but few boards put much effort into it. Short-term fixes and window dressing can be sniffed out quickly by experienced acquirers, but Olsen estimates that up to 80% of potential sellers do little or nothing to prepare themselves in advance for judgment day. 

“There are a lot of savvy community bank boards where it’s almost taboo to even consider talking about selling,” Olsen says. “You’re building a company, hiring employees. It’s difficult to say, ‘Join us, but we might sell tomorrow.’ But not thinking ahead limits people’s planning and can back them into a corner down the road.”

Olsen has been working with a buyer group that hopes to capitalize on a future where there are more sellers than buyers. While banks are valued most for what they do best and should prioritize making those core strengths even stronger, efforts to proactively enhance the institution’s curb appeal can be a critical differentiator when it comes to attracting buyers in a challenging M&A market. 

Hovde says a bank should always operate like it’s going on the selling block, and work to control the things it can control. That means keeping files and contracts current,  addressing easily fixable issues, avoiding long-term commitments, and understanding the market and the bank’s strengths and weaknesses. 

At the very least, Burgess suggests getting a two- or three-year head start. “You need the maturity to say, ‘We’re likely to sell or merge with another institution in a few years’ and then work backwards from the anticipated date to ensure that you’ll get some return from the investment,” he says.

Proactive steps that boards and management teams can take to make their bank more attractive for an eventual sale include:

• Tightening data processing contracts.  Terminating a long-term data processing contract is often one of a merger’s biggest costs. Coats says Lake City Federal will spend about $1.2 million to buy out the remaining three years on its seven-year contract with Fiserv. “One of the first questions that comes up in any deal is, ‘When does the DP contract expire?’” Bass says. “If it’s three or four years into the future, I’ve seen those numbers break up a deal.”
• Addressing regulatory issues.  Even the smallest regulatory issues, such as exam criticisms, can be a deterrent for buyers if they’re not addressed before putting the bank up for sale. “You might think it’s not that important, but it can be tough to convince [a suitor] that’s the case,” Fleetwood says. “Much better to say, ‘We had an issue and cleaned it up.’”
• Locking in key employees.  Making longer-term contracts and noncompete clauses a regular part of doing business well before a sale can help avoid raising employee concerns. Many banks have one or two loan officers or a market president whose loss would significantly hurt the bank’s attractiveness to potential buyers. “If your biggest lender is critical to your success, you need to lock that person in,” Fleetwood advises.
• Cleaning up credit files.   Updated digital files can expedite the due diligence process and communicate that the bank is serious. “The more organized you seem to be, the better perception the buyer will have of you,” Hovde says.
• Gussying up facilities.  Even in the digital age, physical structures should be maintained. Weinstock says he is working on a rural bank deal that risks being blown up because the HVAC system needs more than $1 million of work. “They have significant deferred maintenance, and they’re in a market that’s not growing,” he says. “The market for a bank like that is really limited, mostly because of the decisions they’ve made.”
• Planning for the transition.  An out-of-market buyer, even a big one with a lot of infrastructure, will likely want the CEO to stay on for a couple years to aid the transition and pass along relationships. “Ideally, you should look to close a deal two or three years before the CEO wants to retire,” Hovde says.