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Time to acquire?

Part 1: Consolidation period calls for careful planning

Time to acquire?

These days, community bank boardrooms are abuzz with talk of mergers and acquisitions.

The talk generally springs from a discussion of allocation of capital and how best to enhance the value for shareholders. Is this through a merger transaction? Through an acquisition? Through the proverbial and alleged “merger of equals”? Something else? 

Because M&A seems to be the discussion topic of choice, I thought I would use this blog to offer some basics.

Inside the boardroom: the fiduciary question

The M&A discussion generally begins at the board level with a discussion of what level of excess capital or available capital the community bank has and how best to use it. This is simply the community bank board doing its job.

Capital allocation alternatives, as noted in prior blogs, include returning capital to the shareholders through dividends or stock repurchases, acquiring other lines of business, or acquiring another community bank or the branch of another community bank.

Lately, as the industry is returning to health, acquiring another community bank has risen to the forefront.

For many community bank holding company boards, the acquisition of another community bank or the sale of their own will be the first time they have engaged in that type of transaction.

Inevitable “nomenclature” discussion

Once a community bank holding company board decides a merger or acquisition transaction is the best use of capital, there often follows an odd discussion about nomenclature.

One director will say, “We should to do a merger.”

And another one will say, “No, we don’t want to do a merger. We want to do an acquisition.” 

Frankly, the terminology is basically a difference without distinction.

It is simply a question of whether your community bank holding company will be a buyer or a seller, or will try to structure something that looks like a merger of equals (these do not exist, by the way).

In the latter case, of course, you want your community bank and holding company to be the “more equal.”  Once the community bank board understands the nomenclature, then it needs to understand the process.

Understanding the “currency”

Community bank board members do not need to be experts in M&A. That is why you retain competent professionals. However, the board does need to understand the basic process when a community bank holding company begins to embark on an acquisition transaction.

Assume, for the moment, that your community bank holding company has determined to be a buyer.

The first step toward an acquisition is analyzing what the bank holding company can afford from a capital standpoint, whether it has excess capital that it has or can get or a marketable currency, i.e., stock somebody might take.

With respect to the use of community bank holding company stock as a currency, the board must realize that it is very difficult to get a community bank target that controls an illiquid stock to accept in payment for its illiquid stock another community bank holding company’s illiquid stock that it will not control.

As a result, most community bank acquisition transactions will be for cash.

The only possible exception is if the purchaser is a Sub S that has enough “shareholder slots” left and has a good after-tax cash flow coming off their stock. If that is the case, then the purchasing bank holding company may find a target bank holding company whose shareholders are willing to take the Sub S stock as currency. Otherwise, most community bank acquisitions will be for cash.

Considering your target

Once the board determines its capital capacity and the currency that might be available, the next step is to identify the ideal target.

Your target may be selected for a variety of reasons. It may be a bank of a certain size and capitalization that provides geographic diversity, or product diversity. The target may engage in lines of business that yours does not—it may have a trust department while you don’t. They may have a solution to your bank’s management succession issues—or may be looking to your bank’s offer as the solution to theirs. Or they may enjoy a lasting source of low-cost funds.

Likely multiple banks fit your bank’s criteria. So then the board needs to identify what it considers important characteristics, determine how best to identify those targets, and then identify and rank the targets in order of preference.

Once the targets are identified, a preliminary financial analysis should occur and then the targets should be contacted.

Gauging your target’s interest

Generally, if the CEO or Chairman of a community bank that is looking to buy another institution knows the target bank, I recommend that they make the contact. If they do not know the target, then frankly, it does not matter who makes the contact since it will pretty much be a cold call. Your attorney or merger consulting firm would be the logical candidates.

If there is some inkling of interest after the initial contact is made, then the next step is to run much more detailed financial projections and create an expression of interest to be sent to the target.

The expression of interest can be in the form of a “term sheet” or an actual letter indicating that the purchaser is willing to pay between X and Y for the target—subject to due diligence.

This overture simply serves to see if there can be a possible meeting of the minds before due diligence occurs. Often, if there is an interest in the price, then the other terms will be negotiated.

Don’t forget the nonfinancial factors

If there is some interest in what would often be called a true merger of equals (two $400 million banks coming together), it often makes sense to sit down and see if the social issues, i.e. the non-financial issues, can be resolved first.

Social issues include which charter is going to survive; whether the banks will be separate subsidiaries of the holding company; who will be the CEO of the holding company; where the world headquarters will be located; who is going to be on the board, etc.

It’s good to get such matters on the table early. Non-financial issues in a “merger of equals” will often kill a deal before you get to the financial details.

Doing the due diligence

Once a meeting of the minds occurs as to the general terms of the transaction, then the buyer can conduct due diligence of the seller.

By the way: In a cash transaction, the seller should also conduct limited due diligence of the buyer to ensure the buyer can get the cash to provide the payment and get regulatory approval.

Once that is concluded, negotiations continue as the big, 60-page agreement, known in the business as a “definitive agreement,” is prepared by the buyer’s legal counsel. That agreement is then executed and the transaction is generally announced. (For non-public bank holding companies, it does not have to be.)

Then regulatory and shareholder approvals are sought, and the transaction consummates.

Regulators play a part, so include them early

This is a typical “buy-side” scenario. In the current environment, it will likely be six months or longer from the time the nonbinding term sheet or letter of intent is negotiated until the closing, depending on how involved the regulators get.

In today’s environment, it is a good idea, as a practical matter, to vet the proposed transaction with regulators once the banks/holding companies get serious to see if there are any preliminary hurdles on the frontend that need to be addressed.

As a practical matter, the regulators want to see the resulting bank qualify for a CAMELS 2 rating.

If there are problems with regulatory compliance, asset quality, or otherwise, then the transaction process is certainly prolonged.

Remember, if you have not had experience with community bank mergers and acquisitions, make sure you retain professionals who understand this particular area. If you don’t get professional help at the frontend, you may need a different kind of “professional help” at the end.

Since every buyer needs a seller, I will deal with the sell side of community bank mergers and acquisitions and some of those unique issues in the next blog.

Next: Time to sell?

Jeff Gerrish

Jeff Gerrish is chairman of the board of Gerrish Smith Tuck Consultants, LLC, and a member of the Memphis-based law firm of Gerrish Smith Tuck, PC, Attorneys. He frequently contributes to Banking Exchange and frequently speaks at industry events.

In mid-2016 Gerrish's blog received a national bronze excellence award from the American Society of Business Publication Editors. This followed his receipt of the regional silver excellence award for the Northeastern Region from the same group.

Gerrish formerly served as regional counsel for the FDIC’s Memphis regional office and with the FDIC in Washington, D.C., where he had nationwide responsibility for litigation against directors of failed banks. Since the firm’s formation in 1988, Gerrish Smith Tuck has assisted over 2,000 community banks in all 50 states across the nation with matters such as strategic planning, mergers and acquisitions, common stock private placements, holding company formation and reorganization, and a wide variety of regulatory matters. Jeff Gerrish can be contacted at [email protected].

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