How the COVID Crisis Is Impacting Banking M&A

June 2, 2020 Jim Young

Mergers and acquisitions - once an attractive tactic for banks - have become more problematic during the COVID crisis. Why are some banks pulling the plug on planned mergers, and how are banks that made recent acquisitions handling the new lanscape?

We discuss those topics and more in this week's Purposeful Banker podcast. 


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Jim Young: Hi, and welcome to the Purposeful Banker. The podcast brought to you by precision lender, where we discuss the big topics on the minds of today's best bankers. I'm Jim Young director of content, PrecisionLender, and I'm joined again today by Dallas Wells, our EVP of strategy. This one's going to be pretty straight forward. The jumping off point for our discussion today is the Texas Capital, Independent merger that wasn't. Dallas let's just start there before we get into bigger implications. What happened here and why did this deal fall apart?

Dallas Wells: I think the deal fell apart because the whole world kind of fell apart. So I think what was interesting is you typically don't see deals, especially deals of this size come apart when they're this far down the road. So Texas Capital and Independent Bank are two pretty good sized banks in Texas. I think as a combined entity, they'd be somewhere in the neighborhood of $50 billion in total assets. Something like a five plus billion dollar merger agreement. And so for those of you who have been a part of these deals by the time it's announced, you're way, way into the deal, right?
So they've been working on this thing for many months. They've racked up many millions of dollars of legal fees and advisor fees and just internal time and attention. Texas Capital at the time that they announced that the deal was being scuttled also announced that their CEO, longtime CEO is leaving, stepping down. Chairman of the board, stepping in temporarily while they start a search for a new CEO. So there's obviously this is not a decision that gets made lightly. It's a multi billion dollar transaction. Thousands of employees impacted, tens of thousands of customers watching what's happening here. So big deal.
Why it fell apart. There's lots of speculation as to the specifics, but the things that we know from the most recent quarterly earnings reports from both banks, Texas Capital has a pretty good sized oil and gas exposure. They actually reported a loss in the first quarter, giant loan loss provisions, and a big chunk of it related to two specific loans. So they had a couple of big credits for them go sideways and they started reserving for them. And with that exposure and just a lot of unknowns in that market, some uncertainty on their side.
And then Independent, they actually have a big exposure to commercial real estate, specifically commercial real estate for retail strip centers, which is another just highly uncertain area right now. So I think just a lot of unknowns on both sides. On top of that, you've got the fact that a lot of employees can't come into the office right now. So actually merging two organizations of this size. It's a gigantic undertaking anyway, then with all these circumstances, it was clear just enough extra risk that both sides decided to walk away. And I think also worth noting there is that there was something like $115 million. I may be off on that number, but it was a 100 million plus breakup fee basically for either side and that was waived both directions.
So this was a mutual decision. This wasn't one bank had problems that the other one wasn't comfortable with. It was, they just both came back to the table and said, you know what, let's not do this right now. So big deal and lots of discussion about it in the industry over the last couple of days.
Jim Young: Yeah. And it wasn't what I saw at 115 million. And I was going to say, that's the smallest of silver linings in this whole thing is that, hey, at least you just have to eat that fee. But so the discussion that's being had here, and I guess the first one I think of is you've laid out a lot of perfect storm elements as to why this thing went wrong. And so that's my next question is, is, okay, do you look at it and go, wow, that was just, you tried to do a merger right at this point and you're in Texas. I know you mentioned the retail, but in particular, we've talked a lot about the energy sector and how bad that's being hit. Do you just go, well that's perfect storm, or do you look at this and say, this is an indication of something bigger in the M&A field.
Dallas Wells: I think you don't just have to look at this deal. There's some other things that I'm sure we'll get to it as we talk about the implications here, but the price of these transactions just changed and it changed middle of the transaction, right? So it's like you're shopping for something in the store and you get to the checkout counter and the price on the price tag and the price on the scanner come up as two different numbers. You've got a decision to make at that point of, do you go ahead with the new price or do you no longer want to be a part of it?
I think that's exactly what happened. They were getting ready to dump a lot more time, attention and money into this deal and the value of the deal was just different. These deals have lots of moving parts. There's equity going both directions, there's equity to employees, there's retention agreements, there's the price changing or the value changing has really big follow on effects. So it's certainly a bigger deal for everything else happening in M&A. There's lots of other deals that have been struck that have not yet closed that are, I would say in jeopardy for the exact same kind of reasons.
Now they may not have some of the specific credit issues that were clearly at play here, but they have some credit issues at play and lots of unknowns at play and just the multiples, right, the market multiples are different, which means that all the goodwill that gets baked into closing a transaction like this, the accounting, I think gets a lot more risky than it was 90 days ago. It's meaningful enough that a deal could go from being accretive, to not accretive and that's enough for a lot of boards to just say, we're out.
So I would say every deal that's still pending out there is at risk. And everybody that was in the middle of negotiating is in many ways starting over and saying, we need to redo most of the due diligence we did and we certainly probably need to have a brand new discussion about price.
Jim Young: All right. So I want to tackle this going forward from three different perspectives. One is sort of if I'm a bank that was in the acquisition mode, how do I think about things? The other one is if I was a bank looking to be acquired, how do I think about things? But you just said the magic word goodwill, which made me think are the banks that have already made recent acquisitions put on the books. Again, I keep thinking of these sort of things from a retail customer standpoint, and it feels a bit like I just really putting together all of my stuff and got a mortgage on a house in a neighborhood that is right at my limits, right as the housing market just crashed sort of thing. So that's the feel I have for some of these banks, but let's talk about that first, some banks that have recently made some significant acquisitions, no take backs on that. What happens for them at this point?
Dallas Wells: Yeah. So a lot of that goodwill will be immediately impaired. It has to be written down and we've already seen some of that happen in a recent earnings reports. So, some pretty good sized regional banks. I think American Banker had an article about it last week or so of some of the sizable write downs that have happened. I think Umpqua was one of those near the top of the list, solid operator that's made good, solid acquisitions all along the way. And just, this is a phrase that we've probably are over overusing, but just unprecedented, right? And unforeseen circumstances way beyond their control, but it's still a write down. The goodwill that you have there, the sort of the blue sky left over from an acquisition is not as blue as it was when you closed the deal.
So that's an immediate write down, a hit to earnings that compounds when you're also trying to bump up loan loss provisions and you've probably got some other outside pandemic expenses to deal with of just keeping your business up and running and healthy and your employees healthy and happy, all that stuff. So from those deals that have just closed, that's the immediate economic impact. And I think that's part of what makes all those pending transactions from either side makes people a little wary of them.
Either if you're the acquirer, again, that's an accounting risk to you. If you just got bought, sometimes you're taking stock from the acquiring company as your form of payment and that's probably not as steady of a bet as you maybe thought it was again, just a couple of months ago. So just everything's changed. All aspects of those deals have changed.
Jim Young: Yeah. And it's really, as you mentioned from their perspective there's lessons, maybe for people that are about to go into this, that they can take from it. But if you, from the banks that just made those acquisitions, the lesson of don't make a major banking acquisition one to two years before an unprecedented global pandemic is not really applicable going forward. It's just a, you don't need to be-
Dallas Wells: Well it's a tricky one to execute.
Jim Young: Right. Exactly. You just have to grit your teeth and find a way forward through it. But blame game, probably not something to be played there. But let's talk then about the banks that, and we've had this for gosh, pretty much almost since the previous crisis that M&A has been a big growth strategy for a lot of banks is this we need to scale up and the way we're going to do this is not steadily increasing our own activity, it's going to be buying up other banks.
Does this put a total cooling effect on that strategy? Or we've had the bill bank type discussions, is there a path forward and once you say, hey, actually, there's going to be some rock bottom values out there at this point.
Dallas Wells: Yeah. So what we've seen in banking cyclical, right? We've seen cycles before, not long, quite like this, but they're all a little different. There's still cycles within the industry. And there's typically a lull, a slow period where everybody tries to find their footing and determined strategies and also just figure out what's on their balance sheet and what's on their dance partners balance sheet too. And then after that, the acquisitions pick back up again. They're just of a different nature.
So we saw through the financial crisis. And again, that was one where we had a weakened banking industry, where it was lots of combinations in order to survive and lots of wounded banks that ended up getting acquired for pennies on the dollar. I'm guessing we'll see some of that again this time too. So there through the good times, the acquisitions happen for growth reasons and they happen at premium prices and you're finding good franchises and good things to bolt onto your existing footprint, your existing business model.
Through periods like this, they become much more about just opportunistic buys. And you have buyers who only make acquisitions during times like this, right? So you mentioned Beal Bank. They're the far end of the spectrum, but there's other banks like that where they don't pay the premium prices through the good times, they wait to buy what they feel like are solid franchises when they're on sale. And all you have to do is to look in the equity markets at what's happened to a lot of bank stocks, especially those that have some fuzzy looking exposure that people can't quite get a grip on yet. The banks are on sale.
So people will make some opportunistic acquisitions there. I don't think there'll be as much like panic M&A, as there was last time around of marriages to survive, but there will be some, "Hey, we've always thought this might be a decent bank to take a look at and it was trading at 140 times book. Now it's at 80% of book." Or whatever the case may be, right? That's a significant enough discount that you can step into it and the extra risk you deem is worth it. So it'll come around, there'll be a little lull and then the nature of those acquisitions will be different than they were a few months ago.
Jim Young: So then let me make sure I'm summarizing here. If I'm a bank, maybe again, not on the Beal Bank sort of spectrum, but I'm a bank that this was a principle part of my growth strategy was to make a few, maybe one, two acquisitions over the next five years or that to get to a certain asset level point and that sort of thing, is it just, okay, just keep my powder dry until that point comes around or do I say well, for in the interim, I need to pivot to this particular growth strategy instead.
Dallas Wells: I think if you were willing to make acquisitions six months ago, and that was your strategy, I think that's still the strategy. Nothing fundamentally has changed. Again, just the due diligence is always a malleable process, right? The things you look at for one target versus a different one are going to be very different. So the things we're looking at now in this particular environment are going to be maybe different than we expected. Every deal has a price, right? There is a price at which it's still enticing to you. So I think some of this will come down to what I found in talking to banks and just in watching their behavior, there's different time horizons at play here, right?
So some banks that were looking to do acquisitions, they do them with a fairly short view of them and they're trying to stitch together multiple banks and get to a certain size and probably rolled up again themselves, right? It's part of a longer term. The longer term play is to sell pretty quickly. For others it's look, I'm going to be opportunistic and if the market hates this for two years and we have to eat some losses for a couple of years, and it's a little painful on earnings temporarily, I'm going to look at this five years from now and be thrilled that I bought it. Those banks tend to be a little more closely held. They've got longer term, more patient shareholders, and they're willing to take on a little more short term risks for the long-term gain.
So if you were a bank looking to make acquisitions, you still do it. Just, the details have certainly changed. The price points have certainly changed, but it still fits. And if you were, I would say the difference there is if this was a short term play for you, there's way too much short term uncertainty. And so in that case, those banks, I think will keep their powder dry and they will just wait and say, we'll wait for these markets to stabilize before we resume that or maybe the strategy shifts entirely. There's some interesting and probably painful board conversations to happen at banks that were on that path.
Jim Young: Well, that's what I'm curious about for our third group though, which is the banks that have been setting themselves up or maybe not setting themselves up, but that saw that basically the next move on the horizon is to be acquired. And so let's make ourselves an attractive target for acquisition. That at least to me feels like that is a more, a shorter time horizon on that sort of thing. That if you're a bank in a position where we need to be acquired, do you have the time to pull back and say, all right, well it's maybe not in the next year or two, but let's go ahead and plan on this in our next five years. Or do you have to, again, to go back to the house analogy, do you just have to cut the price because you're moving out of the market, so to speak.
Dallas Wells: Yeah, those banks are the ones that will end up being most affected by this and that's a really tough position to be in, right? So in the banking business, if you're not growing, if you're not investing in the future, you're slowly atrophying and dying and there's a fair number of banks that that's the decision they've made is that it's time for us to exit, right? It's too difficult for us for whatever the circumstances are. There's more value to exit now than to try to stick around independently.
Well, again, the algebra changed there, right? That exit price is just different and on the other side of that, staying independent just got a lot more uncertain, a lot more downside potential there as well, especially since it sure looks like surviving this and thriving going forward means if anything, accelerating some of the digital transformation that was happening out there, like what customers will expect from you requiring them to come into the lobby all the time is even more of a showstopper than it was before.
And so those banks are now stuck between, do we take an even lower price or do we make even bigger investments to try to stick around? Otherwise you're betting that this is a quick enough bounce back, that you can just hold on and stay relevant enough that the price recovers soon. It's really an ugly spot to be in. I think those are the banks and they tend to fall into a certain size group where they've just gotten to an awkward spot where it's hard to be thriving and independent at the size they're at. I think it would be really interesting to see how many of those decide to hold out and how many who just say, this is exactly why we wanted out, right? We are not viable through the sorts of shocks like this, and to be able to come out on the other side. So sorry, the price is less than we thought it was going to be when we started on this endeavor, but we're out. I think there's going to be quite a few that just end up with no choice, but to do that.
Jim Young: Yeah. And the other thing in this equation is just the timeline on where we are on this sort of thing is so unknown. You run that risk of, Hey, all right, we're out, we'll pull out and then all of a sudden, two months, hey, things dramatically change and you feel like man, but that's nature of markets in general, I suppose. So it definitely, this is one a topic I suspect we will be coming back to in the next few months from a variety of different angles. But Dallas, thanks for coming on again.
Dallas Wells: Yep. Thanks Jim.
Jim Young: All right, that'll do it for this week's show. Thanks again for listening. Reminder, if you've got questions about things in the market that you want us to discuss or to dive into our data set and see what we find and talk about on the podcast, just shoot me an email again. It's initial J-Y-O-U-N-G That'll be in the show notes as well and appreciate all the feedback that we've gotten and ideas to this point.
Again, if you want to listen to more podcast or check out more of our content, you can visit the or head over to our homepage to learn more about the company behind the content. Like what you've been hearing, please leave us a review on any of our platforms, iTunes, Google play, Stitcher, and we'd love to get feedback there. Until next time, this is Jim Young, Dallas Wells, and you've been listening to the Purposeful Banker.

About the Author

Jim Young

Jim Young, Director of Content at PrecisionLender, is an award-winning writer with experience in a range of positions in media and marketing, from reporter to website editor to content marketer. Throughout his career Jim has focused on the story – how to find it, how to understand it, and how best to share it with others. At PrecisionLender, he manages the many ways in which the company shares its philosophy on banking and the power of relationships. Jim graduated Phi Beta Kappa from Duke University and holds a masters degree in journalism from Columbia University.

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