Preparing for Mergers & Acquisitions

 

In this episode, we’re revisiting an issue that receives a ton of attention in the industry; mergers and acquisitions. To help us with the discussion, Dallas Wells is joined by John Freechack from Piper Jaffray.

 

   

 

Podcast Transcript

Dallas: Welcome to another episode of “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 am your host, Dallas Wells, and thank you for join us. Today, we are revisiting an issue that is rightfully getting a ton of attention in the industry, and that is mergers and acquisitions. To help us with that discussion, I am joined by John Freechack from Piper Jaffray. Welcome, John, and thanks for taking the time to do this.

John: Thank you. Pleasure to be on here, Dallas.

Dallas: John, why don’t you start by just telling us a little bit about yourself and what your role is there at Piper Jaffray.

John: Absolutely. Well, actually I started my career at a commercial bank, so lots of experience in the industry here, and at Piper Jaffray, we are an investment bank that our team focuses on the financial institution space. Within that we have a number of different capabilities, capital markets, fixed income, research, sales, trading. My specific focus is more in the mergers and acquisition front, capital markets, as well as strategic planning to work with bank and determine, for example, whether or not going down the path of an acquisition, a merger of equals, a control sale is the best course of action for [inaudible 00:01:16] versus remaining independent. We actually just reentered the financial institution space, Piper Jaffray, about a year ago, and have significant amount of experience with the employees here. We’ve been at a number of other investment banks prior to this, but still a relatively new endeavor for Piper Jaffray back into the financial institution front.

Dallas: We’ve seen in our client base, of banks a lot of the M&A activity pick up. I assume that probably has something to do with you guys jumping back in, but what do the trends look like institution wide as far as just basic activity level?

John: Good question. It continues to be a consolidating industry. It’s hard to believe. You look back at the mid 1980’s and we had 18 thousand plus banks in this country. We’re at 62 hundred now.

Dallas: Yeah.

John: You lob on top of that the fact that there have basically been de novos since the economic downturn. The first of which was Bank of Burdenhand in Amish country Pennsylvania. There was finally another on least in New Hampshire, and that’s been it.

Dallas: Right.

John: You go back 10 years and we used to have … It wasn’t unusual to have a couple hundred of de novos in a year. There’s no new supply coming into the industry with new de novo charters. What you can pretty much count on is that we’re continuing to see, call it 3% to 5% of the industry is consolidating on an annual basis. You have a couple of hundred banks being consolidated annually, but no new banks are coming like what happened in the ’90s and early 2000’s. We’re at 62 hundred banks now, and you are going to continue see, I think, call it 200 to 250 transactions over the next couple of years per year as we continue whittle down the size of the industry.

Dallas: It’s been made pretty clear to everybody why there’s not much supply on the front end; just the big hurdles that there are from a regulatory perspective coming in. What are some of the big factors that are driving a lot of that merger activity? Is there some overarching theme or are buyers and sellers being driven by different things?

John: From the buy side, a big part of it, and one of the reasons you’ve seen a few more mergers of equals even.

Dallas: Yeah.

John: Which generally are meant to be discussed and not actually done. There’s always somebody more equal.

Dallas: Right.

John: Getting the social components right is that much more difficult and that kind of transaction. I think it’s a nice barometer to show that the need and desire for additional scale in the current environment.

Dallas: Mm-hmm (affirmative).

John: You hear kicked around a number, for example, that you need to be a billion dollars in assets in the current environment to justify remaining in independent. There is not magic number. Unlike the 10 billion dollar threshold where the regulators come get you. There is no magic number that you need to justify remaining independent. The answer is you need to be bigger than before. Where there is absolutely is this increased compliance burden, that especially impacts smaller institutions. It’s beneficial if you can spread that fixed cost base over a larger amount of earning assets. From a buy side perspective, a huge driver right now is that desire for additional scale.

Dallas: Yeah.

John: Now scope is another key component where … A transaction we just announced about an hour and a half ago involving Byline Bank here in Chicago acquiring Ridgestone Financial Services out of Brookfield Wisconsin, is a nice example of where Ridgestone is basically a mono-line SDA or Small Business Association lender.

Dallas: Right.

John: They generate a significant amount of non-interest income via gain on sale revenue, and servicing income. That’s very attract as you can imagine in this environment to a large institution that’s looking to diversify its revenue base a bit and as we continue to be in this lower for longer interest rate environment, if you have sources of non-interest income, it helps your earnings and it’s viewed favorably by the market.

Dallas: Yeah, you can fight that margin compression a little bit.

John: As typically is the case, our two big drivers, and then of course you also have your … There’s always the element of is it a strategic move? Are you looking to get into a new market? Those are always considerations from the buy side as well. It is the big driver, I think, is that desire for additional scale in this regulatory and compliance environment for a lot of these institutions.

Dallas: John you mentioned that you do a lot of the strategic planning and thinking ahead of time basically before these transactions take place. Obviously, there is some kind of serial acquirer institutions out there that are good at this. They do it all the time. Walk us through for the bank that doesn’t do this all the time what that decision process looks like for the management and for the board. What kind of things are they talking about and thinking about and what’s that basic process look like from a high level?

John: Absolutely, a key component to take finish the thought on the buy side first, you want to look at it and determine a couple of things. One, if you haven’t been in the MNA game for quite some time, make sure that you’ve got the resources. Make sure that you’ve got the team in place where you’re going to be able to integrate this transaction. Make sure that you’re not biting off more than you can chew. Generally, if you’re doing a deal where the target is more than 20% of your assets size, integration can be a little bit trickier. Make sure that you’re going in with your eyes wide open and you’re not doing a deal just for the sake of doing a deal.

From the sell side, we generally will work with clients and basically walk through the exercise of if you remain independent, let’s do a sober analysis of what that looks like over the next 3 to 5 years. Then, look at the potential control sale alternatives should you be looking at a merger of equals as I just discussed. Is there a natural candidate for that? Should you be a buyer? Again, just as I talked about. Do you have the capacity for that? If you come to the conclusion that you want to be a seller … A number of the transactions we’ve done recently, our clients went through this exercise.

I’ll give you one example. We had another deal up in Wisconsin where a bank did a very nice job of cleaning up some credit issues that had cropped up during the downturn, got out from under the regulatory consent order, and then looked around and realized they were in this lower for longer interest rate environment. The economy is better than it was, but it sure isn’t easy to go out and generate new loan volume right now. They just weren’t going to be able to generate, even having the shackles off from the regulatory consent order, to go out and generate the kind of loan volume and the kind of earnings that would justify remaining independent. Partnering up was the logical next step for them.

There are a number of items that you want to think through. Each bank is different. Where succession issues continue to be an issue in this industry … Unfortunately, for the younger generation, community banks tend to get locked in with the JP Morgan Chase’s of the world in their mind. It can be a challenge sometimes right now to get that next generation on board here. We’ve seen that in a number of instances where, especially for smaller institutions where maybe there is a family dynamic, the next generation just isn’t interested in coming into this space.

Dallas: Yeah.

John: It’s still a good business to be in, but I think we would all agree it’s not as good as was 10 to 15 years ago. You look at the numbers. What used to be a 12%, 14% to 18% return on equity industry, now we’re closer to 8% to 10%. It’s just harder to be as profitable as we had been in years past. Again obviously a bit part of that is not just the economic interest rate environment we’re in but certainly in the regulatory environment as well.

Dallas: Yeah, absolutely. For those banks that decide to become sellers, do you see them effectively putting a for sale sign in the front yard or does that process usually start with a buyer approaching them out of the blue? What’s the typical way that a bank ends up getting sold?

John: I think the typical way, as you can imagine, we’ve seen just about everything. Sometimes, yes, occasionally there are hostile offers. Occasionally there is a discussion with one institution that seems to continue to build and you go down that path. Maybe if that does come to a control sale conclusion, you make the decision to make that into a broader option. I think that the most typical path is, as we just discussed, a bank will sit down, look at their alternatives, come to the conclusion that it’s in our best interest at this point and in our shareholder’s best interest if we explore a partnership, if we explore control sale. Then what you want to do is you haven’t already involved your financial advisor like a Piper Jaffray or your legal advisor in that part of the process, then typically that’s where you want to go out and gauge somebody who does work in this space on a daily basis.

First thing you want to do is get your house in order. Where if there are any change in control contracts that you want to put in place for upper management, making sure that you are able to collect relevant information in a timely fashion for potential buyers, and also making sure that from both sides of the fence there, it’s always a good thing to be communicating with your regulators.

Dallas: Right.

John: Just checking those types of boxes, but then what you do is you sit down and look at your potential buyer universe. Maybe there are one or two potential buyers who have indicated strong interest in the past. They also are likely to be the highest bidder in the process, so you say, “You know what? To help keep a lid on this and maintain confidentiality, let’s just go this one buy or these two buyers and see if that results in an outcome that we would find acceptable.” Many times as well, though, you look at it and say, “Well, you know what? There are maybe six to twelve very logical buyers who we believe would have an interest, who we know have the financial capacity and regulatory standing to consummate transaction. Let’s have a little bit broader option and go down that path.” A little bit more rare these days to see an institution going out to 50 potential buyers and really casting the wider net. That’s a little bit more rare. Typically, you see more of a targeted option process. Call it give or take, ten potential acquirers being contacted.

Dallas: Along those lines, we’ve got a few clients who’ve done quite a bit of tire kicking and the deals end up not happening, kind of falling apart somewhere along the process there. How common is that and what should a bank expect as far as you start looking. How many deals are you going to look at before you find something that really works?

John: No question about it. When you are working as a buyer, you really want to focus in. One of the things I would highly recommendation for a potential buyer is to take the time to work with your board, work with your financial legal advisory team, and prioritize your potential target list. The last thing you want to do, if you are the CEO of a bank and you spend time talking to this one bank that you think is going to be a good potential target, the opportunity rises and it turns out your board thinks that’s a horrible idea. You want to make sure that utilize your time wisely and you’re all on the same page there. Once you’ve prioritized that target list, you also want to take the time to court those high priority targets. That still does make a difference in this environment.

What I talked about just second ago about your question about what process does a seller typically engage in, well what if you’re priority target engages in a process where they want to only go to one or two potential acquirers and a much narrower list of potential buyers to go to? You want to make sure that you’re on that list. If you haven’t been involved in MNA for the last decade, maybe you’re a privately held institution, there’s a pretty good chance you’re not going to be on that companies A-list. Unless you go out and your financial advisor knows that you’re looking so they’ve got their ear to the ground. You’re legal advisor knows that. You’ve talked to that bank. It doesn’t have to be overly aggressive. Take them to a ballgame or something, and just let them know, “Hey, I think this would be a great fit for us. Would love it if you got to know our culture a little bit better, and if they day comes where you make the decision to go down that path, we would love it if we got a call from you.”

It doesn’t necessarily need to be a high pressure situation or you submit an unsolicited letter of intent. Get to know them where that can put you in a better position to make sure that you do get the call as potential acquirer if you’re looking to engage in acquisitions going forward.

Dallas: Yeah, so you at least get that opportunity if it arises.

John: You got it, absolutely.

Dallas: You mentioned earlier in specifically talking about mergers of equals and some of the potential difficulties there, but what are some of the things that banks need to think about as their putting the deal together for after the close? With those culture things, the systems integrations. What are the big hurdles that they have to clear there and what can they do to prepare for that?

John: Yeah, well you know what? Communication is critical there. Really this goes for any transaction where, again, in a merger of equals, there’s always a buyer and there’s always a seller as well. A key component there is making sure that you are communicating clearly with one another. This goes back, Dallas, to the question you asked just a second ago in terms of what derails transactions before they even get to a closing. Again, communication is just critical. If you’re a seller, don’t hold back. If you’ve got a skeleton in the closet, get it out in the open earlier in the process because eventually it will get discovered. You tend to lose leverage as time goes by. Making sure that everybody’s on the same page. If you’re discussing the potential offer with the buyer, make sure that you have absolute clarity in terms of what’s being discussed. Are they discussing that? Is it a fixed deal value? Will that change if three months pass between now and time that we announce the transaction? Is there a minimum equity that you’re requiring as a buyer? Make sure that you get all of these issues out on the table sooner rather than later.

That goes for the aftermath of a transaction as well. It’s only heightened in a merger of equals, where if you are not crystal clear in terms of everybody’s role post closing that transaction, you’re going to run into some issues. You want to make sure that everybody’s singing from the same hymnal and understand what their role is going to be with the pro forma organization. You’ve got to make sure in terms of the benefits of this transaction, are you clearly communicating that to the employee base, to the customer base? Can your employees communicate the rational for this transaction to the customers? Not every customer is going to be coming in and talking to the CEO. Can your lending team clearly communicate why this is beneficial for that customer?

Again, I think clarity and communication are absolutely essential. You need to prepare. Like most things, the more preparation you do, the better off you’re going to be. For the integration, the data processing conversion, making sure you’ve got the team in place, that you have the resources available, and that you’re ready. Inevitably, there are going to be some hiccups along the way. Having that plan in place, having the people in place, and trying to make sure that the integration and the transition is as smooth as possible for that customer base.

Dallas: Great, and I think, John, that’s actually a good place to wrap it up as the impact on employees and customers and making sure that you close that loop and really that’s the best way to set yourself up for success. Good stuff, and thank you again for making the time to do this. We really appreciate it.

John: My pleasure, Dallas, and I appreciated the opportunity to join you.

Dallas: Yeah, so appreciate it, and thanks to everyone for listening. We’ll provide links to a few resources including some links to John and Piper Jaffray in the show notes for this episode. You can always find those PrecisionLender.com/podcast. If you like what you’ve been hearing, make sure to subscribe to the feed in iTunes, Sound-clad or Stitcher, and we’d love to get ratings and feedback on any of those platforms. Thanks for tuning in. Until next time, this has been Dallas Wells, and you’ve been listening to “The Purposeful Banker”.