Bank Mergers and Consolidation: Structuring M&A...

Bank Mergers and Consolidation:

Structuring M&A Deals Overcoming Hurdles of Capital Requirements, TARP Funds, and Other Regulatory Demands

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TUESDAY, DECEMBER 3, 2013

Presenting a live 90-minute webinar with interactive Q&A

Mark C. Kanaly, Partner, Alston & Bird, Atlanta

C. Robert Monroe, Partner, Stinson Morrison Hecker, Kansas City, Mo.

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Bank Mergers and Consolidation: Structuring M&A Deals December 3, 2013

Mark Kanaly mark.kanaly@alston.com

(404)881-7975

Bob Monroe bmonroe@stinson.com

816.691.3351

Overview of Banking Environment

• Excess Funding

• Limited organic loan growth

• Lingering credit issues – provisions and credit costs continue

• Hangover capital structures put pressure on bank earnings

• Net interest margin compression

6

Overview of Banking Environment (continued)

• Higher Capital Requirements/Less Leverage

• Higher Regulatory Costs and Scrutiny

• Intense Pricing Competition

• Spread crisis

• Lack of plentiful buyers in $5B+ asset range

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• The United States has far more financial institutions than any of the other major developed economies in the world (sources: CIA World Fact Book; SNL Financial; European Central Bank; Canadian Bankers Association; Japanese Bankers Association)

• Additionally, the United States has more financial institutions per citizen than any of those developed economy peers

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Overview of Banking Environment (continued)

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Overview of Banking Environment (continued)

• This financial services market saturation potentially sets the stage for massive industry consolidation during the next decade

• The majority of this consolidation will occur in the community banking space (less than $10B in total assets)

Types of Banks that are Emerging

• Smaller Banks ($500 million or less) hoping to become larger - MOEs

• Large Number in Midwest hoping to get to $500 million+

• Survivors and Thrivors

• Regional Banks increasing Footprints

• Size seems to be a theme

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Why that Fosters M&A Lack of robust organic loan growth

+ Increasing compliance and regulatory costs

+ Public markets celebrating the stocks of acquisitive banks

+ Sharp decline in FDIC-assisted transactions

____________________________________

= Significant M&A pressure on banks

• The analyst and investment banking communities have been fueling this fire . . .

• Public market valuations speak clearly to this point

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Types of M&A/Trends

• FDIC Assisted Transactions Dwindling

• A lot of Asset Purchase Transactions (leaving bad assets with Seller and entering into Servicing agreements)

• Traditional Stock Purchase and Merger Transaction

• More Stock Deals (?)

• More Branch Deals

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Valuation and Pricing

• Credit analysis and credit marks dictate pricing

• Important role of third party loan review

• Ability to measure / manage risks in resulting loan portfolio

• Deals are priced based upon book value and not earnings

• Analyst community is judging deals by two metrics: • Earn-back period for dilution to tangible book value

• Cost savings

• Role of Goodwill and Deferred Tax Assets

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Earnback/Holdback Periods

• Many deal types (i.e., asset, stock and merger) have Earnback/Holdback Provisions

• Similar to Assisted Deals

• Time Periods vary from 1-3 years

• Deal Documents very hard to negotiate (indemnity provisions)

• Kill many Deals

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Tangible Book Value vs. Earnings Analysis

• Price to Tangible Book Value • Derivative of earnings

• Cited most often in an absence of earnings

• Sets the pricing ceiling in boom times and the pricing floor in recessionary times

• Earnings • True measure of profitability and value

• The key metric in normal economic periods

• Sets the pricing floor in boom times and the pricing ceiling in recessionary times

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Tangible Book Value vs. Earnings Analysis (continued)

• Banks historically traded at 13x to 15x core earnings and sold at 17x to 20x core earnings

• Rising real estate values, lenient lending standards and lower compliance costs permitted ROAs of 1.00% or more

• 5% Tier 1 Leverage was considered healthy, making high ROEs relatively easy to achieve

• It wasn’t uncommon for acquirers, returning 1.30% ROA on 5% capital and trading at 380% of TBV, to acquire targets at 17x-20x earnings and still have an accretive acquisition

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Tangible Book Value vs. Earnings Analysis (continued)

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Tangible Book Value vs. Earnings Analysis (continued)

• More restrictive lending standards and fierce competition for good credits putting pressure on spreads

• Increased regulatory burden is driving higher fixed compliance costs

• Both put pressure on ROAs, making 1.00% exceptional instead of the norm

• 8% Tier 1 Leverage is the new “healthy,” making high ROEs harder to achieve

• Dividend yields will also have a substantial impact on trading price

• Depressed valuations lead to lower merger premiums (per SNL, YTD average P/TBV for bank mergers in the Southeast: 105.3%)

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Tangible Book Value vs. Earnings Analysis (continued)

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Tangible Book Value vs. Earnings Analysis (continued)

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Across market cycles, larger community banks enjoy a significant trading price advantage over their smaller peers

Source: SNL Financial

Tangible Book Value vs. Earnings Analysis (continued)

Regulatory and Other Deal Hurdles

• TARP

• TRUPS

• CRA

• Bank Stock Loans

• AML/BSA/OFAC Scrutiny

• QM

• Consumer Protection Rules

• Consumer Advocacy Groups

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Regulatory Issues Facing Private Equity and Hedge Fund Investors

• Ownership Thresholds and Resulting Ownership Structure

• Voting vs. Non-Voting Positions

• ROI and Internal Timelines

• Liquidity Events

• Multiple Stakes/Co-Investment

• Passivity Commitments

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Other Challenges

• HHI

• Regulatory Orders

• Stockholder Challenges (Dissenters)

• Fairness Opinions for Stock Deals

• Seller Board

• Seller Management

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Other Challenges (continued)

• Pricing (be sure purchase price calculations are understood – use examples)

• Investment Portfolio Valuations and types of Investments

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Credit Diligence and Risk Allocation

• Avoid Surprises

• Conveyance of Order

• Pro Forma CAMELS 2 Requirement

• Third Party Loan Review

• Lending Constraints Going Forward

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Legal Due Diligence

• Review all written and oral contracts as soon as possible

• Data processing

• Employee benefits

• Real estate being acquired • Title work

• Survey (?)

• Environmental search

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Legal Due Diligence (continued)

• Real Property Leases

• Personal Property Leases

• Litigation

• Securities Issued by Seller

• Bylaws and Articles (Bank and BHC)

• Insurance (including D&O and BOLI)

• TRUPS and TARP (if applicable)

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Legal Due Diligence (continued)

• Other Debt Documents (FHLB & Bank Stock loan)

• Past Securities Offering Documents

• Shareholder Agreements

• Sample of Loan Documents

• OREO

• Vendors

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Legal Due Diligence (continued)

• Exams (SAS and Compliance)(be careful)

• Tax returns

• Accountant Work Papers

• Deferred Comp Agreements

• Employment and Retention Agreements

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Earnouts/ Holdbacks

• Negotiation “Bridge”

• Gentlemen's wager

• Equity True-Ups

• Escrow

• Warrant

• Earnouts

• Challenges in Implementation

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Equity True Ups

• Purchase Consideration Normally Determined Last Day of Month Prior to Closing

• May Have an Equity True Up 30-90 Days after Closing with Independent Consultants Handling

• Appeal Process

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Stock vs. Cash

• Board Duties

• Challenges in Valuation

• Diligence Implications

• Securities Law Implications

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