Is It Going to Be a Bumpy Ride?

by Spilman Thomas & Battle, PLLC
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as published in West Virginia Banker magazine, Spring 2014
4/9/2014

Margo Channing (Bette Davis) in “All About Eve” famously said, “Fasten your seatbelts, it’s going to be a bumpy night!” Does that sum up the status of future community bank merger activity? Maybe so.
 
Many financial professionals and American Banker have opined that bank merger activity, especially among community banks, is due to increase rapidly. An article by Andy Peters in American Banker on January 27, 2014 predicts that the recently announced merger of Yadkin Financial and VantageSouth Bancshares represents a tipping point for bank consolidation in North Carolina, and perhaps elsewhere. Of course many thought that activity would take off in 2013, and it did not, with a few exceptions.
 
There were many reasons for slow consolidation activity, but the largest three were uncertainty about bank loan portfolios, low relative pricing for bank acquisitions, and an uncertain economy. Bank loan portfolios and lending procedures seem to be strengthening, particularly among troubled banks. More and more banks are finding relief from special regulatory status. Most banks have written off the loans that have substantial risk. Accordingly, more potential buyers are a bit less concerned with “unexpected consequences.” And yet, many banks that have “turned the corner” still hope for a buyer, either because they have been damaged in the market, capital is still low and difficult to attract, or management is worn out. Stock prices are recovering slowly – more so for banks with a clean bill of health – but they are recovering. Most financial professionals doubt that banks will ever again see the extraordinary price multiples that they saw in the late 1990s through the mid-2000s. Bankers tend to have more realistic expectations of the bank’s worth. The economy, well, it seems to be the economy. Until the government can find that sweet-spot between regulating true risk and over-regulating the community banks that support economic growth, we may remain in a “mild recovery” (read that, “non-recovery recovery”). Add the uncertainty from additional regulation in other sectors, the Affordable Care Act, an increasing deficit, substantial turbulence in the international affairs and markets, etc., and the recipe is not yet in place for confident, private economic expansion. In other words, it probably will not get a lot better anytime soon, so we might as well adjust to a slow pace of growth.
 
West Virginia banks, to a large extent, escaped the “Great Recession” in pretty good shape. There were no bank failures in West Virginia. Most banks apparently have enough capital. “Stable” may be the best description. Reasons for this abound, but it means that West Virginia community banks, as a group, are not “looking” for a buyer or a merger partner as much as banks in many other neighboring states. But despite the general economy, many West Virginia banks are just across the border from neighbor markets that may grow rapidly. Industry in Ohio, shale gas in Pennsylvania, technology development in North Carolina, and federal government hiring and contracting in Maryland and Virginia all present opportunities for expansion. Also, excess capital (if there is such a thing anymore) is its own attraction. West Virginia banks may be in a special position, either as an attractive acquisition or as a possible buyer into a faster-growing market. If your bank is thinking about that, good for you! However, keep in mind that the process has risks that are often overlooked.
 
Everyone knows that you want to buy low and sell high. Or in a bank merger, maximize your value in relation to your chosen partner. Everyone also knows that the process is costly. There are three risks I will discuss today that you may not have considered. The first is timing. In the “good old days,” a bank merger typically took 6-8 months, start to finish. Mergers today are subject to more careful review by higher-level regulators. Approval generally must come from Washington, D.C., not your federal regulator’s regional office. Thus the process is slower, more expensive, and more risky. The recent proposed merger between CMS Bancorp in White Plains, N.Y., and Customers Bancorp in Wyomissing, Pa., was terminated due, in part, to delays. Many other mergers took much longer to complete than expected, including United Bancshares merger with Virginia Commerce Bancorp. Why does that matter? It matters because expected delays affect the price a buyer is willing to pay. Call it the “regulatory risk discount.” This is not money in the buyer’s pocket; it is a real assessment of the cost of the transaction, which now is higher. It even makes it more difficult to find additional investment. Many banks are looking to find more equity to improve their health. Some banks want to expand into nearby markets. Anything that makes an eventual sale of the bank look more difficult also makes an exit look less likely to large investors. The stock will be harder to sell. That’s okay for many community banks with little liquidity, but even small banks in large markets often rely, in part, on sophisticated investors. Regulatory uncertainty tends to reduce possible deal price, which reduces prices for banks across the board.
 
Another problem is that once the bank is put up for sale, that is a clock that is hard to unwind. When a bank has a deal to sell, and that deal is delayed or denied by regulators, that leaves the bank in a weakened position, with fewer options. This is a very expensive process. Legal and accounting costs are high. Failure stings in two ways, because it draws significant money from the bank’s capital, and it puts the bank’s future strategy into question. Shareholders will lament, “Why did management put us through this for a failed deal?” Future merger partners will worry that there is something they missed that is wrong with the bank, or that regulators will deny or delay a second deal also. This stigma can follow sellers and buyers. How do you convince a potential partner that a second deal will work? If you don’t want a second deal, how do you convince the market that you are not going to buy or sell again shortly?
 
That brings up the third, “hidden” risk. How does a community bank build its business when everyone believes that it is trying to sell? Competitors will use that as a reason for new customers to avoid the bank. You can almost hear those competitors say, “This is not really a community bank. You don’t know who you’ll be dealing with in a year.” It used to be that you did know. You would be dealing with the buyer. Once you announced the merger, you began selling the buyer. Now, unfortunately, you cannot be as certain. Uncertainty scares customers, and you may find growth, even in your established market, more difficult.
 
You can reduce these risks. First, develop a strategic plan with your board that explores all your options and opportunities. Don’t be surprised by an offer or a request to buy; know in advance who the possible partners are and what you want. Second, do not talk with someone you know you don’t want to deal with. Don’t talk with someone you are pretty sure that the regulators would not approve. A part of this requires talking with a legal advisor during the planning process. They can help you understand the corporate and regulatory process and also help analyze what partners are possible in terms of anti-trust consideration. They also can advise how you approach a possible partner to avoid future problems. Finally, communicate with your shareholders and your market consistently, intentionally. If you know your strategy, you will avoid saying things that harm credibility. I had a client who swore for many years that the bank would “never sell.” Then it entered into a contract to sell. The deal failed. How much credibility do you think management had after that? Circumstances change, but understanding your strategy and your options, and ensuring that your shareholder communications and marketing are consistent, will help to keep you in the good graces of your owners and customers.
- See more at: http://www.spilmanlaw.com/Resources/Attorney-Authored-Articles/Community-Banking/Is-It-Going-to-Be-a-Bumpy-Ride#sthash.MlvFWwc0.dpuf

As published in West Virginia Banker magazine, Spring 2014

Margo Channing (Bette Davis) in “All About Eve” famously said, “Fasten your seatbelts, it’s going to be a bumpy night!” Does that sum up the status of future community bank merger activity? Maybe so.
 
Many financial professionals and American Banker have opined that bank merger activity, especially among community banks, is due to increase rapidly. An article by Andy Peters in American Banker on January 27, 2014 predicts that the recently announced merger of Yadkin Financial and VantageSouth Bancshares represents a tipping point for bank consolidation in North Carolina, and perhaps elsewhere. Of course many thought that activity would take off in 2013, and it did not, with a few exceptions.
 
There were many reasons for slow consolidation activity, but the largest three were uncertainty about bank loan portfolios, low relative pricing for bank acquisitions, and an uncertain economy. Bank loan portfolios and lending procedures seem to be strengthening, particularly among troubled banks. More and more banks are finding relief from special regulatory status. Most banks have written off the loans that have substantial risk. Accordingly, more potential buyers are a bit less concerned with “unexpected consequences.” And yet, many banks that have “turned the corner” still hope for a buyer, either because they have been damaged in the market, capital is still low and difficult to attract, or management is worn out. Stock prices are recovering slowly – more so for banks with a clean bill of health – but they are recovering. Most financial professionals doubt that banks will ever again see the extraordinary price multiples that they saw in the late 1990s through the mid-2000s. Bankers tend to have more realistic expectations of the bank’s worth. The economy, well, it seems to be the economy. Until the government can find that sweet-spot between regulating true risk and over-regulating the community banks that support economic growth, we may remain in a “mild recovery” (read that, “non-recovery recovery”). Add the uncertainty from additional regulation in other sectors, the Affordable Care Act, an increasing deficit, substantial turbulence in the international affairs and markets, etc., and the recipe is not yet in place for confident, private economic expansion. In other words, it probably will not get a lot better anytime soon, so we might as well adjust to a slow pace of growth.
 
West Virginia banks, to a large extent, escaped the “Great Recession” in pretty good shape. There were no bank failures in West Virginia. Most banks apparently have enough capital. “Stable” may be the best description. Reasons for this abound, but it means that West Virginia community banks, as a group, are not “looking” for a buyer or a merger partner as much as banks in many other neighboring states. But despite the general economy, many West Virginia banks are just across the border from neighbor markets that may grow rapidly. Industry in Ohio, shale gas in Pennsylvania, technology development in North Carolina, and federal government hiring and contracting in Maryland and Virginia all present opportunities for expansion. Also, excess capital (if there is such a thing anymore) is its own attraction. West Virginia banks may be in a special position, either as an attractive acquisition or as a possible buyer into a faster-growing market. If your bank is thinking about that, good for you! However, keep in mind that the process has risks that are often overlooked.
 
Everyone knows that you want to buy low and sell high. Or in a bank merger, maximize your value in relation to your chosen partner. Everyone also knows that the process is costly. There are three risks I will discuss today that you may not have considered. The first is timing. In the “good old days,” a bank merger typically took 6-8 months, start to finish. Mergers today are subject to more careful review by higher-level regulators. Approval generally must come from Washington, D.C., not your federal regulator’s regional office. Thus the process is slower, more expensive, and more risky. The recent proposed merger between CMS Bancorp in White Plains, N.Y., and Customers Bancorp in Wyomissing, Pa., was terminated due, in part, to delays. Many other mergers took much longer to complete than expected, including United Bancshares merger with Virginia Commerce Bancorp. Why does that matter? It matters because expected delays affect the price a buyer is willing to pay. Call it the “regulatory risk discount.” This is not money in the buyer’s pocket; it is a real assessment of the cost of the transaction, which now is higher. It even makes it more difficult to find additional investment. Many banks are looking to find more equity to improve their health. Some banks want to expand into nearby markets. Anything that makes an eventual sale of the bank look more difficult also makes an exit look less likely to large investors. The stock will be harder to sell. That’s okay for many community banks with little liquidity, but even small banks in large markets often rely, in part, on sophisticated investors. Regulatory uncertainty tends to reduce possible deal price, which reduces prices for banks across the board.
 
Another problem is that once the bank is put up for sale, that is a clock that is hard to unwind. When a bank has a deal to sell, and that deal is delayed or denied by regulators, that leaves the bank in a weakened position, with fewer options. This is a very expensive process. Legal and accounting costs are high. Failure stings in two ways, because it draws significant money from the bank’s capital, and it puts the bank’s future strategy into question. Shareholders will lament, “Why did management put us through this for a failed deal?” Future merger partners will worry that there is something they missed that is wrong with the bank, or that regulators will deny or delay a second deal also. This stigma can follow sellers and buyers. How do you convince a potential partner that a second deal will work? If you don’t want a second deal, how do you convince the market that you are not going to buy or sell again shortly?
 
That brings up the third, “hidden” risk. How does a community bank build its business when everyone believes that it is trying to sell? Competitors will use that as a reason for new customers to avoid the bank. You can almost hear those competitors say, “This is not really a community bank. You don’t know who you’ll be dealing with in a year.” It used to be that you did know. You would be dealing with the buyer. Once you announced the merger, you began selling the buyer. Now, unfortunately, you cannot be as certain. Uncertainty scares customers, and you may find growth, even in your established market, more difficult.
 
You can reduce these risks. First, develop a strategic plan with your board that explores all your options and opportunities. Don’t be surprised by an offer or a request to buy; know in advance who the possible partners are and what you want. Second, do not talk with someone you know you don’t want to deal with. Don’t talk with someone you are pretty sure that the regulators would not approve. A part of this requires talking with a legal advisor during the planning process. They can help you understand the corporate and regulatory process and also help analyze what partners are possible in terms of anti-trust consideration. They also can advise how you approach a possible partner to avoid future problems. Finally, communicate with your shareholders and your market consistently, intentionally. If you know your strategy, you will avoid saying things that harm credibility. I had a client who swore for many years that the bank would “never sell.” Then it entered into a contract to sell. The deal failed. How much credibility do you think management had after that? Circumstances change, but understanding your strategy and your options, and ensuring that your shareholder communications and marketing are consistent, will help to keep you in the good graces of your owners and customers.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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