Today's M&A Environment and Your Plan
As many of you know, the bank merger and acquisition market experienced a noticeable slowdown over the past couple of years because of the Federal Reserve’s unprecedented interest rate increases. This was due to the fact that when a bank sells, it is required to recognize the unrealized loss in their bond portfolio. Buyers had been typically unwilling to pay for those losses, even though the buyer would have a stronger yielding portfolio after the merger. Our experience has now shown this mindset has begun to somewhat change.
While we continue to work on several deals throughout the Midwest, we have experienced a change in the mindset of buyers and a noticeable uptick in conversations with sellers.
It is unfortunate that a selling bank does not get to mark-to-market its other assets or liabilities, prior to selling which could offset all or part of the bond loss. Accounting rules simply do not allow for it and the selling bank just recognizes the current downside in the bond portfolio on the sale.
While some buyers have been reluctant to absorb much, or any, of the seller’s unrealized bond losses, we have seen the overall premiums paid in recent deals exceed expectations. We believe this is due to the overall lack of selling banks in the marketplace.
Some buyers have increased the premiums being paid which they are in effect absorbing all or part of the seller’s bond loss. These buyers are then required to record the increased premium as goodwill in the transaction. These buyers will recover the market losses over time, through increased yield, as the bonds are held and approach maturity (assuming the buyer retains those bonds) so they will recapture the overall dollar cost, but again will have booked the additional goodwill in the transaction.
We have a group of banks that would be sellers today but, solely because of this unrealized loss issue, they have been waiting for their portfolios to recover in order to capture the full equity value in their banks. For those banks with large unrealized losses relative to their size, this may be a prudent strategy.
The Federal Reserve has signaled it may decrease rates in the not-too- distant future, but it is difficult to predict when bank portfolios will recover. While the duration of the portfolios are important, those containing mortgage backs are experiencing extension risk due to the slower payments on debt. Obviously, each bank will be different depending upon their overall duration and the makeup of their securities portfolio.
What we do know is that the bank merger and acquisition market over time has been fairly consistent – approximately four percent (4%) of the existing banks are consolidated each year. This obviously fluctuates up and down depending upon market conditions but over time is relatively stable.
Therefore, we do anticipate that we will see an increase in activity over the next 6 to 9 months and a larger than normal number of sellers coming to the market at some point. As mentioned above, each bank will rebound at a different pace, so while we don’t anticipate all of the waiting sellers to hit the market at the exact same time, we do expect a fairly quick pace of sellers hitting the market as mindsets continue to evolve.
During this time, we are helping our clients with strategic planning and working with both buyers and future sellers about being prepared.
Below, we have provided you with some thoughts to consider your future plans.
So if you are buyer or a seller what do you do in the meantime?
The steps necessary to prepare for a successful acquisition vs. preparing your financial institution for sale are different, but both require thoughtful strategic planning. There are a few “checklist” items that you can do in advance to help you make a good acquisition or realize the best value for your institution. While the following are not exhaustive lists, these are a few of the items to review in preparation for a sale.
If you are a potential acquiror:
1. Does an acquisition help you achieve the goals and objectives of the owners?
2. Do you have the capital or capability to raise the necessary capital for an acquisition?
3. Do your people have experience with an acquisition, do they have the appropriate skills and expertise, and do you have enough people to effectively carry out a transaction while continuing to operate your existing bank?
4. Have you had a discussion with your regulators about an acquisition? If you have not previously completed an acquisition an important step early in the process is a discussion with your regulatory agencies.
5. Are there new markets that you would like to expand to that would enhance the bank’s footprint and value?
If you are a potential seller:
1. In today’s environment, a prospective seller should pay particular attention to their bond portfolio and interest rate risk.
2. Do the board and key shareholders understand the current market and have reasonable expectations on the value of their institution before beginning a sales process?
3. When do your vendor contracts expire? Planning ahead for a sale will reduce, and potentially eliminate, the significant cost of early termination fees which are typically absorbed by the seller.
4. How are your earnings? Most bankers think of bank values as a multiple of capital, but multiples of earnings are equally and, in many cases, more important. Buyers are purchasing potential earnings, so the best way for a seller to realize the most value for their bank is to have a history of strong, profitable core earnings. The stronger the earnings, the higher the value.
5. How is your credit quality, and the condition of your loan files? Fortunately, COVID did not have an immediate impact on credit quality, but with the increase in interest rates along with discussion of a recession, credit quality is back on the radar and will be closely scrutinized by buyers. Uncertainty for risk in the loan portfolio will result in lower prices for the overall organization.
6. Are your key employees all at retirement age and/or are they willing to stay through a sale and conversion? With the lack of good, skilled employees in the banking industry buyers are very concerned about retaining key employees.
Failure to properly plan can be very expensive and result in unintended consequences and right now there is time to prepare and plan. Whether you are a buyer, seller, or have an organic growth strategy you must have a plan and path forward to execute on that plan to be successful.
Thank you for letting us share this information with you. If you have any questions, comments or need some assistance, please feel free to email or call us. We would be happy to discuss any of these issues or facilitate a strategic planning session to assist you in a path forward.