The merger and acquisition market for community banks as of mid-2011 presents real challenges for participants on either the buy or sell side. The market could be considered a buyer's market because there are probably more interested sellers than buyers and because the anxiety and pressure is generally found on the seller side. But, acquirers also have significant difficulty in finding an opportunity with an attractive price.
The central problem that must be solved is credibility on credit quality. If the buyer and seller don't agree on the true credit quality of the target bank's loan portfolio, a deal cannot happen. If, on the other hand, a seller/target bank can make available a robust database for its entire loan portfolio that could be opened to potential buyers, this would provide enormous comfort and credibility to any buyer doing its due diligence. Such a database would include:
- A spreadsheet summarizing key metrics for each loan with hyperlinks allowing a buyer to drill down and review all loan information;
- Borrower and guarantor financial statements, tax returns, projections and credit scores;
- All loan documents, guaranties, modifications, title reports, title insurance;
- Payment history;
- Appraisals, past and most recent;
- Credit memos and loan approvals; and
- A description of how the loan's status and grade squares with the analysis of auditors and examiners.
The goal is to give a potential buyer complete certainty as to the accuracy of loan portfolio grades and valuation. Each side can then defend to its board of directors and to its shareholders a price that might otherwise have seemed too low or high. Otherwise, the credibility gap on credit quality will almost always prevent a closing because neither side can defend the price. Obviously, robust security procedures and a tough confidentiality agreement are necessary to protect the disclosing bank and its customers.
Next, management at the selling bank should be regularly updating its board and shareholders as to the bank's expected valuation based on (1) the uncompromisingly thorough and frank loan analysis detailed above and (2) the currently modest price-to-book valuations being achieved in the M&A market. Without being conditioned to understand the bank's market valuation, boards and shareholders might reject an offer that actually is in the range of fair market terms and valuations. For example, as of mid-2011, the median price-to-book value is about 107%. A deal priced at 125% is probably fair for many community banks right now. And, the price likely will be paid entirely or significantly in stock of the acquiring bank. A good market indicator for a particular bank is the pricing it has to offer to attract equity investors. Many times, the tiny premium in an M&A transaction is better for shareholders than the heavily dilutive price at which the bank must issue stock to new investors.
Many small community banks may need to combine with another small bank in order to register any interest with a strategic buyer. This can be an excellent, albeit slightly more complex strategy. The institutions may need to bring in additional capital in order to sell the combination to regulators. Members of the two management teams will need to be re-allocated, but the result can be a win for the individuals as well as the institutions. There is a great deal of talk about the need for mergers to be strategically attractive, and that is true. But, at the level of two small community banks, an excellent strategy and justification for the combination can be as simple as the opportunities flowing from thoughtfully reallocating particular people on the banks' combined teams so as to free more people to develop business and build the combined franchise. For example, instead of two sets of compliance personnel, there can be one and the balance devoted to acquiring core deposits and worthy credits.
In a merger of small banks, the two banks don't have to be geographically close to each other, although proximity is usually important in obtaining regulatory approval. Opus Bank in Irvine, California (the former "Bay Cities Bank") recently succeeded in obtaining approval to buy Cascade Financial Corp. (the holding company for Cascade Bank) in Everett, Washington State. Of course, Opus Bank is sitting on an exceptionally large ($460 million) pool of equity capital raised in 2010, has an approved plan to become a regional bank and could demonstrate its capacity to absorb the liabilities of Cascade Bank.
Daniel Wheeler is a banking regulatory partner in the Buchalter Nemer law firm
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