Looking for the Return of Unassisted M&A

Deloitte

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In December 2009, the Deloitte Center for Banking Solutions published its Outlook 2010, which summarized five trends that would dominate the banking and securities industry.

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• Outlook

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• Publié par: deloitte
• Nombre de lectures: 115
• Langue: English

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Looking for the return of unassisted M&A Banking and securities outlook

Produced by the Deloitte Center for Banking Solutions

In December 2009, the Deloitte Center for Banking Solutions published its Outlook 2010, which summarized five trends that would dominate the banking and securities industry. At that time, we noted that many banks face a strategic dilemma: They want to restore their balance sheets and rebuild capital, and one of the quickest ways to do this is to grow their businesses. In the past, mergers and acquisitions (M&A) were a major source of growth, and this remains an avenue for those unafraid to purchase failing or failed institutions. In this follow-up point of view, we explore the potential for the return of unassisted M&A activity.

Consolidation in the banking industry has been underway for years, and today much of the attention is on opportunities to acquire failed institutions from the FDIC. Since the beginning of 2007, more than 200 banks with hundreds of billions of dollars in assets have 1 failed. Thepace of bank failures has accelerated, and this trend is reasonably expected to continue into the foreseeable future. The potential strategic and financial benefits associated with FDIC-assisted acquisitions are evident. However, bank executives should prepare for the day, perhaps sooner than many expect, when unassisted transactions are back in vogue.

The banking industry faces many challenges including the uncertain economic outlook, asset quality, capital adequacy, bank failures, and future regulations. These challenges and uncertainties are likely to drive further consolidation in the industry, both through FDIC- assisted transactions and through traditional, unassisted acquisitions.

With respect to the landscape for banking consolidation, we can separate depository institutions into three broad categories: (1) relatively healthy or “clean” banks with excess capital that are potential acquirers; (2) banks perceived as undercapitalized or in a weak long-term competitive position that are potential targets; and (3) problem institutions that may be subject to FDIC resolution.

The potential acquirers are currently positioning themselves through “offensive” capital raises and by actively exploring the best ways to deploy excess capital in order to maximize expected returns. Although their initial focus may be on FDIC-assisted transactions, a number of factors suggest that large-scale unassisted transactions may reemerge in the near term.

1 “Failed Bank List,” Federal Deposit Insurance Corporation, http://www. fdic.gov/bank/individual/failed/banklist.html

The vast majority of banks will not fail Although there are currently more than 700 institutions on the FDIC problem list, these banks represent less than 2 9% of all FDIC-insured institutions.Further, most banks on the problem list may not ultimately fail. Among the banks that do fail, an acquirer may not find one that fits their strategic criteria. For example, failed institutions may not be located in their targeted geographies or have a franchise that meets other requirements. As such, these types of acquisitions tend to be viewed as ancillary, or purely economic, rather than transformational. This is why certain franchises tend to have a significant amount of “scarcity” value.

Most institutions perceived to be undercapitalized will not be available for acquisition from the FDIC and are instead candidates for unassisted acquisitions, potentially at significant discounts to historical valuations. Many of these types of banks face uncertain future prospects for competitiveness and growth. They may become willing sellers as they recognize their need to seek a strategic partner in order to maximize shareholder value over the long term. Even in 2009, 179 banks were acquired through unassisted transactions, although most typically involved 3 institutions with less than $1 billion in assets.

Competition for FDIC deals intensifies As the industry begins to recover, potential acquirers are increasingly able to access the capital markets to fund FDIC transactions. In addition, strategic acquirers are more often competing with private investors for failed institutions. Although private equity investors face more stringent requirements, regulators may be becoming more 4 comfortable with private investment in banks in general. In addition to private equity gaining traction in the banking space, a number of blind pools have raised, or are in the process of raising, billions of dollars in capital to acquire 5 banks. Someblind pools are restricted to considering only failed banks as platform acquisitions, but others may be permitted to acquire a clean, platform bank through an unassisted acquisition.

2 “Quarterly Banking Profile: Fourth Quarter 2009,” Federal Deposit Insurance Corporation 3 “Statistics At A Glance,” as of December 31, 2009, Federal Deposit Insurance Corporation 4 Nathan Stovall, “Private Equity Scorecard,” SNL Financial, February 19, 2010 5 Nathan Stovall, “PE Firms Making Headway in Bids for Failed Banks,” SNL Financial, January, 29, 2010, and Christina M. Mitchell & Maria Tor, “More shelf charter dreams to be realized?,” SNL Financial, February 16, 2010

This increased competition has led to somewhat less favorable economics for acquirers of failed banks. Acquisition prices have risen, as perhaps indicated by the fall in the cost to the FDIC deposit insurance fund. In 2008 and 2009, the median cost to the FDIC was approximately 30% of the assets of failed institutions. But that figure dropped to approximately 24% in the fourth quarter of 2009 and to approximately 14% in 2010 through 6 mid-March.

As the number of bidders increases and competition intensifies in the acquisition process for failed banks, the FDIC may have more flexibility in setting the terms and conditions associated with loss share agreements. For example, the FDIC has recently introduced the potential for up-front cash payments from buyers and eliminated the concept of the Stated Threshold and 95% loss share coverage above the Stated Threshold, with all losses now 7 subject to 80/20 coverage.The agency could also look for more ways to share in the potential benefits associated with failed bank acquisitions for buyers such as requiring more claw-back provisions, equity appreciation rights, cash participation instruments, or other forms of contingent consideration.

FDIC-assisted transactions have unique challenges While post-merger integration is challenging in all acquisitions, failed institutions pose special challenges in stabilizing the business, minimizing customer attrition and deposit outflows, and retaining employees. Further, although loss share agreements provide significant protection against future losses, they may limit workout options and upside potential for troubled assets. They also impose additional administrative and reporting requirements. For example, buyers have to maintain multiple sets of records for covered assets (i.e., for accounting, tax, and loss-share reporting purposes) and provide detailed reports on related activities, losses, and recoveries.

6 Nathan Stovall, “Failed Bank Sales Becoming Cheaper for the FDIC,” SNL Financial, March 12, 2010 7 “FDIC Transactions Update,” Keefe, Bruyette & Woods, March 23, 2010

FDIC resolution process is dynamic The FDIC appears to be constantly seeking new resolution methods in an effort to attract more bidders and minimize the costs associated with bank failures. While whole bank transactions with loss-share agreements are currently the most common tool used, the FDIC may explore alternative resolution methods including more elaborate ways to separate good and bad assets and deposits, creatively packaging and marketing selected assets and deposits of failing institutions, tailored structured asset sales, securitization and resecuritization, open bank assistance for non-systemically important institutions, and facilitating acquisitions of troubled institutions outside of the resolution process. Therefore, even if acquirers view certain failing banks as attractive, they may not become available from the FDIC through purchase and assumption of whole banks with loss-share agreements.

One high-profile unassisted deal could change the landscape Although impossible to predict and challenging to get done in the current market environment, one major unassisted acquisition could fundamentally change the industry’s landscape and mindset in short order. Other potential acquirers would likely need to respond quickly from a strategic perspective or run the risk of being at a competitive disadvantage over the long term.

All these factors suggest that potential acquirers should proactively explore unassisted transactions, which could increase rapidly as the industry recovers. Rather than focus solely on FDIC-assisted transactions that may or may not materialize as anticipated, or at all, acquirers should consider looking more broadly for strategic opportunities to effectively deploy excess capital. These opportunities may take the form of unassisted acquisitions as potential sellers explore ways to maximize shareholder value over the long term in light of the current market environment.

Industry leadership Robert Contri Vice Chairman Banking & Securities Deloitte LLP [phone] [e-mail]

Deloitte Center for Banking Solutions Don Ogilvie Independent Chairman Deloitte Center for Banking Solutions [e-mail]

Andrew Freeman Executive Director Deloitte Center for Banking Solutions [phone] [e-mail]

Authors Thomas Kaylor Principal Deloitte Financial Advisory Services LLP [phone] [e-mail]

Christopher Toto Senior Manager Deloitte Corporate Finance LLC [phone] [e-mail]

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