We are seeing more activity in the M&A space than we have for a long while. However, in many cases, banks are pursuing deals for the wrong reasons, supported by the wrong analysis. For these banks, buyers’ remorse seems a virtual certainty.

 

 

For several years now, investment bankers at conferences and in articles have proclaimed the coming M&A boom. While many IBKers may be promoting this trend for reasons related to their personal wealth rather than a buyer’s well being, nonetheless, multiple reasons for consolidation exist. Here are ten:

 

1. A relatively stagnant economy means that banks will find it difficult to grow.
2. Regulations constrain the areas in which banks can generate growth and earnings.
3. Retail banking, once the earnings star, in many cases has fallen on hard times.
4. More branches are losing money. This is an accelerating trend.
5. Most banks have poor sales staffs; they do not know how to sell and their managers seem incapable of teaching them to sell. Becoming the “sales machines” that many banks need to become is unlikely.
6. Regulators, by action if not by design, are increasing the costs for all banks, including smaller banks that can least afford more expenses, to exist.
7. Baby boomers who fueled the growth of banking are disappearing. Many baby boomers run/own banks and want to exit.
8. In many cases groups replacing Baby Boomers (Gen X, Gen Y, and Millennials) are less economically attractive customers with many lacking loyalty to any bank, increasing the challenge of maintaining a sustainable earning stream.
9. Many bank executives/Boards view the outlook for banking as ranging from unclear to bad.
10. For many, running a bank simply is no longer fun or fulfilling.

 

 

There may be more and better reasons to sell, but the above list makes the point. So, why buy?

 

• Organic revenue growth is difficult to achieve and takes time.
• While more banks are successfully cross selling, they are still relatively few in number. Cross sell is hard to do. Acquiring is “easy.”
• Banks want to buy earnings now to quell concerns of investors and the Board. Acquisition may offer a quick fix to earnings needs.
• Management often believes it can severely cut the costs of the combined entity to increase earnings.

 

 

In the worst cases, management considering an acquisition can resemble a runaway train. During a past acquisition boom, we worked with a client team on assessing a target. We were not alone in telling the potential acquirer to take a pass, despite the CEOs desire to feed Wall Street’s growth demands. Perhaps not by chance, we and others were not invited to review the next deal, which was completed. Potential naysayers were excluded from the due diligence team. Ultimately, its poor acquisition selection process served as one key factor leading to the company’s demise.

 

More recently, we worked for a large bank whose CEO hired us after an acquisition and wanted us to answer the question, “What did we buy?” By that he meant that, although the bank had conducted its own brief due diligence, by its very nature that process just scratched the surface in providing an understanding of the acquired entity. They had failed to conduct some of the relatively fundamental analysis that would have given them insights into the acquired company’s earnings potential, including using available data effectively:

 

• Growth potential and competitive challenges and opportunities on a branch-by-branch basis.
• Market analysis to determine likely growth opportunities, screened by industry and risk, among other factors.
• Geographic risk analysis to assess the performance trends of local businesses.
• Cross sell and wallet share potential of the acquired customer base.

 

While leveraging available market analytics will hardly guarantee a deal’s success, proceeding without this type of analysis seems foolhardy. Buyers and their investment bankers need to find the best information available and mine it before putting in a bid. Of course, the buyer’s access to target information varies significantly. In addition, there are different levels of access to the seller’s management, its employees, its loan files, and its internal performance statistics. Obviously, for the buyer, the more access the better. Fortunately, even with only limited access to the seller, banks can better assess and quantify the market opportunity.

 

 

Our client work shows that there are multiple parts to completing a successful deal puzzle, among them.

 

• Detailed branch and market analysis. This is particularly crucial as more branches sink into losses and transactions flee to other channels. Buyers may need to think hard about the premium they are offering for a channel whose transactions may be suffering from a 10%+ annual decline.
• Demographic analysis. Banks with disproportionately older customers will experience greater earning declines.
• Credit file and internal process review. Basically, the more the better. We worked on one transaction where the seller provided an “open kimono” approach that gave great comfort to the buyer. That approach occurs rarely.
• Interviews with key credit and operational personnel. The numbers should tell you what you need to know about the sales staff. The back office people can be treasure troves of information.

 

There may be legitimate reasons why access to people and bank data needs to be limited. But, maybe those deals should be avoided. Just as banks need to be in the loan deal flow so that they can evaluate multiple lending opportunities and select the best lending opportunities, so too should banks be in the acquisition deal flow. We have seen buyers failing to pull back from a deal when they should have in part because they felt they needed to do something. In those cases something usually turns out much worse than nothing.

 

Banks need to seek out objective perspectives when evaluating a transaction. People who are going to get a payday because of the deal have their own interests at heart. Some “trusted advisors” should not be trusted. Acquisitions can reinvigorate companies and take them into new directions. But, now more than ever, buyers need to have an internal bank and external advisor team in place that collects and evaluates the implications of all internal and market data, reviews the processes, people, and culture of the target bank and represents the interest of the stakeholders of the acquiring bank.