Two weeks ago I attended Bank Director’s annual conference on topics related to acquisitions. Discussions, both formal and informal, centered on likely scenarios for the banking industry and the current acquisition landscape.

 

Near-Term Instability
Few speakers suggested that the banking crisis was over while some saw signs of stability (“light at the end of the tunnel”) emerging by the end of the year. As expected, commercial real estate (CRE) dominated the concerns of attendees, many of whom work with or for community banks. Several speakers noted the degree to which past community bank earnings had been strongly driven by CRE activities.

 

Virtually all the bankers I spoke with stated that they expected zero organic growth in 2010 in light of tougher consumer regulations, lower loan demand, and increased risk management procedures, among other factors.

 

Increased Consolidation
While many statistics were provided over the three-day meeting, two of the most telling were:

 

• 1800 banks have non-performing assets greater than six percent.

 

• Over 400 banks have Texas Ratios over 100 percent; 171 of those have ratios greater than 150 percent (Texas Ratio equals non-performing assets divided by the total of tangible equity and reserves).While some banks with high Texas Ratios may be able to turn themselves around, in most cases their recovery is unlikely.

 

The message here is that many more banks are in danger of going under. Certainly, the total will greatly exceed the 140 failures of 2009, reaching two-three times that amount. In addition, some attendees believe that the crisis may not peak this year, with a similar number of banks failing in 2011. Bottom line, hundreds of banks will fail in 2010 and 2011. Buyers can act like picky eaters at a grand buffet with lots of choices and no need to settle for a selection.

 

The Vultures Are Waiting
By vultures, we mean smart investors who possess the capital and the deal-making capabilities to take advantage of the current buying opportunity. Appropriately, more than one speaker stated that today’s environment offers a once-in-a-generation opportunity for stronger banks to pick up weak ones.

 

Unlike just a few years ago, buyers are now in a position of enormous strength versus banks that are looking for capital. I spoke with one Chairman who runs a $1B+ bank in the mid-west. His bank had suffered several quarters of losses largely due to commercial real estate. He was attending in the hope of meeting with potential investors. The likelihood of that occurring was very low, much lower than in previous years for one overarching reason, discussed below.

 

Unassisted M&A Deals Are Few
To many attending the conference, the aforementioned Chairman’s bank provides a target to review and assess and to wait on. As they did last year, FDIC-assisted transactions will predominate in 2010. Few acquirers see a compelling reason to bid on a bank today that may be an FDIC-deal tomorrow. In effect, FDIC-assisted transactions have “sucked the air” out of the traditional M&A market. Bluntly, it is very difficult for a bank to justify going the unassisted route when the expectation is that the number of attractive FDIC-supported deals will grow dramatically this year through next.

 

Some investment bankers at the conference mentioned the value of conducting preliminary due diligence on potential targets that could be of interest if and when they were available under an FDIC umbrella. Creating an acquisition screen and then conducting a preliminary review of potential targets will eliminate some false starts and may allow a bidder to get the greatest value out of the limited due diligence period offered by the FDIC. That makes great sense for acquirers but puts potential sellers in the uncomfortable position of being picked over by bargain shoppers.

 

Of course, some unassisted bank deals will continue to occur, but those few will involve highly attractive strategic opportunities. To the extent that unassisted deals involving weak performers occur, they will be structured to protect buyers in the event of further portfolio erosion. Weak banks (and the Boards of those banks) that are trying to raise funds or sell have to be willing to give up a great deal in order to entice a buyer who has every reason to wait.

 

Managing FDIC Transactions Is Still Evolving
Almost every session highlighted or at least mentioned FDIC-assisted transactions. However, in most cases the understanding of how those deals work was relatively low. Several lawyers and investment bankers discussed deal fundamentals, including the FDIC bidding process, the Purchase & Assumption agreement, and some of the accounting issues. Yet, little discussion centered on how to manage these transactions on an ongoing basis. We expect that will become a topic for next year’s conference as more banks grapple with the complexities of meeting the FDIC’s requirements.

 

Banks Are at an Advantage
Most speakers view banks as being in a privileged position versus their Private Equity (PE) competition. The FDIC appears to view banks more favorably as buyers; banks operate with a longer time horizon and lower return expectations than most PEs; banks can look at these deals from a strategic as well as financial perspective. That said, the number of failed banks may increase so significantly that PEs as well as banks can find attractive targets.

 

Concluding Thought
Despite the unsettled economy, or perhaps because of it, attendance at the conference was close to an all-time high. Weak banks are concerned about survival while the stronger banks are in the best position they have been in many years. Over the next year or more acquisitions = FDIC-assisted transactions. Buyers should know the ins and outs of these deals and determine the preparation they require for managing these deals that typically can last for up to ten years.