More activity has begun to occur in the mergers and acquisition (M&A) space than we have seen for a long while. Whether involving whole bank deals or adding specific capabilities, such as equipment finance, more banks are looking to grow through acquisition. 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.
Multiple factors are pushing banks toward considering acquisitions versus trying to grow organically. Most fundamentally, organic growth is difficult to achieve in the current sluggish economy and takes time. Many banks need an immediate infusion of revenues and in some cases new direction. Layer on top of this a highly energized internal compliance and external regulatory effort that increases bank costs while likely reducing potential revenue streams. Regulators, implicitly, if not explicitly, are pushing banks to combine.
In this environment, greater scale is seen as a way to both provide an increased revenue base over which a bank can spread its costs and to bring in new talent and revenue options that a larger entity often provides. For example, one factor in the recent acquisition of a number of independent equipment finance companies by banks involves the ability to take on a new sales culture that, ideally, can permeate the rest of the institution.
While substantial rationale for acquiring a bank exists, 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 for reasons related to risk and cultural fit, despite the CEO’s 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, this client’s poor acquisition selection process served as one key factor leading to its 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, 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. This institution 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.
What they needed to do and could have done before the deal closed included quantifying and prioritizing the growth potential and competitive challenges and opportunities of the acquired bank on a branch-by-branch basis; undertaking market analysis from available data to determine likely growth opportunities, screened by industry and risk, among other factors; conducting geographic risk analysis to assess the performance trends of local businesses; and determining the likely 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 because of the ability to apply “big data” strategically, as more banks are doing.
Our client work shows multiple aspects 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 likely 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. However, that approach occurs rarely, particularly if the seller has something to hide.
Interviews with key credit and operational personnel. The numbers should tell you what you need to know about the sales staff. However, speaking with back office people can provide a treasure trove of information.
There may be legitimate reasons why access to people and bank data needs to be limited. But, perhaps those deals should also 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 quality and return transactions, 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 receive a payday because of the deal have their own interests at heart and in those cases these “trusted advisors” should not be trusted. Acquisitions can reinvigorate companies and take them into new directions. Yet now, more than ever, buyers need to have both an internal 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 interests of the stakeholders of the acquiring bank.
Mr. Wendel is president of New York City-based Financial Institutions Consulting, Inc. He can be reached at email@example.com.