When St. Louis-based Roosevelt Financial Group closes its deal to acquire cross-state rival Farm & Home next month, it will buy a big market share, a profitable mortgage business -- and a sizable book of derivatives.
It was that off-balance-sheet activity that caused Piper, Jaffray & Co. banking analyst Steve Schroll to probe a little further before deciding that Roosevelt knew what it was getting into. "They obviously took a very hard look at it before deciding to proceed," he said.
Stanley J. Bradshaw, the president and chief executive of Roosevelt, said that even though his own fast-growing thrift hasn't been a major user of derivatives in recent years, he was not deterred by Farm & Home's interest rate swaps.
'Insurance' Against Rate Risk
"It was a very small issue," said Mr. Bradshaw. "This has not been a business for Farm & Home. It's an insurance premium" against interest rate risk.
But merger experts nationally say that as the banking industry consolidates and the use of derivatives grows, there is a greater potential for such risk management tools to become a sticking point in the sale or valuation of banks.
"It's a potential poision pill," said James J. McDermott, president of Keefe, Bruyette & Woods Inc., the New York-based investment bank.
To be certain, it would be an unintended one. Poison pills are provisions adopted by companies to guard against takeover.
Some merger specialists said they were unaware of any deals that have been called off or materially affected because the acquired institution had a book of derivatives. Others suggested, however, that it could be an issue where smaller institutions are being bought.
"Most people would concede that BankAmerica knows more about derivatives than the average regional," said one banking lawyer who handles mergers. "That's why you won't see much fretting unless it is a newcomer to the issue."
John Duffy, executive vice president and head of corporate finance at Keefe, said the key question is whether the would-be acquirer is comfortable with derivatives. "There aren't many banks that are active acquirers that haven't already stuck their toe in the [derivatives] market," he pointed out.
Others said the potential role of derivatives as a deal killer is minimal, even if it is fashionable to worry about such things.
"It's a newly discovered issue, but not a new one," said Chris Quackenbush, principal in the bank merger area at Sandler, O'Neill Partners, which specializes in smaller bank acquisitions. "It's not unlike any other asset quality question. It's an issue that some people are going to be comfortable with and others won't be."
Valuation Know-How
Ben Plotkin, executive vice president and head of corporate finance at New Jersey-based Ryan, Beck & Co., said it comes down to the acquiring bank's understanding of the derivatives portfolio.
"It's always been an issue," he said. "It's a matter of know-how to value the securities because some are harder to price than others."
Ultimately, the comfort level of the bank will depend on how shareholders perceive a newly acquired derivatives book. As demonstrated recently by such well-known companies as Banc One Corp., investors are not always willing to give bankers the benefit of the doubt.
Stifel, Nicolaus & Co. banking analyst Joe Stieven said valuing the derivatives portfolio has become easier. A more difficult question, he said, is how sophisticated is bank management.
In the case of Roosevelt, Mr. Stieven said, the managers know what they are doing. "Even though they don't use [derivatives], they have in the past and they understand them extensively," he said. "Am I comfortable that Stan Bradshaw knows what he's getting into? You bet."
While he is comfortable with the derivatives portfolio he is acquiring, Mr. Bradshaw said that Roosevelt would not be comfortable acquiring an institution that goes beyond risk management.
"We just want to make sure we know what we're getting into," he said. "We wouldn't get into a situation where there were surprises."
