Green shoots are starting to peek through the deep freeze in the merger and acquisition market. But bankers emerging from hibernation will find a regulatory approval process transformed beyond recognition.
Management proposing M&A must be prepared to defend its record and plans on all fronts — both business and regulatory. Of course, the deal approval criteria have always included "financial and managerial resources," "future prospects" and the "convenience and needs of the community." However, regulators are looking at them in a whole new way.
M&A applicants are required to "justify the adequacy of the proposed capital structure," but pat statements about being well capitalized will no longer do. Prepare for a serious discussion of how much capital is enough to support the proposed business plan and risk profile. Also expect tough scrutiny of capital elements that are not voting common equity. The best results will come to applicants who present concrete capital adequacy metrics, such as credible stress tests, as opposed to arbitrary "eyeballed" capital ratios.
Banks still recovering from the last crisis should expect resistance to expansionary business proposals, especially if the other party is weaker. Be prepared to demonstrate that the bank's troubles are behind it, and make sure the facts back you up. Resolve all major supervisory concerns from the last exam.
Even perfectly healthy banks could find the regulators skeptical that they have enough management expertise and infrastructure to handle the combined business. Regulators could require detailed staffing and integration plans, if only to prove that management knows what it's doing.
Dealmaking banks will see even bigger changes in the regulators' review of their proposed business plan. Policy shifts have narrowed the range of acceptable business models. Nontraditional, out-of-area, and wholesale-funding-dependent proposals face an especially tough slog. Plans will also need to conform to new guidance on topics including funding and liquidity, commercial real estate concentrations, correspondent risk and compensation.
Perhaps most shocking to bankers will be the rigor with which regulators will challenge the bank's business strategy and underlying assumptions. In the past, many regulators avoided second-guessing management's judgment. But the present crisis has left them especially alert to questionable business models.
Banks will need to base growth projections with well-supported sales and pricing assumptions, realistic expense budgeting and a credible plan to compete and win. Many applicants will struggle to develop and defend a business strategy with the rigor and detail regulators expect to see.
Applicants with retail business lines or compliance exam issues will feel the new teeth of the convenience and needs prong, as well as the related requirement to consider CRA performance in approving deals. The past two years have seen numerous deals — from systemically important conversions to simple branch applications — delayed or scuttled by compliance or fair-lending issues.
Bankers who fail to get their compliance and fair-lending house in order before signing deals will find a toll gate blocking the road to closing.
Another bank consolidation wave is inevitable as the market thaws, and banks that approach regulatory approval the old way could find themselves stuck in the mud. Successful closers will be those that address business, supervisory and compliance issues proactively and comprehensively — both before and during the application process.
