Bankers could suspend M&A as they assess the fallout from Hurricane Harvey and Hurricane Irma.
Natural disasters tend to put longer-term strategic plans on hold as buyers and sellers make sure their franchises return to normal and employees and customers are safe. At the same time, bankers may want to review a target’s post-disaster condition.
It seems unlikely that the storms did enough damage to force parties back to the negotiating table, which a happened to Capital One and Hibernia in 2005 after Hurricane Katrina. Still, the hurricanes serve as a reminder that material adverse effect clauses and other safeguards are key components of merger agreements.
“M&A fades into the background because you want to concentrate on your own customers,” said Rusty Cloutier, who was the president and CEO of MidSouth Bancorp in Lafayette, La., when Katrina and Rita struck in 2005. “Most of the focus is getting them back up and rebuilding their business.”
The energy downturn had already hampered deal activity around Houston before Harvey struck. While seven deals in Texas are pending, many of them have involved sellers in the Dallas area, according to Keefe, Bruyette & Woods.
Eight deals are pending in Florida with sellers based in markets such as Jacksonville, Tampa and Naples.
Natural disasters can influence consolidation in several ways. In some instances, damages to a bank’s operations could trigger certain protections that, in turn, could lead to a price reduction.
That scenario is unlikely to play out in Florida, said John Corbett, president and CEO of CenterState Banks in Winter Haven, Fla., which has deals pending for HCBF Holding in Fort Pierce and Sunshine Bancorp in Plant City.
Corbett, who says his company's deals will be completed as planned, noted that Florida bank stocks have already recovered from the hit they took before Irma struck.
Damage in Florida, while “uncomfortable,” will largely be addressed in a few weeks, Corbett said. “I don’t think you have seen anything like Katrina.”
A severe disaster like Katrina could activate a deal’s material adverse effect clause, or MAC, which allows a buyer to walk away from a deal if an event has a significant impact on a seller's operations. In the case of Capital One and Hibernia, the parties instead agreed to lower the purchase price by 9% to reflect how Hibernia’s assets were hurt by Katrina.
Material adverse effect clauses are rarely invoked, said Fernando Alonso, a lawyer at Hunton & Williams in Miami.
Still, the recent storms should prompt aspiring buyers to check their agreements to make sure they are properly protected.
National Commerce in Birmingham, Ala., aims to do “everything we should to protect our shareholders” when it agrees to an acquisition, such as including material adverse effect clauses, said Richard Murray IV, the company’s president and CEO.
Irma is unlikely to affect the $2.4 billion-asset company’s pending purchase of FirstAtlantic Financial Holdings in Jacksonville, Murray said.
“It’s hard to foresee a storm that would create that type of issue,” Murray said. “We don’t feel like it has in this case, but it is hard to predict the future.”
During negotiations, buyers generally try to make a material adverse effect or material adverse change clause cover as much as possible, while sellers want to narrow them by inserting carve-outs for events like natural disasters, said Jeff Gifford, a lawyer at Dykema Cox Smith. After 9/11, for instance, more clauses started to include carve-outs for terrorist attacks.
“Given recent events, I wouldn’t be surprised if we see an increase in natural disaster or ‘acts of God’ carve-outs … in M&A deals, generally, not just in the banking industry,” Gifford said.
Banks may also alter how they complete due diligence after storms. Potential buyers that would typically review up to 70% of a loan book might insist on a broader evaluation after an event like Harvey, said Brian Johnson, a managing director in the financial institutions group at Commerce Street Capital in Dallas.
After a storm such as Harvey, a buyer may want want more information on the insurance coverage for collateral, while the physical condition of branches would have more importance.
Some bankers said Harvey isn’t doing to deter them from considering deals around Houston.
Green Bancorp in Houston would still be open to buying banks in the area, said Geoff Greenwade, the company’s president. Still, he said, the $4.2 billion-asset company would consider how a seller’s commercial clients fared during the storm and if they would be able to quickly recover.
“Houston is still a great business market,” Greenwade said. “We have a lot of community banks we compete against. I admire quite a few of them and they would be on our list of banks we would go call on.”
There are ways to work around disagreements about loan performance as banks hammer out a merger, industry experts said.
The parties can create an escrow account for part of the purchase price, said Curtis Carpenter, head of investment banking at Sheshunoff & Co. Investment Bank in Austin, Texas. Carpenter has helped sell banks in Louisiana after Katrina and Rita and in Joplin, Mo., after the costliest tornado in U.S. ripped through the town in 2011.
The escrow funds could be doled out to the seller or returned to the buyer, depending on how flagged loans perform.
First Bancshares in Hattiesburg, Miss., used this method when it agreed in October to buy Iberville Bank in Plaquemine, La. Under terms of the deal, 8% of the $31.1 million cash payment was held in escrow as a contingency for loan losses tied to flooding in Louisiana.
Many hiccups could be avoided by taking a wait-and-see approach, which seems to be the case right now in parts of Florida and Texas.
Before Harvey hit eastern Texas, M&A discussions were heating with some “strong offers” being discussed, Carpenter said.
“From an M&A perspective, I am bullish on the Houston market going forward … but there will be a pause,” Carpenter said. “During that pause, all the moving parts related to the cleanup and recovery will make it challenging to make a deal happen.”
Houston is the nation’s fourth-largest city, and its population has grown by almost 10% from April 2010 to July 2016, according to the U.S. Census Bureau. There are still plenty of buyers that are interested in gaining a foothold there, industry experts said.
Florida is “the No. 1 state for net migration,” Corbett said. “That’s all you need to know. Despite the hurricanes, more people want to move here than any other state in the country.”
Despite Irma, Florida bank consolidation will remain relatively on pace with the level of activity seen over the last 18 months. There is increasing scarcity value among larger publicly traded community banks, said Christopher Marinac, an analyst at FIG Partners.
Another lure for buyers could be the expected inflow of deposits from insurance checks and federal assistance, particularly in a rising interest rate environment.
The storm recovery “will be a distraction or a delay,” Marinac said. “But I think the big picture doesn’t change how the trend of how M&A continues to play out.”
Gerald Lipkin, chairman and CEO of the $23.4 billion-asset Valley National, said that, while Irma "caused damage on a large scale," it probably will not delay the pending purchase of USAmeriBancorp in Clearwater, Fla. Valley, which is based in Wayne, N.J., is still upbeat on Florida, where it has already bought two other banks.
The same can be said for David Zalman, chairman and CEO of Prosperity Bancshares in Houston. Zalman said he is still bullish on the $22.3 billion-asset company’s home market and is prepared to buy another bank there despite the destruction.
A big reason for such confidence is Prosperity’s refined method of combing through a seller’s loan book to determine underlying quality. The company conducts its own review, which typically covers about 90% of a seller’s portfolio.
“This may be bold, but I would say" that Harvey will not "affect Texas at all,” Zalman said. “Texas is really a lot different than other states. We have a can-do attitude.”