As more banks venture into the M&A market, buyers still want a little extra protection against risk.
Merger and acquisition agreements are including more specific and sophisticated provisions for adjusting the deal price, or even letting a buyer back out, if the credit quality of the seller's portfolio deteriorates.
An example came Monday, when F.N.B. Corp. in Hermitage, Pa., announced plans to buy Comm Bancorp Inc. in Clarks Summit, Pa. Under the agreement, F.N.B. can walk away if Comm's delinquencies exceed $65 million before closing.
Several other deals in the past year have included similar provisions, and buyers will probably continue to require them, at least until the economy recovers.
"I would be surprised if you saw any deals at all, of size, that were executed without a walk-away provision, particularly without a provision that required delinquencies at a particular threshold," said Jason O'Donnell, an analyst at Boenning & Scattergood.
Before the financial crisis, most merger deals included a standard provision that allowed a buyer or seller to terminate the agreement in case of something's causing a "material adverse effect" on the deal or a "material change." In today's environment, closing conditions are driven much more by numbers, said Michael Reed, a partner in the DLA Piper law firm in Washington.
"On a qualitative closing condition, every party can fight over what a 'material change' is," Reed said. "Whereas if you agree on specific ratios or specific numbers, and also agree on how you're going to do the accounting for them, then it's a lot more objective than subjective. That provides certainty, obviously, on both sides."
In F.N.B.'s case, the company inserted the specifics.
Under the agreement with Comm Bancorp, a "material adverse effect" would occur if its delinquent loans — as of any month's end before closing — equal or exceed $65 million. It describes delinquent loans as all those more than 30 days past due, nonaccruing, restructured and impaired, "other real estate owned" or net chargeoffs. (The definition is not exclusive — other kinds of problems could be argued to constitute adverse effects.)
F.N.B. has bought 10 banks since 2001 but never before included such a specific condition, said Stephen Gurgovits, the company's president and chief executive.
"We put it in just to protect on the downside if, in the next four months or so before closing, there would be some catastrophic event in asset quality," he said, adding, "which we obviously don't anticipate."
Comm Bancorp, the parent company of Community Bank & Trust Co. has faced some credit-quality stress. Nonperforming assets totaled $25.5 million at June 30, or 5.41% of total assets, and the company has had to restate its financial results twice this year.
Nevertheless, Gurgovits said, Comm "is in good shape." F.N.B. took a "very, very conservative" $30 million mark against potential losses in the loan portfolio, he added. "We just wanted additional protection," he said of the delinquency threshold.
Price-adjustment and walk-away provisions have appeared in deals in the Northeast, where most traditional whole-bank deals have been concentrated — especially in the active Pennsylvania market.
Among the buyers to include such provisions are First Niagara Financial Group in Buffalo, in its deal for Harleysville National Corp.; Bryn Mawr Bank Corp. in Bryn Mawr, Pa., when it bought First Keystone Financial Group in Media, Pa., and Northwest Bancshares Inc. in Warren, Pa., in its deal for NexTier Inc. in Butler, Pa.
And as in the case of F.N.B., most of those deals involved sellers with asset-quality issues.
The reasons are twofold, said Damon DelMonte, an analyst with KBW Inc.'s Keefe, Bruyette & Woods Inc. With so few bank failures in the Northeast, deals with assistance from the Federal Deposit Insurance Corp. have been rare. Looking for value in deals with weaker banks, buyers without the loss protection of an FDIC-assisted deal must find other ways to limit risk.
This is helping deals get done, DelMonte said.
"In order for the two sides to come to a common ground, I think there needs to be some sort of a safety net for the buyers," he said.
First Niagara is widely cited as the first company to use such a provision when it signed its deal in July 2009 to buy Harleysville National.
First Niagara developed a sliding scale, whereby the exchange ratio — that is, the number of First Niagara shares that Harleysville stockholders would receive in the merger — would shrink if Harleysville's delinquent loans surpassed $237.5 million. And if delinquencies had risen above $350 million, First Niagara could have walked away from the deal.
Michael Harrington, First Niagara's chief financial officer, said the company first determined what it was willing to pay for Harleysville and then developed the scale to trim the purchase price in proportion to any increases in credit exposure.
In the end, the provisions never kicked in — Harleysville's credit quality actually improved.
"I think we had a good starting point," Harrington said. "We felt comfortable about their credit quality, but everyone recognized that, in order for us to effect the transaction, we needed to have this ratchet provision to protect ourselves."
Each provision varies in complexity and is tailored to the seller.
Bryn Mawr included a similar sliding scale in its deal with First Keystone. As with Harleysville, First Keystone's delinquencies never reached the threshold.
In a deal announced in May, Northwest included a provision that would reduce the price for NexTier if the seller's loan-loss provision exceeds $7 million before the deal closes. It also would let Northwest walk away if delinquencies exceed $48 million.
Reed, the Washington lawyer who represents banks in mergers and acquisitions, said more of his clients are exploring customized price-adjustment provisions. And analysts have said they expect to see more such provisions in the near term.
Harrington of First Niagara said it depends on the deals.
"To the extent that the environment stabilizes, you might see less of these types of provisions, but it really depends on who the buyer and seller are, and their relative positions of strength and weakness," he said.
