Employees are the real value in acquisitions, veteran bank buyers say
Mergers are disruptive.
A deal can create anxiety among a seller’s employees and put extra pressure on those who work at the buyer to deliver on forecasts. Customers can also become concerned that personnel or the quality of service could change, giving rival banks a chance to poach business.
It is important for banks involved in a deal to clearly communicate with their staffs, quell nerves and properly compensate the people they want to stay.
Those were some of the big takeaways from a recent panel discussion at the University of Mississippi’s annual banking symposium involving three seasoned bank buyers.
The panelists — Dan Rollins, chairman and CEO of BancorpSouth; Hoppy Cole, president and CEO of First Bancshares; and Chris Mihok, a director and investment banker at Keefe, Bruyette & Woods — also gave advice on how to price and structure deals and addressed the rising trend of credit union acquisitions of banks.
This article, the second of two parts, is an edited transcript of their remarks. Part one covered the fundamental reasons to pursue a merger deal, geographic expansion and the value of deposits.
How do you take advantage of disruption from other deals, like the pending merger of BB&T and SunTrust?
DAN ROLLINS: M&A is a disruption on the buyer’s side and the seller’s side. It causes disruption in the market. If you’re not the buyer or seller there will always be opportunities. Even the smaller transactions — it doesn’t have to be BB&T-SunTrust. People get nervous when someone comes in and says we’ve sold our bank. Everybody hides under their desk and says, "Please don’t let it land on me." It creates friction immediately.
HOPPY COLE: We’ve already seen a little of it in our Florida markets, but we don’t have a great deal of crossover with BB&T and SunTrust. We do in the Panhandle and Tallahassee. But it is a disruption. To the extent you’re established you can be beneficiaries of that. Of course, we’re on both sides of that because we’re doing some of the disrupting, too. So it's always important to safeguard your assets and your people. If you're stable and established you benefit from it.
How do you retain the best and the brightest when you're the acquirer?
COLE: As far as customer-facing employees, we take the philosophy that we want to keep all those people. When we go in, we offer retention contracts, employment contracts. We structure those so they're financially rewarded. We tell them: "We know you don’t know us but stay with us a year. And we’re going to pay you for that." That gives us time to get our heads around the customer base and gives them time to figure us out. It takes some of the uncertainty out of that particular employee.
And if you have any role in the [Bank Secrecy Act] function … we keep all of those people.
ROLLINS: It is all about how you treat people. It is how you reward them. I tell the team: "We’re going to play defense for the next six months. We’re going to run this boat straight through the hurricane that’s coming. We just need to strap in and ride it through." We have to convince them that we’re the best place to be for the next 18 to 24 months. "If you hang on, you’re going to kind of like it here."
CHRIS MIHOK: What works well is communicating on the front end. There's uncertainty that an employee feels when a target announces they’re selling. They’re wondering will they have a job tomorrow. Will they have a job in three to six months? To preempt that, banks need to go and communicate to those key employees, sometimes before a deal is even announced, and tell them that they have a job. It is critical to make them feel special, because they are.
You don’t want to pay a premium for a bank and only have four people left after three to six months.
What are seeing in terms of pricing and structure?
MIHOK: When you look at transactions, some of the structure depends on where the stock is valued for the buyers. Sellers generally like to have some certainty of price. Buyers like certainty in their shares’ direction. Many times, I’ll recommend [that buyers] do fixed exchange ratios so they know how many shares they’re issuing in a transaction. And buyers are agnostic as to where their price goes. Part of the reason they’re agnostic is because if they thought the deal would meaningfully lower their stock price in the long run they wouldn’t do the deal.
When we look at financial parameters, there are multiple things the investment community looks for. They're looking at whether the rate of return exceeds the cost of capital. What's the financial impact to earnings, both on an absolute basis and an incremental basis? They're looking at the impact to capital ratios, both in terms of book value and earn-back period. They also look at the underlying assumptions. The deal has 30% cost savings — are there opportunities for more? Is attrition factored in?
One other metric we look at is the pay-to-trade ratio. We look at where the buyer is trading, on a tangible book basis, relative to what they’re paying. Generally, we like to see that metric below one. If a bank is trading at 175 times book value publicly, we’d want them to pay a discount in the area of 160, 150 … something of that nature. The difficult issue is when you have volatility like we’re having now, with buyers’ stocks moving around, making it very challenging to negotiate deal. That’s why we saw a slowdown in M&A at the beginning of the year.
Are sellers looking more for cash or stock?
ROLLINS: Sellers are all different. But I think it depends on the buyer. Sellers want liquidity, so they might take more of one bank’s stock than another’s. Sometimes they prefer cash, but it depends on what the seller is looking for. You have some sellers whose objective is to take the last penny off the table. If that’s their objective coming in, they’re going to want all cash with zero risk. If their objective is to build something for the future, while protecting their folks and their communities, then they’re looking for long-term value with the combined organization.
MIHOK: I think it will continue to change. As in industry, we’re the most capitalized that we’ve been in the last seven years. Banks will continue to look for ways to redeploy that excess capital. You can only return so much capital to shareholders through dividends and buybacks, so putting cash in an M&A transaction is a way to accelerate return on capital to shareholders. Given the capital levels at banks, returning more capital to shareholders through cash M&A makes sense.
What is the typical split of cash and stock right now?
MIHOK: It depends on the nature of the bank. The larger institutions are open to a majority, if not all, stock. A private seller with a concentrated amount of ownership selling to another small bank may be looking for cash. It is dependent on the board, the target and the shareholders.
What are your thoughts on credit unions buying banks?
MIHOK: If you look at 2007 to 2017, there were about 15 deals where credit unions bought banks. There have been more than that in 2018 and 2019. A third of those deals are in Florida, which has more favorable banking laws to help credit unions buy banks.
When a credit union buys a bank, the more they pay the more capital they create. For a bank today, when they create goodwill — a premium over the value of the assets and other intangibles — it is deducted from capital. From a credit union standpoint, it is added to capital. It makes no sense. On top of it, the compensation for management teams of credit unions is based on the size of the institution and the membership they have. It disincentives credit unions to act rationally. They can build up, just for the sake of being bigger, and pay themselves more.
COLE: We’ve competed twice with credit unions [in deals]. One we won, and the other we didn’t.
One of the transactions was a limited auction where the credit union jumped in and offered a substantially higher price. The seller came back to us to see if we’d change our consideration to add more cash. It changed our consideration and our price.
The second one was a transaction where we had in-market market share and were looking to buy three or four branches to add to what we already had. We should have been in a pretty good spot for substantial cost saves. The credit union came in with a premium that was not quite double ours. When we calculated the earn-back, it would have been 10 years for us. There's no market discipline, which is kind of scary because of what that can mean to our industry.
What about nonbank lenders? Think they’ll hang around?
ROLLINS: We’re always going to have those nonbank lenders. They expect rates to be going negative, so they’re putting out long-term, fixed-rate loans with early-payment penalties. They’re way out on the low-rate side of things.
COLE: I think they’re going to be there. I’ll be interested to see in the next down cycle how some of the automated platforms behave, particularly on the retail side. I want to see how their credit quality stacks up. What has been surprising to me is the number of banks that are in the automated business. There are people who say they have an algorithm. It's never worked out well for me. I guess we’ll see.