How One Bad M&A Deal Turned a Buyer into a Seller

Some acquisitions simply fail to live up to expectations. Others cripple the buyer.

Delaware Bancshares in Walton, N.Y., made a branch deal that fell into the latter category. Now the $372 million-asset company is selling itself to Norwood Financial in Honesdale, Pa. The story is a cautionary tale for community banks seeking to remain viable by making acquisitions.

In 2014, Delaware bought six branches from Bank of America. Also that year, the company took out a $12 million loan — secured by all of its bank's stock — and used part of the proceeds to pay for the branches, according to a series of regulatory filings. The deal doubled Delaware's branch network and extended it into a second county with attractive demographics.

In its application to buy the branches, Delaware estimated that no more than 10% of the branches' $139 million of deposits would run off before the deal closed, meaning it would gain $125 million of new deposits.

But by the time the transaction closed in September, the branches had lost 40% of their deposits, leaving only $83 million for Delaware, according to a proxy statement filed Thursday. Not only has runoff been high but originations of new accounts "have been slow," the proxy said.

Other banks that have bought B of A branches in recent years also ended up with fewer deposits than they counted on. But Delaware had other problems, too.

"In addition, the increased technology and other costs associated with operating the expanded branch network are significant," the proxy statement said, adding that Delaware "has yet to fully grow, and may not be able to fully grow, sufficiently to cover the costs associated with such expanded infrastructure."

Delaware, in its application, also agreed to take "necessary and reasonable action" to raise capital through a stock offering or private placement within 18 months of the deal's closing. The company agreed to keep its bank's Tier 1 equity capital ratio above 8% until it sold stock.

In early 2015, the board cut the company's semiannual dividend after struggling to make payments on the loan.

"The shareholder base, some of whom rely to a significant extent upon dividend income, expressed concerns and the board further evaluated potential strategies to raise equity," the filing said.

Delaware's board, however, realized that it would be difficult to lure new investors to the company's thinly traded stock without creating "significant dilution" for existing shareholders. By October, discussions that once centered on raising capital had shifted to other alternatives, including selling the company.

Delaware's investment bank contacted 19 institutions; two provided letters of intent by late December and two others, including Norwood, gave verbal expressions of interest. Delaware's board favored Norwood's proposal because it "represented the highest proposed consideration … and involved a mixture of cash and stock," the filing said.

Norwood and two other institutions were allowed access to more information, though Norwood was given the first opportunity for on-site due diligence. Norwood lowered its offer in January by 3%, to $16.55 a share, which still remained the highest bid. Negotiations eventually prompted Norwood to raise its bid slightly, to $16.68 a share.

A deal was reached on March 10, with the $751 million-asset Norwood agreeing to pay $15.4 million in a deal that valued Delaware at 116.3% of its tangible book value. Norwood also agreed to retire about $20 million in senior debt and trust-preferred securities held by Delaware.