When Tower Bancorp Inc. of Harrisburg, Pa., acquires First Chester County Corp., it will utilize a provision that lowers the price of the deal if the seller's delinquencies rise. Such provisions have become more common in deals in the Northeast as buyers seek to minimize their risk, but this is the first time a seller has crossed the threshold.
"It goes to show you that in this case, the adjustment mechanism was a useful tool to get the deal signed and have the buyer and seller agree on the value initially, and agree on the value if adverse changes occurred, which it appears they did here," said Michael Reed, a partner in the law firm DLA Piper in Washington.
He added: "It's a tool that both buyers and sellers should be very mindful of and willing to use."
Analysts expect to see more of the provisions in bank M&A deals, especially given how it has benefited Tower, which will acquire First Chester at a fraction of the initial $65 million price. The deal likely will close in the fourth quarter.
First Niagara Financial Group in Buffalo included a price adjustment provision in its deal for Harleysville National Corp. in April, and Bryn Mawr Bank Corp. took advantage of a similar measure in its acquisition of First Keystone Financial Group in June.
The measure also has popped up in recent deals in Pennsylvania, including Northwest Bancshares Inc.'s proposed $20.3 million acquisition of NexTier and F.N.B. Corp.'s $70 million deal for Comm Bancorp Inc.
The dearth of bank failures in the Northeast has fueled these provisions. Without the loss protection provided by assistance from the Federal Deposit Insurance Corp., those companies seeking to acquire distressed banks must build their own safety nets, said Matthew Clark, an analyst with KBW Inc.'s Keefe, Bruyette & Woods Inc.
"In a region where there are fewer FDIC deals, this type of structure works well," Clark said. "It plays to their hand."
This strategy appears to have paid off for Tower.
Its deal with the $1.1 billion-asset First Chester includes a sliding scale provision, in which the exchange ratio — the number of Tower shares that First Chester shareholders would receive — would shrink if delinquencies surpass $55 million as of the last business day of the month before the closing date.
If delinquencies exceed $90 million, Tower could walk away from the deal. Under the provision, the number of shares for First Chester stockholders would increase if credit quality improved.
"We wanted a structure that protected our shareholders, but at the same time rewarded their shareholders," Andrew Samuel, Tower's chief executive, said in an interview. "We felt like a pricing mechanism would probably be in the best interest of both parties, and protect our shareholders if delinquencies got out of whack."
Indeed, delinquencies have nearly doubled since the deal was signed last December, and First Chester entered into a formal agreement with its regulators earlier this month.
As of July 31, First Chester's delinquencies totaled $77.7 million — enough to lower the exchange ratio to 0.291 from 0.453, which would vastly reduce the number of shares Tower would have to issue to First Chester shareholders.
Yet despite the deteriorating credit quality, Tower isn't sweating. "The way I look at it is the pricing mechanism that is put in place is working the way we had intended it to," Samuel said.
Whitney Young, an analyst with Raymond James, said Tower will take a conservative mark against First Chester's loan portfolio and structured the deal anticipating that credit quality would worsen. The price adjustment makes the deal even sweeter, she said.
"I do think that they had their eye on this all along and probably had an idea of where it would end up," Young said. "I don't think … that they were caught off guard."