The sale of a technology vendor, especially a critical provider such as a core processor, often has bankers reaching for antacids.
Regulators are pressing banks to complete thorough due diligence on third-party vendors. But things can get complicated by consolidation of technology firms, such as the recent announcement that Davis and Henderson will buy Harland Financial Solutions.
There are certain steps bankers should to take when a vendor is sold to make sure that risk management is upheld and regulators remain satisfied, industry experts say. The savviest bankers can even turn these potentially stressful events into opportunities.
"Consolidation has been a concern for all banks," says Brad Smith, president and chief executive of Abound Resources. "When it happens, banks need to jump on the vendor management bandwagon and learn as much as they can about the new company."
While conducting initial due diligence, bankers should consider the likelihood and implications of a vendor's sale, Carolyn DuChene, deputy comptroller for operational risk at the Office of the Comptroller of the Currency.
If a vendor is being sold, bank executives should start gathering information on the acquirer, including reports on its security measures, level of expertise and background on its board and top managers. It is important for bankers to reach out to their regular vendor representative for updates, says Aaron Silva, president and CEO at Paladin.
D+H, based in Toronto, is overseen by U.S. regulators since it already provides some services to banks in this country, says William Neville, president of D+H USA. Because of this, the company understands the type of documents that banks will need to satisfy risk management assessments. D+H is also publicly traded, so considerable information is readily available.
D+H recently completed its own successful regulatory review, Neville says. After D+H buys Harland, the company's executives will hit the road and host town hall style meetings to answer lingering questions, he says.
"We plan on being around for a long time," Neville says. "This is a major investment we don't take lightly."
Bankers should also determine if a vender merger exposes the bank to more risk or changes how services will be provided, DuChene says. Banks often complete this task but fail to present the results to directors in a meaningful way, Smith says. The level of review should relate to each vendor's importance to the bank. For instance, banks that use Harland's core processing should complete a deeper review.
Executives at CoreFirst Bank & Trust immediately began researching after learning of Harland's proposed sale, says John Blakeney, the Topeka, Kan., bank's director of automation and operations. Harland, a unit of Harland Clarke Holdings, is the $997 million-asset bank's core processor. CoreFirst also uses an online mortgage-application service from D+H.
An acquirer's appetite for software development is always a concern, Blakeney says. Sometimes after a merger, the combined company will stop supporting less successful products, he adds. This often forces banks to go through the disruptive process of switching to a new product.
Executives typically have concerns about a deal's financing and the overall health of the combined vendor, Blakeney says. Such worries can influence how much the acquirer invests in improving current products or developing new ones.
"If the acquiring company has fairly deep pockets, they may bring more money into the development process so you end up with a better product," Blakeney says. "But you could see the opposite, with the quality of service deteriorating until you move systems."
Generally, the underlying value of a vendor's acquisition stems from the revenue generated from contracts. Because of this, banks usually are barred from voiding a contract if their vendor is sold, industry experts say.
But this also means the acquirer is less likely to make drastic changes for fear of angering its new customers. Typically, acquirers "will be slow to rock the boat," says Trent Fleming of Trent Fleming Consulting. "They won't be heavy handed."
For instance, D+H's "day one plan is no changes organizationally or to product lines," Neville says.
Banks that are close to renegotiating contracts usually those with 18 to 30 months left on their current deals can take advantage of a merger, Silva says. It generally takes time for the combined company to finalize policies and there can be residual emotional, cultural and political conflicts from the deal that make it easier for banks to haggle for favorable deals.
Before the contract expires, bankers should present the acquirer with a "status quo" agreement that outlines their expectations, such as desired products or what office they want to service the contract, Silva says. The bank should include remedies, such as compensation, if the expectations aren't met.
Vendors "usually respond favorably because they want to keep you," Silva adds. "It's like the Wild West. You can almost cut any deal you want."
If a contract is about to expire, executives could also push for a short-term extension of the agreement, Fleming says. Such an extension would allow management to see which products might be cut from the new company's roster, he says.
With all of the consolidation in the technology sector, Fleming has also started urging more banks to include sunset clauses in their vendor contracts. Such a clause would allow the bank to review using products offered by other companies if their current product is being dropped.
There is always a concern that an acquirer is "buying the vendor to get rid of a competitor and you end up in a forced conversion," Blakeney adds.
Service level agreements in a vendor's contract are also the bank's first line of defense if it is unhappy with how a merger turns out. If a product's quality diminishes after an acquisition, the bank can attempt to use a breach of contract claim to terminate the deal, industry experts say. "It is evident that we will see more vendor consolidation," Smith says. "It's not a great thing for our industry but it's the reality."