M&As still hot: The conversation around consolidation

Editor's Note: The mergers and acquisitions market dominates many conversations in the financial industry. With that in mind, BankBeat impaneled seven M&A industry insiders to discuss current trends, strategies and overall advice.The panel:• Don Johnson, partner, Eide Bailly; Minneapolis• Marc Ward, attorney, Fredrikson & Byron; Des Moines, Iowa• Craig Mueller, managing director, Oak Ridge Financial; Minneapolis• John Freechack, principal, Piper Jaffray Financial Institutions; Chicago• Jim Sheriff, senior partner, Reinhart Boerner Van Deuren; Milwaukee• Kevin Janke, partner, Wipfli; Eau Claire, Wis.• Neil Falken, principal, CliftonLarsonAllen; Minneapolis.Q: How would you describe the M&A market right now?Johnson: It is active. I would stress interest.Freechack: The one interesting dynamic is you certainly have buyers, publicly-traded buyers, who are able to utilize their currency. The vast majority have higher ability to pay than they did last fall.Sheriff: I would say starting with the last quarter of 2016 and continuing through early 2017, in Wisconsin the activity has settled down some. My own view is with the election of President Trump a lot of bankers who have been very fearful—and ever since 2007 and 2008 with the recession and the bad times—we saw a lot of banks looking to bail then and get out. They couldn't even get book value in some cases. As we got to the election, a lot of my clients saw a little bit of a rainbow. We might actually be able to make money on margins. There seems to have been some sort of resurgence.Falken: I would call it active. There are some bankers now looking at this from the standpoint of a way to sell their bank as they have recovered from the economic downturn and get some value..Q: How long can community bank owners expect this environment to last?Ward: Higher interest rates might actually encourage more sales. On the one hand, you have higher cost of funds for an acquisition. On the other hand, someone selling a bank now has better investment opportunities to place the proceeds.Mueller: Part of that will really have to do with what legislators can get accomplished, predominantly with the tax rate. If the tax rate and capital gains rates are positively effected, meaning they're lowered, then that certainly gives the sellers more of an impetus to want to take advantage of that particular rate.Sheriff: There will be a lull, at least until people see if regulatory relief helps them out. I don't think there's going to be much passed on that. If maybe some of the economic changes—if there's increased loan demand, if they're making a higher margin—if that doesn't pan out the way I think some bankers hope by the end of the year, then sales could pick up.Janke: If, in fact, the regulatory burden shrinks, there might be some participants who otherwise would have sold that elect to stay in the banking business.Falken: The bid/ask price is going to widen again. That margin will widen because I believe the sellers, if they do go to the market, are going to believe their bank is now more valuable without any real tangible proof of anything changing in the economy yet. Buyers are not willing to pay for that..Q: Will rising interest rates and regulatory reform encourage some banks to push forward on their own?Johnson: Regulatory and interest rates, if it's going to help the profitability, obviously, they may be thinking that.Ward: The regulatory burden might be easier, but there's still those other factors. Succession issues, the lack of market growth, there are other factors than just the regulatory and economic environment.Mueller: That certainly is a possibility, however what we're seeing for banks selling is management and succession. Secondarily, it's all the regulatory burden. In most cases, will a person sell just because of regulatory burden? No, not necessarily, but when you add that to the fact that the ownership or the CEO may be at a point where he wants to look at retirement and he or she may have a shareholder base that is requesting and maybe at this point wanting some liquidity, those are the major reasons people sell.Freechack: We've actually seen that with some of our smaller clients. They view it as a more promising environment than they did six months ago. They're more excited about their prospects as an independent entity than they were pre-election. There's always execution work that comes along with that strategy of remaining independent. There is always macro, political economic uncertainties that come along with that.Janke: Interest rates rising might lend itself to additional profitability with a lot of our banking clients. Additional profitability might be the thing that narrows the gap between buyer and seller expectations in the market. That might spur additional activity because now sellers are hitting the numbers that they wanted to get but couldn't find buyers for earlier.If, in fact, these banks can start making the money that a rising interest rate environment would cause, then all of sudden that disconnect or that difference between buyer and seller is smaller and those deals get done..Q: Size matters. Larger banks typically bring larger buyers. With that in mind, do you see any merit to preparing to be acquired by first making an acquisition?Ward: I've known institutions to do that. It's usually more than buying just one additional bank. They have a long-term plan of acquiring several, but that takes a lot of time and a lot of planning. That's a potential strategy. Because of the time it takes, you can't just buy anything at any price. You have to pick your options carefully and price it carefully. Unless you have a number of years on your planning horizon, I don't think it makes too much sense, but it's available to those who have that luxury of time.Mueller: If a smaller bank, call it a $250 million or a $500 million bank, is highly-profitable, chances are we will be able to find a buyer for that bank that will recognize the value of the earnings that it would be purchasing if it bought that bank. Yes, it is the bigger you are the higher the valuations are in the marketplace, but underlying that is the more earnings you have and the better the earnings—and 'better,' I realize, is a relative term—the higher the valuations will be.Janke: I think that makes sense to a point. When you get to the real large banks, their profitability isn't as high as the $5 billion to $10 billion bank. There seems to be a sweet spot there. There certainly is validity to the strategy of making my $100 million bank become $250 million or $500 million or even $1 billion because I think the pricing and the efficiencies are there, as well as there are additional buyers at that higher level than there are at that $100 million level..Q: What common obstacles arrive with M&As that are frequently unexpected by the bankers?Mueller: The biggest thing that we're seeing is managing expectations on both sides. The sellers want to get a huge premium for their bank and the buyers want to pay as little as possible.Freechack: One thing that can be a bit of a surprise at times is that even though you have had a number of inbound inquiries over the years, once push comes to shove, it doesn't necessarily mean all of those potential buyers are going to submit a bona fide offer. Timing can be an issue for some buyers, maybe there is something else on their plate. Maybe there is a higher priority that they are working on a different transaction.Falken: If anyone ever tells you your two cultures are very close to each other, or use the word "identical," they're lying to you. People can get through the technical stuff. You can figure out the computers and you can figure out how to do the switch-overs to certain things. It really is understanding the culture and the people..Q: What other considerations would you factor into a deal from the outset?Ward: Obviously the purchase price is the No. 1 consideration but key employees and how they're going to be treated, if there are employees who need to be part of the transaction going forward, at least for a limited amount of time, that needs to be addressed up front. Those are probably the two biggest issues you see.Freechack: It's important that you've planned for it. You've worked with your advisors to be sure you're prepared for when an opportunity presents itself. You want to make sure you prioritized potential merger targets. You and the board are on the same page in terms of what type of institution are we looking to merge with so that you're not wasting your time on opportunities that really aren't going to be a good fit for you. Also, so you're being proactive in getting to know those potential merger partners. It doesn't have to be a hard sell, but certainly helps if you have a working relationship or at least a rapport with these potential acquisition targets. If a potential seller is only going to go to a handful of the most logical potential acquisition candidates, you want to make sure that you're on that short list.