5 steps to be ready to sell (July 10, 2008)

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5 steps to be ready to sell (July 10, 2008)

The M&A market is very quiet now, but plenty of banks would like to sell once conditions improve. Here are some guidelines to be ready for that

By Steve Cocheo, executive editor, This e-mail address is being protected from spam bots, you need JavaScript enabled to view it

Thus far, M&A volume for 2008 remains significantly off the pace for 2007. In the first quarter, only 42 bank and thrift deals were announced, versus 86 in the first quarter of 2007.

The speed and depth of deterioration in the financial services sector have made both buyers and sellers hold back.

Sellers haven’t adjusted their thinking to the reality of the economic situation, and many potential buyers are hesitating to buy right now, given the potential for paying to own someone else’s problems.

These and other factors are discussed in depth in the article, “Time to sell your bank? Maybe. But can you?”, which appeared in the July 2008 print edition, but also appears elsewhere on the site (click here).

There are steps that banks interested in selling can take now, however, during the market lull, to make themselves more attractive when opportunities arise.

Bankers should review the following list—an expanded version of what appeared in print—with two caveats from attorney David Baris: “There’s only so much you can do. You are what you are.”

And also: Own up to things up front, before due diligence begins.

“Buyers don’t like surprises,” says Baris, with the Washington, D.C., office of Kennedy & Baris LLP. “If they find a problem later, that undermines the credibility of the target institution.”

1. Eliminate the negatives. This is the top recommendation from most advisors, and typically what they really mean is, clean up the loan portfolio, both in content and records.

“Buyers will discount 100% for any kind of uncertainty,” says Jeffrey Gerrish, attorney and consultant at Gerrish McCreary Smith LLC, Memphis, Tenn. So he advises getting the portfolio in shape before bringing the bank to the market. The more the bank’s loan files can be brought current, loose ends tied up, and missing documentation found or arranged for, the cleaner the portfolio will look during due diligence.

Troubled loans that can be sold off, worked out, or otherwise taken care of now, should be.

“If you have command of this, the rest falls into place pretty quickly,” says Don Musso, FinPro, Inc., Liberty Corner, N.J. Otherwise, warns Musso, buyers will use the presence of such loans in the portfolio as leverage to negotiate down the price. Further, he explains that in such situations buyers will see unaddressed junk as either a sign that existing management is ignorant, or that the holes in the portfolio are likely even deeper than they appear.

One gambit a seller with troubled loans can consider is something advisors say worked during the late 1980s and early 1990s. One name for it is the “earnout sale”; another is the “contingent payment” strategy. Essentially, the buyer and seller agree on a price, with an agreement that if the recovery on a group of underperforming loans turns out better than projected, the seller’s stockholders will receive a sweetener later on.

“It can be done, it is done, and it is the subject of discussion again,” says attorney David Baris, “after having been off the table for years.”

However, the experts warn that the seller interested in such a deal may have an uphill battle. “Most bankers think it is too complicated,” says Gerrish.

2. Become realistic regarding what buyers really care about.
If your bank is going to go into selling mode, you’d better be ready to face some hard truths. Attorney Walter G. Moeling, IV, co-chair of the financial institutions group at Powell Goldstein LLP, Atlanta, says buyers don’t care about your bank’s name and history; know that they’ll only be able to hold onto some of your staff; and have a little interest in branches, but not as much as you’d think. Jeff Gerrish says that any nontraditional activities that aren’t producing a strong earnings stream “are just dead weight around a buyer’s neck,” something they’ll ditch after the acquisition.

Moeling brings clients to reality by telling the story of a seller he represented. He and the client were testing the waters with a prospective buyer. The potential seller was proud of its brokerage operation. The buyer couldn’t have cared less: “We already do that, and we do it our own way.” Next, the seller spoke of its successful insurance operation; again, a yawn. Finally, the target’s management pointed to the new branches it had opened, and the buyer was blunt: “In three years, they won’t be funded completely, and we won’t pay you now as if they were. So there will be discounts.”

Flummoxed, the target’s CEO asked, “Then what do you want?”

The answer: “We want your customers and your deposits—and your assurance that they’ll stay with us.”

Harsh? Maybe, but it’s the real world. “Acquirers want stuff that will stay with the bank after it is acquired,” says Moeling, “and that’s core deposits and core loans.”

And Baris warns that sellers can expect buyers to stratify even core deposits into more-desirable and less-desirable layers.

3. Reconsider management contracts.
Contracts with the CEO and other top managers—typically the top credit staff—represent a ticklish balancing act that may ultimately need resolving by the nonexecutive chairman and the board. Top officers seek change-of-control clauses and other payments and protections for themselves, naturally. On the other hand, these are the rainmakers who can often pull core business with them, so the bank and its shareholders have a vested interest in retaining them to stay on for some period with the buyer.

“A CEO’s value is never higher than 24 hours after a deal has been announced,” says Curtis Carpenter, managing director, Sheshunoff & Co. Investment Banking, Austin.

Addressing this concern applies not only to making a good deal, but to the selfish interest, in the case of purchases made with stock, of keeping the buyer’s stock strong and attractive should the seller’s shareholders later decided to reap their profits from the merger. Baris suggests striving for management contracts that at least ensure that the buyer will have a reasonable, orderly transition.

4. Avoid entangling vendor and facilities contracts.
A related point to No. 3. If your bank appears to be moving toward selling, advisors agree, don’t create a batch of long-term contracts that a purchasing bank will either have to live with or buy out.

Physical properties are a good place to start. Baris recommends reviewing the leases on branch and other locations that the bank doesn’t own, to ensure that an acquirer would have a reasonable exit strategy. In some cases, Baris suggests a bank moving towards selling might consider reducing its branch network.

5. Consider hiring a financial advisor.
An obvious suggestions from a group of M&A advisors, but that doesn’t mean it is bad advice.

Many community bank management teams have an idea, from their CEO’s conversations around the industry, about who might like to buy them. But that doesn’t mean that simply telling those suitors that the time has come to marry is what’s going to get shareholders the best price.

“You don’t get the highest prices,” says Sheshunoff’s Curtis Carpenter, “unless there is a sense of competition.” BJ

[This article was posted July 10, 2008, on the website of ABA Banking Journal, www.ababj.com, and is copyright 2008 by the American Bankers Association.]

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