Survival of the Fittest - Key Considerations for Successful M&A

For about nine years, analysts have predicted two game changers for the banking industry – an M&A boom and an interest rate hike. The M&A prophecy came true in 2014, with the highest transaction volume since 2006. Based on year-to-date transaction activity, this trend will continue through 2015. The prevailing factor that’s driving the M&A boom? Growth. Buyers and sellers seem to agree that bigger is better. Survival of the fittest tends to be predicated on asset size. In almost every bank, it seems that leadership is weighing their options – buy or sell. So many variables influence the success of a deal. Besides size, they can include culture, geography, regulatory challenges, cost savings, earnings and (perhaps the most sensitive factor) pricing.

To illustrate some of the ways in which creating a win/win scenario is more of an art than a science, consider the point of view, intentions and motives for the seller and buyer. The motivation to sell can vary. Banks typically fall into a couple of categories that qualify them as acquisition targets. For smaller banks, unmanageable regulatory burdens may be driving them to try to get out of the market. Mid-sized banks trying to stay in the game may recognize a need to merge, and therefore may be interested in a more liquid investment. Regardless of their motivation to sell, price is the most important transaction driver. To assess the adequacy of a price, sellers tend to focus on what it represents as a multiple of an institution’s book value.

Buyers tend to approach deals with more of a windshield view. They are focused on the future earning capacity of the target and how quickly the transaction will become accretive to earnings. In theory, future earnings and the growth potential tend to drive the overall valuation of a bank franchise. In reality, many other factors can impact the price. Undoubtedly, projected cost savings is a key driver in the buyer’s analysis of pricing. Other characteristics influencing pricing decisions include the size of the target and, of course, location. Sellers are prudent to look beyond price as a multiple of book calculation to find their actual value. Conversely, buyers need to understand qualitative factors, such as culture and talent, which could impact the target’s future earning capacity.

What is the key to getting a deal off the table and finding win/win for the buyer and seller?

The bottom line is that sellers and buyers should perform robust due diligence around all aspects including price, operations, cost savings, current and future value, culture, and regulatory and interest rate risks. Additionally, buyers are prudent to recognize that what drives shareholder value in the current low interest rate environment may differ from what drives value in a rising rate environment. If the prophecy about rising interest rates reveals itself in the near future, it may impact the projected return on investment.

Have you engaged in an M&A transaction? What factors have impacted your deal, and how do you see interest rate changes impacting your approach?

Topics: M&A, Bank Growth

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