Financial Service Command Center: Legal Trends and Analysis for Financial Service Providers (Vol 1, No.3) Merger Wave?

Briefings on significant legislative, regulatory and judicial developments affecting the financial services industry.

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(July 2013)   You can’t read the financial press without hearing about the imminent tsunami of community bank consolidation. It’s an incessant drumbeat, fomented, one suspects, by those who might profit from a transaction volume uptick. The drummers say that a perfect storm is brewing to force industry amalgamation. Bankers are told that a raft of factors-Dodd-Frank compliance costs, the CFPB, the looming Basel III, shrinking margins, regulatory excess and increased liability risk, along with the sheer workload boost-have all combined to create fatigued managers and directors who can see no plausible alternative to merging into a heftier institution.

2013 hasn’t quite worked out that way. Merger activity has decreased as compared with 2012[1. The American Banker (July 10, 2013) reports that there were "102 deals through June 30, about 11% fewer than a year earlier. And deal values plummeted 22% to $4.5 billion."  It goes on to quip that: "For the last few years, advocates of bank M&A have had an experience akin to rooting for the Chicago Cubs: early optimism followed by disappointment. Economic uncertainty, market volatility and stubborn sellers have created obstacles."] and the predicted tidal wave has not yet gained traction, especially here in the Northeast. Instead, many healthy community banks-the survivors who emerged from the storm with strengthened balance sheets-are waiting for valuation increases and holding out for higher prices. Having fought and won the asset quality war, shed their remaining TARP securities and perhaps raised fresh capital, they reason: what’s the rush-why not wait for the pricing environment to improve? We can’t see a clear path to organic growth and survival as a prosperous independent bank, but if we just tread water for a while, we may be able to fetch a higher price for our shareholders.

The trumpeted merger wave may arrive or it may not, but one thing is clear: successful bankers and directors don’t decide their banks’ future on self-interested predictions. Yes, they consider the macro forces affecting the industry, but they also examine and weigh their banks’ unique features, like: succession plans, loan demand, market demographics, shareholder population and stock liquidity. Their deliberations are more informed and thoughtful and are not animated by the stampede mentality. And as a happy bonus, decisions having these qualities earn business judgment rule protection in shareholder litigation.

Some banks will decide to sell after balancing the mix of information and assessing the strategic choices. Their officers and directors must then get comfortable with the material terms of the deal they strike with the chosen buyer. Those terms are negotiated with the help of financial and legal advisers and are embodied in the merger agreement. While a comprehensive review of merger agreement contents is beyond this article’s reach, major terms include:

  • Price/Consideration:  What’s the Seller worth? Will the Buyer pay with stock, cash or a combination of the two? If stock, what will be the exchange ratio for the Seller’s stock?  What about Buyer stock dilution and floors and caps for both the value and number of shares to be issued in the merger?
  • Structure:  If the Buyer and Seller both are stand-alone banks, the transaction likely would be a straight bank merger. But if one or both parties have parent bank holding companies, a more complex process would be involved, taking into account factors such as required shareholder and regulatory approvals.
  • Approvals:  Board and regulator approvals are always required. A need for shareholder approval will depend on the deal structure, the law of any holding company’s state of incorporation and its charter and bylaw provisions.
  • Social Issues:  Will the Buyer invite any Seller directors to its board?  What about offers to Seller’s key officers? Will the Buyer create or expand an advisory board for Seller directors who don’t remain on the board?
  • Representations:  Both parties make customary representations, but the Buyer cares more about them than does the Seller, especially in a pure cash transaction where the Seller’s shareholders have no stake in the Buyer’s future. Typical representations include matters such as corporate authority and status, regulatory compliance, employee benefits/agreements, environmental matters and pending litigation or investigations.
  • Covenants:  Covenants are promises about the parties’ conduct between the signing of the transaction agreement and the closing. They include matters like capital expenditures, incurring of debt and generally operating the Seller in the ordinary course pending the closing, as well as undertaking to cooperate with regulatory filings, landlord consents and other steps needed to close.
  • Material Adverse Change:  Buyers understand value and make offers based upon financial information they get from the Seller during due diligence and from public and commercial sources. Naturally, they want to get what they bargained for. To protect against a meaningful decline in the Seller’s enterprise value between signing and closing, merger agreements will often have a material adverse change, or MAC clause. MAC clauses may be general, or tied to specific criteria like earnings or asset quality. If the MAC clause is triggered, the Buyer will be able to re-negotiate or cancel the deal.
  • Competing Proposals:  The Buyer will want to lock up the Seller and prohibit the solicitation or acceptance of competing offers, while the Seller will want the ability to negotiate with other suitors if its board of directors concludes that it must do so to discharge its fiduciary duties to shareholders. Merger agreements typically address these competing needs with “no shop”, “fiduciary out” and breakup fee provisions.
  • Termination:  The merger agreement will identify termination grounds, such as failure of regulatory or shareholder approval, uncured breach or mutual consent, and specify notice requirements and other mechanics.

Trendy pundit chatter shouldn’t drive merger decisions. Focused thinking and steady perspective should be the guide. These time tested principles are most likely to produce winning results for those who decide to sell, and for those who decide to continue solo.

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Article written by Clifford S. Weber, Esq., a partner at the HH&K White Plains, NY office.  For more information contact Mr. Weber at (914) 694-4102 or cweber@hhk.com.

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