Succeeding in today’s financial marketplace is challenging, with more intense regulation, ongoing competition from other industry players, and hungry fintech companies eager for a slice of the consumer banking pie. It is also harder to keep up with customers’ expectation for mobile financial apps that offer the same easy access and simple navigation they find in the retail world.
A good strategy for many medium- and larger-sized institutions ($500+ million in assets) is to pursue strategic mergers. For example, a community bank might consider merging in a smaller bank with branch sites that would complement its own locations. Or perhaps the bank under consideration provides a service that would fit the acquirer’s product offerings.
Also contributing to the growth in mergers is the expectation that, if the Financial Choice Act is passed, there will be a rollback of some of the more onerous provisions of the Dodd-Frank Act. Most merger activity is occurring in Midwestern states, which have a high concentration of smaller financial institutions. This is reflected in the chart below:
Reasons to merge
The key to achieving a good merger is ensure good planning: finding a good market fit, sharing a similar philosophy, and preparing for the merger well in advance. If those items can be checked off the list, consider these benefits of merging:
- Enhanced market power and competitive relevance
- Ability to expand branch network and grow market share without a brick-and-mortar investment
- External growth and a more diverse customer base, resulting in less reliance on organic growth
- Broader array of products and services for the combined institution
- Opportunity to streamline back-office efficiencies
Issues to consider
When ALM First helps a financial institution through a merger, we emphasize that combining two institutions takes time, often up to a year to complete and even more if there are system incompatibilities, a clash of cultures, or disagreements among merger partners. To avoid these problems, planning should take place as soon as possible after the decision is made, giving careful thought to three key factors: negotiation, integration, and culture.
Negotiation – With appropriate planning, a merger can be a positive event for both parties. But before the ink is dry, make sure to consider these integral components:
- Employees – Mergers are stressful, so it’s important to give employees of both the target and acquiring institution frequent updates. They will want to know about changes to salaries and benefits, how responsibilities may change, to whom they will report, and whether their job is “safe.” Those asked to stay through completion should be incentivized and those who leave right away should know what their severance package will include.
- Governance – Many times, mergers fall apart at the last minute because of issues dealing with board representation of the new entity. There is no standard formula to determine the right number of board seats that should be offered to the target. For example, if the transaction is a merger of equals, 50% of the board seats could be given to the target, while 50% are reserved to the surviving institution. ALM First recommends that regardless of the decision, the discussion should occur early in the process.
- Commitments – Both parties must be open. The target financial institution should explain any operational trouble spots and unwritten agreements. Also, due diligence may not reveal issues like problem employees, high turnover, or the stability of the new customer base. In turn, the acquiring financial institution shouldn’t make commitments it won’t keep, like promising customers that familiar employees will continue to serve them if it isn’t likely.
- Customer expectations – Be upfront with customers so that they understand the acquiring institution’s policies on rates and fees, as well as daily operations. Will the loan approval process be different? What about funds availability? Promote positive changes, such as additional services or faster loan processing, only if they will continue.
Integration – It is challenging to merge systems and operations, so the acquiring institution must fully understand the projected costs it will incur, as well as the time it will take to integrate systems, workflows, and staff.
- Finance and accounting – Merger accounting is complex, and it is important to be thorough. FASB requires merging institutions to use the acquisition method of accounting, which includes identifying the fair value of the new organization, as well as measuring and recognizing the assets (and liabilities) being assumed. The acquiring institution also must set a level for goodwill, evaluating it for impairment at regular intervals.The acquiring institution also should engage valuation experts who understand merger requirements. For example, it is important to assess the merging financial institution’s value, but this cannot be done until after regulatory approval. A financial partner with expertise in valuation methods knows the rules and is practiced at determining adjustments to projected loan losses. Auditors also should be engaged early on to ensure valuation methods meet appropriate accounting standards. They can offer guidance on the level of analysis needed, as well as help with amortization schedules. Using financial and auditing experts also increases the confidence of management, the board, and regulators.
- Systems and infrastructure – It is important to know the terms of the merging institution’s core system agreement and early-termination fees, as well as those for other long-term contracts and commitments such as the CRM platform or building and equipment leases. In addition, the acquiring institution should decide whether the target institution’s branches will complement those of the acquirer and help expand the branch footprint.
- Products and services – Consider if the two institutions’ products and services will complement each other. For instance, does the merging institution have an SBA platform, providing an opportunity to expand into small-business loans? What convenience-services does each institution offer? Are mobile and online delivery channels compatible?
Culture – A key reason some mergers fail is that the CEOs do not share the same values or perspective. Both financial institutions should share a common approach to managing customer and employee expectations.
- Values and philosophy – It is vital for the new entity to operate under one culture. Review compatibilities and inconsistencies in areas such as staff training, employee development, and advancement or incentives. Get a bead on employees’ level of trust and respect for management. What about work environment? Is one relaxed while the other is more formal?
- Customer relations – Consider each financial institution’s attitude toward its customers. While profits are important, there won’t be any if customers don’t experience good customer service. How aligned are the institutions in offering quality service?
While mergers are time-consuming and often complex, the advantages can more than compensate for the effort, especially if it means staying competitive and growing market share. Careful planning and paying attention to sticky issues upfront can help institutions minimize or eliminate many problems. A successful merger can help an institution to not only survive, but thrive – ensuring a prosperous future.