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Is The Time Right for De Novo Banks?

Ten years ago, business was booming for community banks—profitability driven by a hot real estate market, a wave of de novo banks receiving charters, and significant premiums paid to sellers in merger transactions. Once the community bank crisis took root in 2008, however, the same construction loans that once drove earnings caused significant losses, merger activity slowed to a trickle, and only one new bank charter has been granted since 2008. But as market conditions improve and with Federal Deposit Insurance Corporation’s (FDIC) release of a new FAQ that clarifies its guidance on charter applications, there are some indications that an increase in de novo bank activity may not be far away.

To understand the absence of new bank charters in the last six years, one must look to the wave of bank failures that took place between 2009 and 2011, which involved many de novo banks. Many of these banks grew rapidly, riding the wave of construction and commercial real estate loans, absorbing risk to find a foothold in markets saturated with smaller banks. This rapid growth also stretched thin capital and tested management teams that often lacked significant credit or loan work-out experience. When the economy turned, these banks were not prepared for a historic decline in real estate values, leading to a wave of FDIC enforcement actions and bank failures.

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Building a Better Mousetrap: Executing a Merger of Equals

With merger activity on the rise during 2014, some boards of directors are considering whether the time is right for their financial institution to find a strategic partner. These boards, particularly those serving institutions with less than $1 billion in assets, may believe their banks need to gain size and scope to maintain a competitive footing. However, these boards may also want to maintain the strategic direction of the institution or capture additional returns on their shareholders’ investment. For these boards, a merger of equals with a similarly-situated financial institution may hold the greatest appeal, as a combined institution could gain greater competitive resources and additional return for its investors than if it were to remain an independent institution. Although a merger of equals may be appealing to both management and the board, the particular circumstances required to execute such a transaction can often be elusive. A merger of equals may involve structural considerations that are slightly different from other acquisitions:

  • Geography. The merging institutions typically have complementary, rather than overlapping, market areas. Some commonality among the markets is helpful, but significant overlap can eliminate many of the synergies associated with a merger.
  • Competitive Advantages. A merger of equals may make sense for financial institutions that have different specialties or expertise. For example, a bank with a high volume of commercial real estate loans may be able to diversify into C&I by finding the right merger partner. Deposit pricing can also create attractive opportunities, with low-cost deposits from slower-growing markets funding loan growth in an adjacent market.
  • Enhanced Currency. Mergers of equals are usually stock deals, allowing the shareholders of each institution to maintain their investment in the combined company. The goal is for the value of the combined entities’ stock to receive an uptick in value at the conclusion of not only the initial merger, but also upon the ultimate sale of the combined institution.
  • Management Integration. Combining the management teams and the boards into an effective team for the surviving bank without bruising egos can be challenging. However, a common goal and meaningful relationships between members of the leadership team of the two institutions can be helpful in finding a path forward.

If two like-minded banks are able to identify each other, negotiating the terms of the transaction can be a complex process, as many management and cultural issues must be resolved prior to entry into the merger agreement. Who is going to be the chief executive officer of the combined institution? Who is going to be on the board? Often, new employment agreements will be negotiated in order to lock in the new management team through the integration of the two institutions. The merger partners should also use the negotiation process to formulate an identity for the resulting bank. While a strategic plan for the combined institution is not a component of the merger agreement, a merger of equals demands that the two merger partners work together to chart a future course for the combined company. Unlike other acquisitions, where the work of integration will begin in earnest following the signing of the merger agreement, formulating a management team, as well as the strategic and business plans of the combined bank, starts at the negotiating table in a merger of equals.

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