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Congratulations, it’s a Merger!
Never mind if it’s legal,” he asked. “Is it a good idea?”
For some of us, economic cycles are predictable. In good times, we bank lawyers help form new banks; in bad times, we lift them out of the ditch; and when the world starts to right itself, we encourage business combinations.
In Tennessee, we are seeing the first of these business combinations, whether in the form of acquisitions or mergers through statutory share exchanges. Sellers like to call these transactions “mergers” or “business combinations.” Buyers often prefer the term “acquisition.” Regardless of nomenclature, we are pushing or pulling banking companies together to make bigger, stronger financial services companies that will, we hope, be better positioned to withstand future economic fluctuations and increased regulatory scrutiny and associated costs.
Key Drivers of Merger Activity
Bankers lament more about the increased cost of consumer compliance regulation than they do about interest rate risk and lack of loan demand. Spreadsheets and balance sheets make sense to them; piling on new, complex and mostly baffling regulations designed to protect consumers from big, bad banks are an increasing source of anger and frustration. At a recent meeting of Tennessee bankers with representatives of the Consumer Financial Protection Bureau in Washington, I watched with some fascination as blood pressures around the room rose on both sides of the table. Bankers challenged the wisdom of proposed rules that bankers think will actually make credit less available and shrink the possible choices of products and services. One Bureau analyst, forced by his boss, I guess, to sit through yet another meeting with hostile bankers, played with his iPhone and rolled his eyes disparagingly at the questions posed by community bankers from across the state. It was not a pleasant hour.
With the rising cost of compliance, bankers are weighing the desire to remain independent and the realities of having to hire more staff, lawyers and consultants to keep up with the quickly evolving regulatory environment.
Improvement in the value of banking companies’ stocks is also a factor in the renewed energy around bank mergers. Some sellers have been willing to take a buyer’s stock as consideration for a merger if they view that stock as a good long-term investment. There is little activity in private markets for community bank stock — a trade among family members and friends now and again — but buyers understand who the players will be and are frequently more interested in liquid stock as deal currency than in an immediate cash payout.
The aging of boards of directors and bank management, as well as shareholders weary of not receiving dividends throughout the recession, are also factors in deciding whether to sell a bank. A failure of succession planning is frequently the catalyst for a sale. Directors hear their biological clocks ticking and begin to wonder if it would be so bad, after all, to sell the company.
Banks are also acutely aware that geographic diversity and the types of loans available in those markets are keys to success. A bank with a concentration in hospitality lending would do well to find a merger partner whose portfolio has a better mix of loans. A strategic merger of two companies in different, but compatible, markets is often a nearly perfect match.
But Is It a Good Idea?
Some years ago when I was general counsel for the Tennessee Department of Financial Institutions, bank lawyer Dan Small and I were enjoying an adult beverage in a local Nashville watering hole. He took out a fountain pen and drew the structure of a transaction on a cocktail napkin, explaining to me why his idea for a particular merger worked. Impressed with his legal acumen and creative approach to an opportunity, I folded the napkin, put it in my purse and presented it to the Commissioner the next morning. “See this structure Dan wants to use? It’s legal and it works.” My boss, the banking commissioner, sat back in his chair and mulled a bit: “Never mind if it’s legal,” he asked, “is it a good idea?” I had no idea.
Good unions must be more than legal — there must be a good reason both to merge two companies and careful thought about how a transaction should be structured. Merger transactions can be constructed in a variety of ways to gain the best tax treatment for shareholders, to preserve tax assets such as net operating losses, and to effect other desired results. Tax lawyers, benefits counsel, and other professionals should be engaged early in the decision-making process so that the pre-nup is fair to all parties — and as the late Commissioner Jeff Dyer suggested, “Is it a good idea?”
We’re Engaged! Now What?
Once two banking companies have done their dances, held hands, smooched a little, and decided they might want to get married, how is the knot finally tied? Virtually every union of two (or more) banking companies has the same rituals, modified here and there to account for cultural differences, dowries and difficult family members. In no particular order of importance, the essential questions to answer, sooner than later in the courtship, are these:
- Are the goals of the two companies compatible?
- What will the consideration for the transaction be? Buyer’s stock? Cash and stock? All cash?
- Who will run the bank after the merger? Which CEO and CFO will survive?
- Who will be on the board of directors? Can egos be managed for the sake of shareholder value?
- What will be the name of the surviving bank? This is often the most contentious of all questions in a merger of equals.
- Will the combined bank have enough capital to make regulators happy? More than the investment banker thinks is enough is the right answer.
- Will our respective banking teams work well together?
- Who will lose his or her job?
- Can we keep our same health insurance and see the same doctors?
- Are there employment or vendor contracts we’ll have to pay out?
- Are the credit cultures of the two banks similar or is one a hot-shot lender and the other, too conservative?
- Will we still have the same regulators?
- Will we still get to enjoy casual Fridays?
Somewhere in all that, some thoughtful soul will ask, “Is this a good deal for the shareholders?” That should have been the first utterance, even before one bank asks the other to the prom, even before that first visit with the families, even before you hire the wedding planners.
The Wedding Planners
Banks that decide to merge should not venture too far into the process until they have each hired the typical advisers who will help make that special day everything the parties want it to be. An investment banker who won’t recommend the deal just so he gets his commission; a law firm with bank merger expertise and experience; an accounting firm that is familiar with the bank; and maybe various consultants to assist with the necessary background checks we call “loan review” — these are all experts who can make or break a transaction. Banks should not skimp on the essentials. Buy cheaper food for the reception, but don’t do the deal without a fairness opinion.
Agreements Among the Parties
Papering a bank merger transaction kills a lot of trees. The first essential agreement is a mutual non-disclosure and confidentiality agreement by which both banks promise to keep each other’s confidential information, well, confidential. An “NDA” for a bank merger needs some unique provisions that deal with the confidentiality of customer information. The NDA also should bind the banks’ advisors, directors, officers, employees and agents because a bank merger takes a village, and too often secrets get out before it’s time.
The second agreement is usually called a “definitive agreement.” It is typically drafted by Buyer’s counsel and sets out the essential terms of the transaction:
- Transaction consideration
- Representations and warranties of both buyer and seller
- Termination provisions and any “break-up” fee
- Conduct of the business until closing
- Required approvals by boards, shareholders, regulators
- Other agreements unique to the transaction.
Once upon a time, I did an acquisition transaction with my great friend and fellow bank lawyer Bob Thompson at Bass Berry & Sims. His client was buying my client bank in an all-cash deal. The price was fair. The parties were in agreement. However, the president of my client insisted on having two dedicated parking spaces in the bank’s parking lot assigned to him for life. Apparently, it was a deal breaker. When Bob finally stopped laughing, he begrudgingly gave in, and we got the parking spaces. It’s amazing what matters to people. A definitive agreement is negotiated between the parties, usually with counsel taking the lead in the negotiations. When the parties have agreed, the respective boards of directors will review and approve the agreement, and then the transaction can be announced to the public. Cue the engagement party with toasts, speeches from the best men, and photos in the local press.
In most marriages, families’ blessings are sought. A license is required. Daddy wants to run a credit and background check on his daughter’s intended. Bank mergers, depending on whether one or both banks have holding companies, must be approved by various state and federal regulators. State-chartered banks must submit an application to the state’s banking regulator, in Tennessee, the Tennessee Department of Financial Institutions, as well as to the state bank’s federal regulator, either the Federal Deposit Insurance Corporation or the Federal Reserve Board of Governors. National banks will file applications with the Office of the Comptroller of the Currency. If one or more holding companies are involved, the Federal Reserve must act on those applications.
This article is not designed for an in-depth review of the regulatory process, but it’s complex and time-consuming. Most noncontroversial transactions will be approved by the local offices of the regulatory agencies within 60-90 days. If there are unique issues or if one of the banks is subject to any type of state or federal supervisory action, regardless of the issues, the application “will have to go to Washington,” a phrase that strikes fear in the hearts of bankers. I love Washington with its great seafood, beautiful and historic monuments, museums and lovely open spaces — but when an application ends up on the desks of one or more federal lawyers and analysts (disrespectfully called “the black hole”), we know the process will be stalled. If we live long enough, however, the application will be approved eventually, and the parties can get on with the ceremony.
In a typical business combination transaction, the parties prepare a joint proxy statement, which becomes the Buyer’s offering document if securities are being exchanged. Once shareholder approval is obtained where required, in accordance with either state law or federal law for national banking companies, the “I-now-pronounce-you’s” can be uttered when both regulatory and shareholder approvals have been received.
The Honeymoon — and Later
After the merger is complete and the honeymoon is over, the real work of integrating two different companies begins. Operating systems may change; some personnel will be gone or be in different jobs; credit cultures will clash and become reconciled. Most of the time, customers can’t tell the difference because even if the happy couple has a spat or two behind closed doors as they get used to squeezing the toothpaste from the bottom instead of in the middle of the tube, they won’t fight in public. Soon the parties will settle in with each other like an old married couple — and begin talking about starting a family by hunting for the next deal.
KATHRYN REED EDGE is a member in the Nashville office of Butler Snow LLP with offices in Tennessee, Mississippi, Alabama, Pennsylvania, Georgia, Louisiana, New York and London, England. She is a member of the firm’s Government and Regulatory Practice group and concentrates her practice in representing regulated financial services companies. She is a past president of the Tennessee Bar Association and a former member of the editorial board for the Tennessee Bar Journal.