Published in Wisconsin Banker
April 2010

M&A, the 2010 Way
Banks seek opportunities in FDIC-assisted acquisitions

By Becky Nelson

No one wants to see a bank fail, particularly in one’s own backyard. But should that situation occur a well-positioned peer institution could make an acquisition almost overnight.

When the Wisconsin Department of Financial Institutions closed the Bank of Elmwood in Racine last October, a familiar competitor – South Milwaukee-based Tri City National Bank – assumed ownership of the bank less than a week after submitting its bid.

But before that, the senior management team and board of directors at Tri City National did their research.

That’s an essential first step in a process that moves quickly once initiated. “Preparation months in advance pays off. You do not want to be in a position where you’re learning about the process and bid structures, analyzing the target institution and getting your team together at the last minute,” said R. Clark Locke, vice president at Hovde Financial, who assisted Tri-City National with the transaction.

According to the 2009 Bank Executive Survey conducted by Grant Thornton and Bank Director magazine, 42 percent of the 246 bank executives responding were interested in bidding on a failed institution. Only 2 percent of respondents had acquired a failed bank in the last year, and 7 percent had bid unsuccessfully.

With 702 banks on the FDIC’s problem list as of Dec. 31, and 37 bank failures so far this year as of March 19, qualified acquirers will see more opportunities ahead.

The Process
A bank must register on the FDIC-connect Web site to receive notices of bid opportunities and get approval from its primary regulator before bidding.

Generally, banks must be rated 1 or 2 and be at least twice the size of the failing institution, explained Brian Buchholz, a partner at Wipfli LLP in Eau Claire.

Ron Puetz, chairman and CEO of Tri City National Bank, had begun board discussions about purchasing another bank in late 2008.

In early 2009, Tri City had approached Bank of Elmwood about a possible acquisition or purchase of one or more branches. Tri City
conducted due diligence; Bank of Elmwood consulted with regulators, but no deal could be reached.

In October, after learning that the bidding process for Bank of Elmwood had begun, Puetz viewed information about the bank online and scheduled a two-day on-site due diligence appointment for four staff members.

Bank management and directors also reviewed the 86-page non-negotiable purchase and assumption agreement.

The bank team returned from the due diligence visit and met with executive management on a Thursday evening, followed with a special board meeting on Saturday. Tri City submitted its bid, due by Monday morning.

On Tuesday, Puetz learned the bid was successful. By Wednesday, the 76 examiners began making their way into town and on Thursday afternoon they met with Tri City National principals. On Friday at closing time, DFI’s Mike Mach announced Bank of Elmwood’s closing to staff and an FDIC representative shared the news that Tri City had acquired the bank.

Tri City National grew from two locations to seven, with more than $1 billion in assets. “Being in a deep recession that a fellow banker has been unable to survive – this kind of situation is not the way we planned to grow our bank,” Puetz said. “But we’re pleased that we have been successful in maintaining the Bank of Elmwood’s former customers.”

Tri City also retained Bank of Elmwood’s 80-person staff, including its former chief executive and son of its founder, Jess Levin.

“Jess is a good man. We saw the need to show his loyal customers that he’s still here,” Puetz said.

Best Practices
Tri City National followed what another consultant calls one of the best practices for potential failed-bank acquirers: making contact with the other institution before it fails.

“More often than not, these institutions are open to that type of
a dialogue and sometimes even open to sharing documents for due diligence purposes,” said John Adams, director of mergers & acquisitions at Sheshunoff & Co. Investment Banking in Dallas, Texas.

Banks must be able to objectively visualize the bank after the acquisition. “What are you left with in terms of operations, earnings and your core institution?” Adams said. “Then there’s the idea that this is, after all, a bank failure. There’s a lot of negative publicity involved and there is going to be some customer base deterioration – that needs to be factored into the analysis.”

Each piece of information becomes critical when the clock is ticking to make a bid. Adams cautions bankers that they may encounter unfamiliar accounting practices during the course of FDIC-assisted transactions.

Bidders can choose to bid with or without a loss-sharing arrangement with the FDIC, with the first being much more common.

Under a loss-sharing arrangement, the bid is comprised of a premium
on deposits (the median is 0.20 percent) and a discount on the assets (here the median is 11.9 percent), calculated net of the equity being acquired. The FDIC develops a “stated threshold” below which the FDIC shares losses 80/20 and above which they are covered 95/5.

“The acquirers’ bid should include discounts for estimated losses not covered by the FDIC and other expenses not covered by the FDIC, such as increased cost for collecting, monitoring and reporting to the FDIC for up to 10 years,” Wipfli’s Buchholz said.

Tri City’s successful bid of negative $110 million did not include loss sharing. The bank acquired approximately $290 million in loans, equal to about $190 million less the discount, as well as $250 million in deposits. Before the acquisition, the bank had a Tier 1 leverage ratio of 13.25 percent and a risk-based capital ratio of 18.4 percent.

“Would I have done anything differently? Sure,” Puetz said, citing what he calls a million-dollar mistake. “We’re still working through all of it. We believe that we have adequate discount for all of the loans, but only time will tell as we work through each and every credit, dispose of each and every piece of other real estate owned, and modify or call each of the impaired loans so that they meet our standards.”

Nelson is a freelance writer for the Wisconsin Bankers Association.