Category: Buying banks

Posted on

 Current Whole Bank Purchases Illuminate Core Issues and a Glaring Deficiency

The five whole bank purchases by credit unions announced in 2021 illustrate the importance of answering the ten “transaction level” questions posed yesterday.  Each instances adds more complexity to those common issues . A review of these four credit unions’ actions follows.

  1. This month, Wings Financial Credit Union completed the acquisition of the $72.4 million Brainerd Savings and Loan, a Mutual Federal Savings Charter.

This in-market acquisition’s primary difference is Brainerd’s mutual ownership structure.  Brainerd and Wings cannot legally enter into a merger agreement, so the transaction is structured as a branch sale of Brainerd’s sole office, with a purchase and assumption of assets and liabilities, a voluntary liquidation of Brainerd, followed by a distribution of any residual assets to Brainerd’s mutual depositors.

Completed early in June, both parties have kept details private.  There have been no disclosures of valuation for assets and liabilities nor how the well-capitalized mutual’s reserves will be distributed.

Secrecy creates a situation lacking accountability.  How should depositors’ collective wealth be allocated to executives who facilitate the sale?  For the directors of both institutions, what is their fiduciary responsibility for disclosures to their owners?

Converting mutual banking charters serving the general public into private sales with no disclosure is an unsettling precedent. Because CEO’s and boards manage common wealth, respect for the values of honesty, openness, and trust are a vital factor of mutual and co-op design.  How will Wing’s leaders inform their member-owners about this use of their reserves and the benefits they should expect?

2. Vystar’s purchase of HSBI is the largest bank acquisition by a credit union to date.

Heritage Southeast Bancorporation, Inc. (HSBI) serves as the holding company operating three legacy brands Heritage Bank, Providence Bank and The Heritage Bank in their historical home markets. The holding company oversees $1.6 billion in assets and 22 branch locations across Southeast Georgia, through Savannah and into the Greater Atlanta Metro area.

The transaction combining these three previously independently owned banks was completed in September 2019.  Their independent business models focused on local commercial and real estate loans with virtually no consumer lending.

These mergers are the primary reason for the five-year growth shown below in Heritage bank’s assets:

Avg Yearly Asset

2016 = $409m

2017 = $445m

2018 = $490m

2019 = $1.055b

2020 = $1.457b

 

Its Pretax Operating Income Trails the Peer

2016 = 0.49% ROA (6th Percentile vs. Peer)

2017 = 0.92% ROA (14th Percentile vs. Peer)

2018 = 1.21% ROA (29th Percentile vs. Peer)

2019 = 0.37% ROA (1st Percentile vs. Peer)

2020 = 0.41% ROA (3rd Percentile vs. Peer)

When HSBI’s combination of three separate banks was announced in the fall of 2019, two CEO’s explanations were included in the newspaper story:

The combination is expected to offer shareholders several benefits, including ownership in a larger, more diversified and scalable company that has increased capital flexibility and operational effectiveness and efficiency, as well as improved liquidity in their shares.

“We look forward to continuing the ‘customer first’ cultures of each of our legacy organizations, while also providing our shareholders with a more marketable stock,” said Brad Serff, the President for the legacy Providence Bank division. 

“There are advantages to the merger,” Smith, CEO of The Heritage Bank said. “As a larger institution, we’ll have better resources, we’ll have more employees together obviously, and together we’ll just be stronger. We’ll have more effective buying power, we’ll gain efficiencies. 

Smith emphasized that on the client side, Heritage Bank will be able to offer a wider array of products, and the internal changes happening will affect the consumer or client in a minor way, if at all. Everybody worries about when banks do this, Smith said. But we’re the oldest bank in the area, and everyone else has done this.

“From a client standpoint, it should not change anything as far as the products and services we offer,” Smith continued. “In fact, the services could be enhanced. That is our intention. As far as what the client will see—the reality is, our branches are all staying the same, and the people are staying the same.”

Now all those assurances except one would appear unfilled.  HSBI stock certainly became more marketable, and fast.

Vystar is paying 1.80x tangible book value ($15.16 per share at 3/31/21) or $196 million for this bank combination that had yet to be fully implemented. The stock price jumped from $14.50 to $25 when the $27 share offer was announced. The market valuation prior to the announcement was only $105 million. This offer is a windfall for the new holding company’s shareholders.

The purchase price is approximately 22% of Vystar’s March 31, 2021, reserves. How will this transaction affect its net worth ratio now and in the future?

In addition to the financial issues are the challenges of an out of area purchase. HSBI’s headquarters in Jonesboro, GA, is 400 miles from Vystar’s headquarters.  The credit union has no brand recognition, legacy, or existing networking advantages in these new markets.

The HSBI consolidation was less than 18 months along. Each bank had retained their local identity.  Now another transition is needed for employees, customers and the communities served.

Small town banks, especially in commercial lending, are in the relationship business.  Will those advantages continue?   What benefits will Vystar bring to these markets which had just gone through an ownership change?

Yahoo Finance compares HSBI’s current stock price ($25 per share) to its earnings for the trailing 12 months.  At March 31 this ratio for HSBI’s  stock price is 177 times these trailing earnings, a stratospheric number.

Offering approximately two times book value for a company assembled a year and half earlier with a limited performance record seems sudden. Vystar’s challenge will be to convert their substantial premium and  three-bank unfinished combination into a competitive benefit for the credit union and its members.

  1. Lake Michigan Credit Union purchases Pilot Bank and its six Florida branches for $97 million.

The early June announcement of the credit union purchase of this Tampa-based bank caused the per share price to jump from $4 to $6 in less than a week.  At the agreed price of $6.25 for the 15,483 shares, this equates to a total value of over 1.8 times the bank’s March 31 book value.

Pilot bank focuses on commercial and industrial loans with a specialty in aircraft financing.   This will bring Lake Michigan’s west coast Florida branches to 19 (plus 46 in Michigan.)  The credit union says this further expansion into Florida is motivated to serve members who visit there in winter.

This transaction raises a similar set of challenges as for Vystar when expanding outside a credit union’s long time operational base. Tampa is 1,250 miles from Grand Rapids. Will the Florida customers and borrowers see the Lake Michigan brand as relevant to their local circumstances?

The price is 150% higher than the total market valuation before the announcement which makes the financial return especially important for this out of area investment.  The total purchase price would be approximately 10% of the Lake Michigan’s March 31, 2021, reserves.

  1. GreenState simultaneously purchases two banks with total assets of $1.1 billion.

On a credit union performance scale of 1-10, GreenState Credit Union would rank an 11.  Their numbers and service  are almost without peer.  This makes their  announcement on May 25 to buy two banks simultaneously unusual given their extraordinary in-state record.  One acquisition is in suburban Chicago and the second in Omaha.

Oxford Bank and Trust is headquartered in Oakbrook, Illinois and has six branch locations in Addison, Naperville, Plainfield, and Westmont. The press release says Oxford has assets of $730 million, with $405 million in commercial and consumer loans, $635 million in deposits and $71 million in capital.   The two headquarters are 220 miles apart.

Premier Bank established in 2011 is a locally owned, community bank serving the Omaha and surrounding areas, as well as the Nebraska City community. The bank has three branches in Omaha, and one branch in Nebraska City. At March 31, the bank reported $383 million in total assets with almost $40 million in capital.   Loans are primarily commercial and real estate.  GreenState’s head office  is 246 miles  from Omaha.

Both banks are privately owned so there are no public stock quotations.  No financial details were released.  However, the two institutions’ book value from FDIC reports is $111 million at March 31.  Both are stable, high performing and supportive of the sale to a credit union with which they apparently have no prior experience.

Assuming a purchase price of 1.75 times book value for the banks (no numbers were announced), that would equal $195 million or 27% of the credit union’s March 31 reserves.

GreenState raised $20 million of subordinated debt in the 4th quarter to add to its reserves.  Was this in anticipation of these purchases? Was this use in the supplemental capital application filed with NCUA?  If yes, that would seem to open a whole new purpose for supplemental capital.

These two out of area mergers raise the same questions as the previous out of state transactions. The GreenState brand is new in each market; both banks’ balance sheets focus on commercial and real estate, not consumer loans.  Implementing two on boardings, conversions and integrations at once will require an intense operational focus for the next 12-18 months.

“Market-based Transactions” & Other Observations

In early 2020 NCUA proposed changes to its rule (part 708(a)) on bank combinations. The proposal, currently in limbo, received almost 40 responses.

NAFCU’s comments on the proposal were supportive, stating that this is just the market at work, describing the bank’s decisions as “the best option available for consumers:”

Combination transactions are voluntary, market-based transactions that must receive approval from both the NCUA and the Federal Deposit Insurance Corporation (FDIC) and as such, should not be subject to overly prescriptive regulatory requirements that could put these transactions as well as affected consumers at risk.

Bankers’ baseless attacks on the credit union industry regarding the sale of banks to credit unions have raised false alarms—these are voluntary, market-based transactions, wherein the banks’ board of directors are voting to sell to credit unions as the best option available for consumers.

However actual events are more complicated than this defense.  Each transaction above for which the sale price is known is a significant commitment of capital (10-22%) and major operational undertaking. Unlike organic growth initiatives, these “opportunities” are brought to credit unions by consultants or brokers reaching out for ready buyers. The serendipity nature of these offers should remind that they may or may not readily match a credit union’s market vision or operational readiness.

The examples where a sale price is disclosed suggest that bank owners have mastered the art of buying low and selling high. This raises a question: why would these shareholders sell for cash if they believed their bank had this inherent future potential?

A former credit union CEO commented on these events: Credit unions enter negotiations with the idea of buying market share and bragging rights.  Who brags about buying a trophy?  Banks arrive at the table with one thing in mind– ROI.

What alternatives for organic growth are being pushed down credit unions’ to-do lists? Are GreenState’s in-state opportunities and appeal so saturated that venturing into suburban Chicago and Omaha are a better option for members?

Each credit union has previous purchase transactions. What were their customer retention  outcomes?  How long was payback on these investments?  In what way did these experiences benefit current members?

Others who have evaluated these opportunities claim that they come down to a simple buy-versus-build financial calculus when considering a new market:

“When I calculated the cost and effort to build my way into a new market with high barriers to entry, I proved to myself that the costs associated with acquiring a turn-key, profitable book of business was in the ballpark.”

An Unsettling Lack of Transparency

What is common to all five purchases is the lack of information to evaluate the transactions on impartial, objective criteria with market comparisons.

Relevant details are not disclosed before the deals are closed as occurs in most bank-to-bank purchases.  Such public scrutiny can dampen excesses that may occur when core facts are not disclosed.  This secrecy also prevents the credit union system from learning from these examples.  The expertise relied upon now is at best conflicted as their compensation primarily comes when closing the deal.

These purchases have significant consequences for members, their credit union, the customers acquired and the employees and communities where the banks are operating. The credit union’s value proposition should be in writing and available to all affected parties.

Because coops manage “common wealth,” transparency is a critical leadership competency.  Without relevant information, confidence in these transactions is difficult to support.  Sooner or later, this lack of openness could lead to disappointing outcomes—but the sellers will have already taken their money to the bank, so to speak.

Chapter III will review what the member-owner’s.role should be in this use of their collective capital. They are not only owners but also the beneficiaries, or losers, should these deals turn out to be poor decisions.

Posted on

Ten Questions for Whole Bank Purchases     

Some proponents assert that buying banks is just another market option for a credit union.   Similar to expanding a branch network, investing in technology or launching a rebranding campaign, this is just a business decision that needs to be “pencilled out” to see if it makes financial sense.

Analyzing a purchase transaction is not simple.  Every transaction has a different market context and unique financial data.

Ten Questions Before Any Purchase

Credit unions buy banks with cash, not stock, which is the common practice in bank-to-bank purchases.  Some data provided in bank announcements to enlist shareholder support are also relevant for credit unions.

The following list focuses on evaluating the purchase transaction itself, not the broader public policy implications or a credit union’s strategic framework.

  1. What will be the total expenses of the transaction for all fees, consultants, contract cancellations etc., and how will these costs be recorded by the credit union? What transparency will the credit union provide to demonstrate its own due diligence work.
  2.  What is the dollar total of bank assets and/or liabilities the credit union must sell as ineligible for a credit union charter? If significant, why is the merger being considered?
  3.  How will key personnel be retained and will there be a cultural fit? What obligations will the credit union have to the former executives and employees of the bank? Will covenants or conditions such as non-compete clauses limit major stockholders, senior and/or key executives whose stock has been paid out from becoming competitors. An observation from a merger veteran:  Credit unions talk about “buying” skills during a merger.  If you can’t keep a commercial lending team, mortgage banking team, wealth management team, then you are not buying anything.  Those jobs are like free agency – they sell their skills to the highest bidder.  You are not acquiring a piece of equipment, a patent, or a manufacturing process, you are buying people.  This is a service and relationship (networking) industry.  A star performer can take their network (and team) anywhere.  A merger is often the “nudge” the star performer needed to make a change to a different employer.  If they don’t see a direct benefit from the merger, you run the risk of losing them.
  4. How will the transaction affect the credit union’s net worth position? If all bank capital is absorbed in the acquisition, will the credit union remain well capitalized and able to realize its growth prospects in the newly obtained market?
  5. How will the additional assets affect the credit union’s overall ROA, efficiency, and concentration ratios? What is the payback period (breakeven) on the cash paid out in the transaction? How do various customer retention scenarios affect this return?(Proforma balance sheet and income statements before and after the purchase are useful in addressing these changes.)
  6. How much overlap with current markets exists? If high overlap, why merge to begin with?  If low overlap, is the credit union reaching too far from its geographic core?  How will an investment in a market where the credit union has no presence benefit current members?
  7. How will the bank customers become “involved” credit union members? These bank customers did not choose the credit union, have no direct experience with it and are probably unfamiliar with their acquirer. Can the credit union retain these relationships plus gain new ones?
  8. Why did the credit union pay a premium over the market valuation for this transaction? If the franchise is so desirable, why were there no other bids? How will existing market competitors–bank or credit unions–react?  Will there be critical comments such as taking away jobs, tax revenue, deposits, and local leadership from the community? Might competitors hire away key personnel?
  9. What are the regulatory requirements to be navigated? Will FDIC require public announcements be placed in affected markets?  What process will each regulator follow when evaluating the purchase—will different criteria be used for the FDIC and NCUA? Depending on the selling bank’s structure, will potential double taxation affect the price–  once on the asset value increases in liquidation and again on gains from shareholders’ stock sale.
  10. What existing plans will this acquisition defer, disrupt or postpone? What new risk mitigation measures will this event require?

Knowing questions to ask in any undertaking does not lead to easy answers. Any list of due diligence questions is incomplete as each circumstance introduces special factors.

However, using a check list can help assemble the basic information and analysis to consider versus the generalizations sometimes used to justify these purchases.

Tomorrow I will look at the four current transactions and their individual explanations.

 

Posted on

Chapter II: Bank Purchases by Credit Unions: Just Another “market transaction?”

(Two blogs precede this chapter II. One posed the issues of credit unions buying banks; a second reviewed cooperatives’ public policy role.)

As of mid-June, four credit unions have announced agreements to purchase five whole banks. Each of the four purchasing credit unions—Lake Michigan, Vystar, Wings Financial and GreenState (buying two banks at once)—have had prior instances buying a whole bank and/or branch combinations.

These events raise both policy and transaction questions. One explanation by NCUA and trade associations is that whole bank purchases are “just the free market at work.” Nothing out of the ordinary. Two independent firms make decisions in the interests of both sets of owners and their communities.

Not Market-Tracking Decisions

However, this explanation is neither complete nor useful. It is incomplete because only one side of the sale is open to owner scrutiny—the selling bank which must have shareholder approval. The credit unions purchasing the assets and liabilities act like private buyers. They rarely release any factual or financial data except press release generalities such as market expansion, diversification, acquiring new lines of business or adding professional expertise.

When facts about the transaction—such as the sale price– are presented, they are from the seller’s briefing their owners not by the purchasing credit union.

In a “normal” market-driven bank purchase (or merger via exchange of stock) both parties will provide their rationale for the transaction. Here are several excerpts from 2021 sale announcements provided by the bank undertaking the purchase, not the selling party:

BancorpSouth said it expects to have $125 million in merger-related costs. The bank said it plans to save $78 million in annual non-interest expenses as a result of the merger. The bank plans to achieve 75% of its merger-related cost savings by 2022, and 100% in 2023. or,

Webster plans to cut about 11% of the combined entity’s annual noninterest expenses, American Banker reported Monday. The company expects to incur $245 million in merger-related expenses, but the deal is projected to save $120 million while the company generates an extra $440 million per year. or,

NYCB and Flagstar: Accelerating Our Transformation Strategy: NYCB estimates the merger will result in additional capital generation of $500 million annually, as well as $125 million in annual cost savings. The bank expects to incur $220 million in merger-related expenses. (the release includes full operational and financial estimates)

Each of these purchasing banks provides data about the transaction, how it will benefit shareholders, goals for cost recovery and the expected return on investment in following years.

Credit union purchases convert firms subject to market monitoring into private entities. No longer can external markets assess management’s performance. Coop member-owners are not involved in the process before or after.

Investing Beyond a Firm’s Experience

In many areas of commercial enterprise there are wealthy individuals or firms who jump into an industry by “investing” in competitive arenas different from where they made their wealth. Consider Silicon Valley entrepreneurs buying professional sports teams, wealthy heirs venturing into the film and entertainment business, young work-from-home retail investors jumping into $0 cost online stock trading, etc.

Long time professionals sometimes refer to these new entrants’ cash inflows as “dumb money”–affluent outsiders bitten by a bug to try something different or indulge a personal interest. And there are plenty of brokers, salespersons and expert third parties helping these newbies learn the ropes and get into the business—for a fee.

These promoters make their living by closing deals. Their most common message is urgency–“act now or miss out” — if you don’t, someone else will take this opportunity off the table.

But how is an interested credit union member supposed to weigh such an event? One approach is to ask if the member would buy the bank’s stock for their personal investment based on the information available to their credit union?

Would You Buy This Bank’s Stock?

Too difficult for a member? Here is an actual case.

A $605 million credit union announced in July 2019 an agreement to buy all the assets of a bank with the following performance record:

  • June 30, 2019, bank data: $97.8 million in bank assets, $77.6 million in deposits; $11 million in equity; a $7.0 million FHLB loan; and loans of $73.7 million.
  • The bank has had negative income every year since 2008.
  • The “efficiency ratio” for 2018 was 111.08% and for 2017, 129.0%. At June 2019, 127.8%. Every period’s operating expenses have exceeded income.
  • Two consent orders were issued by the Office of the Comptroller of the Currency. The December 19, 2012, one was followed by a second on November 2015 designating the bank a “troubled institution”.
  • This order was ended in February 2019 after the bank raised $4.5 million new capital issuing 600,000 new shares for a price of $7.50 per share in January 2018. The cost of the offering for the bank was $366,000 or 8.1% of the gross proceeds.
  • The bank’s 2018 annual report states its core market deposit shares as: 1.69% Arlington Heights, 2.83% Rolling Meadows, and .03% in Cook County.
  • The 2018 annual report included the bank’s outlook: We do not anticipate net income until we experience significant growth in our earnings.At mid-year 2019, just before the credit union announcement, the bank’s operating loss was $262,000.

Would a person buy this bank’s stock that has not had positive earnings for a decade, promises none going forward and has miniscule market share? The new investors in 2018 paid $7.50 per share; the day before the announcement the share price was $6.80-below what the new investors paid.

The credit union offered $10.33-$10.70 per share or $2.4 million higher than the book value and 55% higher than the market valuation prior to the sale.

The credit union addressed none of this operating history, even though the facts were public. The credit union offered no information about how this decade long losing operation would benefit it or the members. The purchase was finalized by Corporate America Family Credit union and announced on April 30, 2020.

Why did the credit union bail out this bank’s owners with their members’ collective capital? How will this $13-$14 million dollar “investment” provide any return for the credit union? No one knows; the outcome is now hidden away from external or internal oversight. On the public facts, this would not appear to be a “smart money” move.

Tomorrow I will provide critical questions to evaluate these purchase transactions.

Posted on

Should Credit Unions Buy Banks?

Two major credit union purchase and assumptions of commercial banks have been announced recently.   The $7.5 billion GreenState Credit Union in North Liberty, IA is buying two banks outside Its home state with total assets of $1.1 billion.

In April the $10 billion Vystar Credit Union in Jacksonville, Fla., agreed to buy the $1.5 billion Heritage Southeast Bank of Jonesboro, Ga., for $189 million, becoming the credit union industry’s largest bank acquisition.

Excess Cash on Hand?

With the average annual asset growth over 20% for the largest credit unions, the explanation that buying size to get to the future faster  would seem questionable.  Organic growth has taken off.

Is it possible that all the excess cash on hand is burning holes in credit union pockets?   If that is a factor than it is well to remember the age-old wisdom about money and value: asset values of banks tend to benefit from excess liquidity and suffer from a dearth of it, like most other asset classes.

Three Ways of Approaching the Issue

In upcoming blogs I will look at several examples, some pending and others completed, around three topics.

  1. Is the purchase of whole banks consistent with the public policy role of credit unions, a role that  justifies their exemption from income tax?  In the political arena, local and nationally, do these transactions help or harm credit union’s reputation?
  2. How do purchases benefit existing member owners? Are the disclosures and information credit union CEOs provide about these transactions adequate for existing members whose loyalty created the capacity to do these cash purchases?
  3. Looking at several examples, albeit with incomplete details, do these investments appear to be financially sound, especially in instances where the announced price is substantially above recent market value?

No Easy Answers and No System Dialogue

At each level of analysis there will be differing viewpoints.  NCUA has taken a hands-off approach signaling that these are merely “market-based transactions.”   I believe this is a misuse of the term.  At one point Chairman Harper, as a board member, indicated concern that “former consumers of the acquired banks will not have the same level of consumer financial protection oversight in their new credit union.”

Because an activity is legal does not mean it is wise.  Either as policy or in a specific instance.

Another difficulty is assessing the financial impact of these larger events on the purchasing credit union.  It may not be possible for years to know the benefits or costs on the acquiring credit union or the communities and customers  whose accounts were transferred.  For example what is the retention rate of depositors?  It is one thing to acquire assets, it is another skillset to manage them effectively.

As a general maxim, the purchase or merger of commercial entities tends to reduce shareholder value.  Before its recent disposal of its media assets, AT&T (T) spun off its DirecTV and other pay-tv services into a separate company, with private-equity firm TPG Capital as a 30% owner of the new entity. The deal valued the pay-tv services at a combined $16.25 billion, compared to the $66 billion that AT&T paid for DirecTV alone in 2015. (CNBC)

My goal in following articles will be to ask questions and to confront the seemingly nonchalant acceptance of this activity within the credit union community.   Through dialogue I hope credit unions can become more aware of what is at stake and what future actions might be, if different from the vacuum that now surrounds these activities.