Whether you realize it or not, your community bank is a player in the merger and acquisition game.
In today’s environment, many institutions’ primary means of growth is through acquisition. As a result, unsolicited offers and “feelers” grow increasingly frequent. For other community banks, enhancing long-term value for shareholders requires a sale in the near future, whether as a result of an unsolicited offer or proactive marketing of the institution.
But the often-overlooked player is the community bank that simply wishes to remain independent.
Remaining on your own is no longer an idle task. You can’t just sit there, having made that decision.
Regardless of where your community bank falls on the spectrum—the buyer, the seller, or the “not interested, thanks”—each alternative has unique strategic considerations and potential pitfalls. In this blog, I will discuss five steps to assist community banks in maintaining their independence.
In the next two blogs, I will highlight five common mistakes of community bank buyers and then five common mistakes of community bank sellers in the current merger and acquisition market.
1. Get in the right structure.
Remaining an independent community bank is more than simply saying your bank is independent.
To remain independent requires action. For most community banks, that means reorganizing into a bank holding company structure, which provides corporate benefits, anti-takeover measures, and operational efficiencies that a bank cannot achieve on its own.
For banks with holding companies, another alternative is reorganizing as a Subchapter S corporation, for tax purposes. This lowers the organization’s overall tax burden and can significantly increase profitability and after-tax shareholder cash flow.
Still other organizations may find it preferable to switch charters to a more favorable regulatory structure, which may be particularly useful if your existing regulatory relations have soured.
2. Restore core profitability.
Although most community banks suffered diminished profitability in the past several years, currently, community bank profitability is increasing across the industry.
The question going forward will be whether it is true core profitability or simply setting aside less for your loan loss reserve.
Future, bottom-line profitability is the mark of an institution’s true value and must be the primary focus in order to continue to achieve independence.
There are implications to that.
This may require avoiding certain growth and expansion “opportunities” that really provide no immediate return and pose long-term drains on income and raise expenses.
This may also require taking a critical look at the profitability of the bank’s branches, products, and services—and making difficult decisions regarding their long-term viability. For example, do you really need that $15 million trust department that has never made any money?
Drive the efficiency of the organization, improve profitability, and there will be no need to sell out to the first offer that comes along.
3. Provide for board succession and mangement succession.
Often, a community bank finds itself considering an offer simply because it lacks appropriate succession at the top.
Think this through. Are all of your directors approximately the same age? Do they share the same time horizon for investment purposes? Does your board lack a process that ensures its renewal and regeneration (including mandatory retirement and director evaluation)?
Then your community bank is much more likely to accept the first modest offer that comes along.
Similarly, if the board does not groom younger management personnel for succession, then there will be no one to confidently fill senior executive management roles when the existing management team retires. That also often leads to a sale. Careful management and board succession planning can avoid such a result.
4. Engage in annual strategic planning.
Strategic planning comes in various shapes and sizes, but our firm’s approach has always been to make it practical and substantive. At least annually, the board and management should critically assess whether they want to sell the bank and, if not, how to keep the bank independent with the resources available to it.
If the board and management cannot demonstrate the ability to continue to provide a return to shareholders as favorable as would be achieved in a sale, there may be a fiduciary duty to sell. Engaging in a substantive strategic planning process can help drive the community bank to clearly define the ways that it can maintain independence. The steps mentioned in this article can even serve as a basis for the strategic planning process to ensure that independence is maintained.
5. Enhance shareholder value.
The other steps mentioned in this blog are really a subset of the overarching mandate: Enhance shareholder value.
Financial institutions are for-profit institutions that, as a critical mission component, should strive to achieve greater returns for those investors who put their money at stake.
While community service and providing opportunities for employees and customers are tangible goals, the board and management are primarily tasked with finding, creating, and sustaining value for shareholders.
If that end is pursued, all other goals and initiatives will fall into place. As noted above, the true value of a community bank is measured by its future earnings potential.
Having a plan that fully enhances shareholder value will, as a result, enhance future earnings potential, which is the surest way to maintain independence for your organization.
If a board and management are unwilling to enhance value for shareholders, then the first offer that presents more favorable alternatives may trigger a fiduciary duty by the board and management to accept the offer.
Remaining independent is no longer a passive condition. Rather, it is a state of being that is actively achieved. These steps will help ensure your organization remains independent in a consolidating environment.
Part 2 of this 3 part blog will discuss Five Common Mistakes of Buyers.