M&A bound? Get core IT contract in order today

Whether your bank intends to be a buyer or a seller, attention must be paid to your core processing contract long before you go anywhere near the deal table.

So advises a study by BPI Network, with research provided by Paladin fs, LLC, Less Burn, More Return: The Core Way Forward: How Core Services Contracts Can Reshape the Future of Community Financial Institutions.

“The value and return on mergers and acquisitions can be seriously diminished by not addressing poorly structured core IT contracts in advance of an M&A definitive agreement,” the study’s executive summary states.

The study’s points concerning M&A are a subset of its work concerning the intricate world of core processing contracts, a circumstance compounded by many other factors, including the pace of consolidation in the vendor community. The report details some of the issues that arise between core vendors and bank customers, and includes strategies banks use for obtaining the best core deals, in general.

One example: Better timing of contract negotiations. “The ‘sweet spot’ for negotiating and finalizing a renewal contract with your vendor (s) is between 18 and 24 months before expiration,” the report advises.

“The closer you get to expiration, the harder it is to negotiate,” says Dave Murray, BPI director of thought leadership. He explains that a bank needs the leverage of the implied sufficiency of time to find a new vendor. That leverage comes from the understood ability to be able to walk away from a vendor, something that lack of foresight and preparation negates.

Exposure to impact

Overall, the study found that only 46% of the responding bankers felt their institutions’ core contracts were optimally structured to provide for M&A. One such detail is the impact of a major increase in processing, in the course of absorbing a target’s book of business and customer records.

“Many experts would question whether the confidence level should be even that high,” the report states.

The report does not reflect solely the outlook of likely buyers. While 36% of the sample expect to be acquirers, 27% anticipate selling, and 21% said their banks could go either way, depending on opportunities that present themselves.

Concerns identified include contracts that offer volume discounts that “top out”; penalties for early termination; and transition penalties. One expert quoted by the study authors pointed out that merger premiums are so much thinner today than in years past that core cost issues can more severely impact the overall economics of the deal.

One positive argument for negotiations: The report points out that in this day of a consolidating industry, acquirers are actually in the position of helping their core vendors displace a competitor.

Another key matter: Whose processor “wins.” The study found that, for a variety of reasons, in one out of three cases, the merged institution uses the acquired bank’s core processor, not the acquirer’s.

“Every institution should demand a survival incentive written into their contract by their incumbent vendor,” the report stated.

Examples of impact

The M&A portion of the broader study looked at unexpected events triggered by M&A, including penalties, hidden costs, and unfavorable legal terms. Drawing on the experiences of the survey sample, the report recounted examples of deals that went awry because of core contract issues. Among them:

• A bank signed a letter of intent to sell, but during the deal making its own core contract auto-renewed. The contract included a $1.5 million early termination penalty. The deal was cancelled.

• A mid-sized community bank acquired a smaller community bank. Integration issues for both internet banking and billpay applications made it necessary for the merged entity to run both systems side-by-side for two years while problems were fixed. Over $400,000 in unanticipated costs resulted.

• A larger community bank acquired another institution that had an imaging system that produced files that were incompatible with the acquiring bank’s system. Conversion fees added over half a million dollars of additional costs to the acquisition.

Download the BPI Less Burn, More Return report.