Bank failures fell from 92 in 2011 to 51 in 2012; however, bank merger and acquisition (M&A) transactions increased from 178 in 2011 to 236 in 2012 (source: SNL Financial). This tells us that while the supply of FDIC-assisted transactions is decreasing, the demand for open-bank transactions is increasing. Assuming these trends continue in 2013, acquiring institutions will need to focus on several things:
Due diligence—but how broad?
While acquiring institutions typically conduct high-level financial due diligence, such as discounted cash flow analysis, multiple analysis, or portfolio-level credit due diligence, many elect not to conduct comprehensive due diligence that provides a broader and deeper analysis of a target.
Comprehensive due diligence assesses all significant facets of the business, including but not limited to credit, risk management, niche businesses, operations, technology, management, and marketing. Outputs may include:
Why do it?
Taken together, these outputs should provide the detail necessary to validate the assumptions made in initial valuations. Variances that cannot be explained away may serve as input into deal structuring and negotiations. Broader and deeper analysis mitigates the risk of failing to uncover financial risks, over-estimating synergies, and under-estimating integration costs.
Comprehensive due diligence also can accelerate the capture of synergies. The outputs above can inform and expedite integration planning, providing the integration team with specific direction as to where and how synergies will be captured as well as associated costs to achieve them. And the faster synergies are captured, the quicker they appear as net contributions to the bottom-line.
With so much at stake, why would you elect not to conduct comprehensive due diligence? Institutions offer a variety of reasons:
While there are inherent costs, the value of comprehensive due diligence arguably outweighs these costs. Again, keep in mind that variances from initial assumptions may provide room to negotiate and offset these costs. And fear and inexperience may be overcome by using a proven methodology, tools, and templates.
Let’s take a look at each element in more detail.
Portfolio credit mark.
In today’s environment, arriving with confidence at a credit portfolio mark requires a rigorous loan-level review of the credit portfolio. Identifying the appropriate sample set is critical. Criteria by which to identify the appropriate credits to review include but are not limited to:
Also, developing a tool to capture the key data elements of a reviewed credit is imperative. Credit reviews are often fast-paced, and team members review a significant number of credits in a short period of time. Providing the detail to substantiate a credit mark may help your executive team in negotiating and structuring the deal.
Target operating model.
An acquiring institution may develop an initial “target operating model,” which is a bottom-up analysis of the number of FTE’s that would be required to support the combined institution. Developing a model at this level of detail is critical given the relative percentage of cost savings often attributed to consolidating resources.
To start, it is important to apply key productivity measures against estimated operating volumes of the combined institution. Then, you may take the estimated level of resources calculated and validate against third-party benchmarks. Specific areas of focus typically include operations, shared services, sales, customer service, and branch administration.
A synergy model and an integration budget each may comprise several hundred line items. And, if the model and budget are constructed properly, the results should roll-up, producing a holistic view to validate initial valuation assumptions. Synergy line items should be ongoing—either reduced costs or increased revenue.
There are several steps through which you may identify synergies, including but not limited to:
While synergies are ongoing, items in the integration budget are one-time charges that must be invested to combine the institutions. There are several considerations for establishing an integration budget, including but not limited to:
During integration planning, these estimates may be adjusted as more detailed information is uncovered and incorporated. In developing these tools, consider employing a sensitivity analysis, incorporating several possible outcomes such as conservative and aggressive, as opposed to a deterministic outcome.
Don’t ignore the opportunities.
Comprehensive due diligence assesses areas of targets that may often be ignored yet significantly affect the value of a transaction. If planned and conducted well, it can help you avoid entering into a transaction with serious risks and/or paying too much for a target.
West Monroe Partners assists an array of financial institutions with evaluating and executing mergers, acquisitions, and other transactions. For more information, please contact Neil Hartman.