MERGERS AND
ACQUISITIONS IN A DOWN
ECONOMY
Western Independent Bankers
June 2, 2009
Presented By:
Dave Muchnikoff and Barry Taff
Silver, Freedman & Taff, L.L.P.
3299 K Street, N.W., Suite 100
Washington, D.C. 20007
(202) 295-4500
[email protected]
[email protected]
Silver, Freedman & Taff, L.L.P.
LOCAL BANKS FACE BIG LOSSES
Journal Study of 940 Lenders Shows Potential for Deep Hit on
Commericial Property
Wall Street Journal Headline: May 19, 2009
Silver, Freedman & Taff, L.L.P.
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Who Is Selling?
Community Bank
 Unlikely to sell in down market - succession may be only reason to
sell
Distressed Bank
 Acquire at a large discount to book value
Stalled De Novo
 Acquire undeployed capital at a minimal cost
Silver, Freedman & Taff, L.L.P.
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Why Buy Today?
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Bank stocks are down – many trading below book value
Lower trading multiples
Weak earnings
Targets forced to sell
Alternatives are limited
Limited competition
Capital is king
Cost savings and cross-marketing opportunities
Expand branch/ATM locations, improve customer access
Silver, Freedman & Taff, L.L.P.
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Why Not Buy Today?
What are you acquiring? -- Unknown Asset Quality -- How big is the
hole?
 Don’t want to acquire someone else’s problems
 Capital is more expensive
 Possible Regulatory problems
 Limited secondary market
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Silver, Freedman & Taff, L.L.P.
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Who Should Be Buying?
Well Capitalized Banks with:
• Strong capital/credit
• Good standing with regulators
• Experience
• Good asset quality and generation
Private Equity with:
• Large amount of money raised
• Varied strategies
• Minimum return expectations approach 20% or more
• Bank holding company status can be an obstacle
Over Capitalized De Novo:
• Alternative strategy to deploy excess capital
• Limited universe of suitable targets
Banks interested in a Merger of Equals
Silver, Freedman & Taff, L.L.P.
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Merger-of-Equals
 Double the size of the company
 Create a stronger acquiror and more valuable target
 The likelihood of the displacement of fewer employees (as
compared to a sale of the company)
 The possibility for retention of local identity
 The opportunity to significantly expand the reach of the
franchise
 Enhanced liquidity and visibility
 Execution risk is higher than acquisition
 Must share power (management, Board)
 Potential for third party interlopers
 Not many available candidates; hard to find other banks with
similar size, valuation and culture
Silver, Freedman & Taff, L.L.P.
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Principal Social Issues in a Merger of Equals:
Board / Committees:
• Board representation based on equity, assets, income?
• Advisory board?
• How is board succession handled, for how long?
CEO/key officer succession:
• Who will be the CEO, CFO?
• Severance payments, consulting agreements and
succession plans?
Determining who stays and who gets fired
Silver, Freedman & Taff, L.L.P.
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Deal Considerations
Typical Compensation and Benefit Issues:
Salary adjustments
Creation of new officer positions
Employment contracts (1-3 years, with CIC protection)
Change-in-control/severance payouts (1-3x payments)
Retirement plan enhancements (SERPs)
Post-merger consulting contracts
Merger transaction bonuses; stay bonuses
Advisory/emeritus boards/board retirement plans
Agreements regarding participation in future stock plans
Silver, Freedman & Taff, L.L.P.
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Legal / Regulatory Considerations
Typical Compensation and Benefit Issues:
Regulatory issues developing if compensation to Board or officers
appears gratuitous or extraordinary
General Rules:
If plan / agreement in place before merger and benefits are
“reasonable and customary” then should be upheld
Increases in salary or benefits generally permitted if levels are
brought up to acquiror levels
Special TARP Issues
Silver, Freedman & Taff, L.L.P.
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Tax Considerations
Understand IRC Section 280G – may have a significant impact on
deal costs and post-merger consulting agreements
Any “change-in-control” related payments in excess of 3x 5year average taxable income may result in:
• 20% excise tax to executive; and
• Loss of tax deduction for acquiror
All payments triggered or accelerated by transaction may be
included (accelerated vesting of stock grants, SERPs,
insurance and health care)
Bona fide post-merger payments typically are not included in
280G analysis, such as payments under consulting and noncompetition agreements, new employment contract or board
fees
Silver, Freedman & Taff, L.L.P.
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Typical Merger Agreement Terms:
Structure and pricing of transaction
Representations and Warranties
Restrictions on operations pending closing
Board seats, committees and advisory board
Employment / change in control contracts / other severance and
branch arrangements
Termination provisions and termination fees
Silver, Freedman & Taff, L.L.P.
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Typical Due Diligence Documents
Regulatory exam reports / correspondence
Corporate minutes
Audit reports / correspondence
Internal audit reports / correspondence
Underwriting policies and procedures
Large loan files / classified or watch list loans
Corporate governance documents (charter, bylaws)
Litigation / personnel files
Environmental reports
Material contracts
Silver, Freedman & Taff, L.L.P.
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FDIC FAILED BANK TRANSACTIONS
There are three alternatives:
1) Purchase and Assumption with Loss Sharing – Buyer acquires all loans at book
value after reversal of reserves, certain marketable securities at fair market value and
a limited amount of other assets at book value including OREO, and assumes deposit
liabilities and certain indebtedness for borrowed funds, with the acquired loans being
subject to loss sharing with the FDIC. This is the type of transaction we will be
discussing today.
2) Purchase and Assumption without Loss Sharing - Buyer acquires all loans based
upon the discount contained in its bid, certain marketable securities at fair market
value and a limited amount of other assets, and assumes deposit liabilities and certain
indebtedness for borrowed funds. In this case, Buyer is not entitled to any loss sharing
payments from the FDIC and assumes complete risk with respect to the assets
acquired based upon its discounted bid.
3) Clean Bank – Buyer acquires marketable securities, a limited amount of other assets
(but excluding loans other than overdrafts and loans secured by assumed deposits),
and assumes deposit liabilities and certain indebtedness for borrowed funds. The
Buyer has an option for thirty (30) days after closing to acquire the loans of the failed
bank at book value. This transaction is a deposit acquisition with an option to buy
loans.
Silver, Freedman & Taff, L.L.P.
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HOW DO I RECEIVE INFORMATION ABOUT BUYING A
FAILING BANK FROM THE FDIC?
• You must be a financial institution who is approved to bid by its
primary federal regulator and the FDIC Division of Supervision
and Consumer Protection
• You are provided password access to an FDIC designated
website
• Through the FDIC website you can access bid and transaction
information and documentation relating to the failing bank that
will be offered for sale after you electronically agree to the
FDIC Confidentiality Agreement
• This information is normally posted on the FDIC website
approximately 4 weeks prior to the due date for bids
Silver, Freedman & Taff, L.L.P.
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WHAT TYPE OF INFORMATION WILL I RECEIVE
ELECTRONICALLY FROM THE FDIC REGARDING
THE BID PROCESS AND THE FAILING BANK?
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Confidentiality Agreement
Bid Instructions
Bid Forms
Transaction Summary
Transaction Recap
Recent Call Report Information
Purchase and Assumption Agreement
Single Family Loss Sharing Agreement
Non-Single Family Loss Sharing Agreement
Purchaser Eligibility Certification
WILL I BE PERMITTED TO DO DUE DILIGENCE?
You have a choice of doing due diligence of the loan files over the
internet for two days or on-site for two days.
Silver, Freedman & Taff, L.L.P.
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WHAT WILL I BE BUYING?
Assets To Be Acquired
 Loans and outstanding loan commitments
 OREO
 Marketable securities
 Capital stock of an acquired Subsidiary, if applicable
 Certain prepaid expenses
 Cash and receivables due from other financial institutions
 Federal funds sold and repurchase agreement
 Credit card business, if applicable
 Safe deposit boxes and related services
 Trust business, if any
 Books and Records
 Amounts owed to the Failed Bank by an acquired Subsidiary
 Rights with respect to Qualified Financial Contracts
 Rights to provide mortgage servicing for others and to have mortgage
servicing provided to the Failed Bank.
Silver, Freedman & Taff, L.L.P.
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WHAT WILL I BE BUYING? (cont’d)
Purchase Price of Acquired Assets
 The purchase price for the assets is book value other than marketable
securities which are purchased at fair market value. The book value of
loans is calculated after reversal of specific and general reserves.
Option Assets
 Buyer has a 90 day post-closing option to acquire the following assets at fair
market value:
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Bank owned premises
Furniture, fixtures and equipment
Other equipment
Option Contracts:
 Buyer has a 90 day post-closing option to assume or reject the following
contracts:
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leases for bank premises
data processing leases (to the extent assignable)
third party service agreements
Silver, Freedman & Taff, L.L.P.
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WHAT WILL I BE BUYING? (cont’d)
If Buyer exercises its option to acquire bank owned premises or assume a lease
on bank premises, in either case it must purchase the furniture, fixtures and
equipment located at such bank premises for fair market value.
Assumed Liabilities
 Either all deposit accounts or insured deposit accounts only, as elected by
the Buyer
 Borrowings from the Federal Reserve Banks and Federal Home Loan Banks
 Ad Valorem taxes applicable to any asset acquired
 U.S. Treasury tax and loan note option accounts, if any
 Liabilities secured by or otherwise related to the assets acquired and
contracts assumed
 offensive and defensive litigation liabilities relating to an acquired loan but
limited to the Buyer’s loss sharing obligation with respect to such loan
Silver, Freedman & Taff, L.L.P.
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HOW DOES LOSS SHARING WORK?
FDIC covers 80% of the losses on acquired loans and OREO up to a specified
dollar threshold amount and 95% of the losses above the threshold amount
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the threshold amount is normally provided by the FDIC to potential bidders
approximately 1 week before the bids are due
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Only 90 days of accrued interest on a loan is included in the loss coverage
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Loss sharing payments are made by the FDIC on single family loans for up
to 10 years during the month following a short sale, realization of final
proceeds on a foreclosure sale, a loan modification or restructuring, or a
portfolio sale.
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Loss sharing payments are made by the FDIC with respect to non-single
family loans and OREO on a quarterly basis based upon charge-offs at the
80% coverage rate. To the extent that the FDIC’s coverage obligation is
95%, the additional 15% is paid at the end of 8 years.
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Loss sharing on non-single family loans and OREO applies to charge-offs
during the 5 year period following the closing and recoveries are shared
with the FDIC for an additional 3 years.
Silver, Freedman & Taff, L.L.P.
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HOW DO BIDDERS KNOW WHAT TO BID?
You bid a specific amount as an asset premium or discount and
separate amount as a deposit premium. Normally, the asset bid is a
negative (discount) amount and the deposit bid is a positive
(premium) amount.
 In many instances, the bidding has been competitive. In some
cases, there have been no bids.
 Most winning bids contained a net negative (discount) bid that was
less than the winning bidder’s loss exposure on the acquired loans.
For example, if the winning bidder is liable for 20% of the losses on
$100 million of acquired loans (i.e., $20 million) and 5% on the
remaining $300 million of acquired loans (i.e., $15 million), the
winning bidder requested a payment from the FDIC that was less
than $35 million.
 Other Examples -- Risks
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Silver, Freedman & Taff, L.L.P.
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WHAT ARE THE BID AND CLOSING PROCEDURES?
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A bid must be submitted on the form provided by the FDIC together
with the Purchaser Eligibility Certification and a certified copy of
resolutions adopted by the board of directors of the bidder approving
the bid and authorizing the execution of the bid by the person signing
the bid form on behalf of the bidder, and approving the transaction and
the transaction documents, and authorizing the execution of the
transaction documents by the persons who will be signing such
documents on behalf of the bidder.
Bids are normally due at 10:00 a.m. on a specified Wednesday and the
winner is notified by 3:00 p.m. on the same day.
On the next day, Thursday, FDIC personnel will discuss the entire
closing process with the winning bidder in person or by telephone.
On the following day, Friday, the transaction is closed at 5:00 p.m. The
FDIC closing team will meet in person with the winning bidder’s closing
team during the day to review closing procedures and the roles to be
performed by FDIC personnel and the winning bidder’s personnel,
respectively, in connection with the closing.
Silver, Freedman & Taff, L.L.P.
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WHAT ARE THE BID AND CLOSING PROCEDURES?
(cont’d)
Prior to closing, the FDIC and the winning bidder will execute the
transaction documents.
 Immediately prior to closing, the FDIC places the failing bank in
receivership.
 At closing, the winning bidder must have at least one of its
personnel at each branch of the failed bank working with FDIC
personnel on the transfer
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Silver, Freedman & Taff, L.L.P.
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DOES THE WINNING BIDDER PAY MONEY TO OR
RECEIVE MONEY FROM THE FDIC?
The winning bidder will not pay any money to the FDIC. If the First
Loss Tranche is a positive number, then the winning bidder will
absorb the first losses on the acquired loans up to such positive
amount and then loss sharing starts.
 If the First Loss Tranche is a negative number, the winning bidder
will be paid the negative amount by the FDIC by wire transfer
before the end of the first business day following the closing
 The First Loss Tranche is the sum of (i) the winning bidder’s asset
premium (discount) bid as reflected in its bid, plus (ii) the winning
bidder’s deposit premium bid as reflected in its bid, plus (iii) the
dollar value of the assets being acquired (book value, except
marketable securities are at fair market value) less the dollar
amount of the liabilities assumed, which may be a positive or
negative amount.
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Silver, Freedman & Taff, L.L.P.
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DOES THE WINNING BIDDER PAY MONEY TO OR
RECEIVE MONEY FROM THE FDIC? (cont’d)
Example 1
 Negative Asset Bid
 Positive Deposit Bid
 Positive Net Equity
of Assets Acquired
minus Liabilities Assumed
First Loss Tranche
= <$15 million>
= $2 million
= $5 million
= <$8 million>
Since First Loss Tranche is a negative number, the negative amount (i.e. $8
million) is paid in cash by the FDIC to the winning bidder.
Silver, Freedman & Taff, L.L.P.
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DOES THE WINNING BIDDER PAY MONEY TO OR
RECEIVE MONEY FROM THE FDIC? (cont’d)
Example 2
 Negative Asset Bid
 Positive Deposit Bid
 Positive Net Equity
of Assets Acquired
minus Liabilities
Assumed
First Loss Tranche
= <$15 million>
= $2 million
= $14 million
= $1 million>
Since First Loss Tranche is a positive $1 million, the winning bidder absorbs the
first $1 million of losses on acquired loans before loss sharing starts.
Silver, Freedman & Taff, L.L.P.
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Who We Are
Silver, Freedman & Taff, L.L.P.
Washington, D.C. based law firm specializing in financial
institutions:
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Mergers and acquisitions
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Regulatory and Enforcement Matters
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Debt and Equity Securities Offerings
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Recapitalizations
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Compensation and Employee Benefit Matters
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Securitizations
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Credit Union to Thrift Conversions
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Mutual to Stock Conversions
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Charter Conversions
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Holding Company and MHC Formations/Reorganizations
•
Bank and Thrift De Novo Formations
Silver, Freedman & Taff, L.L.P.
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