Deposit Dilemma — A Playbook for Using M&A as a Proactive Tool to Solve Funding Issues

DEPOSIT DILEMMA A Playbook for Using M&A as a Proactive Tool to Solve Funding Issues 

By Leonard J. DeRoma, Head of Liability Analytics

Virtually any financial institution with a high loan-to-deposit ratio or with funding challenges in today’s difficult and highly competitive environment for gathering and retaining deposits should at least explore M&A as a potential solution. The right acquisition can, overnight, provide the same amount of liquidity your bank can generate on its own over the next five years. However, pursuing acquisitions as a solution to the deposit dilemma must be done with diligent planning and a carefully developed process.

Simply expecting your investment banker to bring you deals is not how the process works best. As the CEO of an acquisitive bank, most M&A opportunities will be introduced to you in one of two manners:

  1. You get a call from the investment banker representing the seller (not your advisor, but the other bank’s advisor) inviting you to participate in a bidding process, and then you turn around and engage your own investment banker upon acceptance of that invitation.
  2. You create a transaction yourself by leveraging the relationships with other bank CEOs you have developed (also referred to as the ‘negotiated transaction’). Investment bankers and lawyers are brought in ‘after the handshake’ to formalize and process the deal.

It is important to note that the investment banker for the buyer is generally engaged after the opportunity has been identified. In fact, investment bankers tend to prefer it that way because they have a transactional business model. Their preference is to represent sellers because that is the equivalent of having a ‘bird in hand’, while representing a buyer without a committed seller means they are taking a risk of expending their time and resources without a guaranteed pay day.

In most situations, would-be acquirers participate in a bidding process (option number one above). Unfortunately, this approach severely limits the probability of a successful transaction with the right bank. First, you will only be reacting to banks that ‘are for sale’, irrespective of how they alleviate your bank’s issues. Unfortunately, most of the banks currently ‘on the market’ are banks in your footprint that have the same challenges with funding. Second, the chance of success is very low, since you are likely one out of 10 or so banks invited to participate in the process. Third, because it is “shopped” and in an auction situation the price will be high. Fourth and perhaps the most overlooked aspect of this approach is the ‘fatigue factor.’ Each time this type of an opportunity surfaces, it essentially diverts the time of key members of management to assess and analyze the opportunity, with most of their time wasted on unsuccessful bids.

The Missing Piece of the Puzzle: A Proactive Process

Unless you get lucky, the “opportunistic” M&A approach won’t end up with a successful acquisition of the right bank. Instead, a bank in need of deposits needs a well-defined strategy and process that leads to the highest quality transactions. The right playbook for developing an acquisition strategy looks something like this:

  1. First determine your strategic objectives and then evaluate whether M&A and/or organic growth can help the bank achieve its goals. If you are a bank with a 100% loan-to-deposit (LTD) ratio and plan on growing your loans by 10 percent next year, and you set up a strategic objective to reduce your LTD ratio to 90% by relying less on CDs, what is the best way to achieve that? M&A should not be a ‘hip shot’ reaction to news from an investment banker that a target is for sale. A good strategic plan treats M&A as a tool that can supplement or complement organic growth. This will lead you to create criteria for ideal targets: for example, all banks within 150 miles, with excess liquidity of at least $100 million, and with transaction accounts representing at least 30 percent of the deposit base.
  2. Develop a target list based on that criteria, and then analyze each bank. The list itself shouldn’t be limited to only targets that are or will likely be for sale. Banks not yet for sale are opportunities to get ahead of the market– especially if they have the characteristics of banks likely to sell in the future. The analysis of each target should include deep-dives into both the loan and deposit portfolios, considering the ability of the target’s loans and deposits to absorb changes in interest rates, as well as credit risk issues, including CECL and stress testing analytics. All analyses should be performed in conjunction with how each target’s loans and deposits fit with and alter those of the buyer. If you’re a bank with a 100% LTD ratio, a target that also has a high LTD ratio will be a poor fit, irrespective of how impressive their loan growth has been.
  3. Translate the robust analysis of each target into a valuation specific to your bank. Target valuations should include both a financial component and a strategic component. Each target should be valued on what they are worth to you, regardless of market prices. You gain an edge when a target’s worth to you exceeds its market price. You don’t need to waste much time on those targets that are worth less to you than they are to the rest of the market.
  4. Design an outreach strategy for each target. This needs to be done properly and carefully, with an analysis and reconnaissance of each target to determine the angle that most likely makes it a willing seller. Each target will have a unique narrative. Simply approaching a banker and saying, “If you ever thought about selling, I’d be interested,” is not enough. Can you offer them more than the market without overpaying? What are their important intangibles? The approach to a target with weak earnings and a controlling shareholder will be dramatically different than one to a target with strong earnings but with a succession planning problem or an aging shareholder base.
  5. Execute the outreach and manage the development of each relationship. Once the outreach occurs, some targets will be ruled out, some may require the ‘long game’ and if lucky, one or two will be immediately interested. Each touch point with any target following the first outreach but prior to sending a Letter of Intent should be handled with care and have a specific objective.
  6. In certain situations, you may be invited to participate in an auction. Since you have already performed the preceding steps, you can make an immediate and well-informed decision on whether to participate. This approach eliminates the frequent ‘fire drill’ process that encumbers 10 days of management team’s time with little chance of success. If you decide to pursue the target in an auction, it not only increases the efficiency of the process, it also improves the chance of success because the go-ahead call likely means the target is worth more to you than the market, giving you an advantage. If you have previously reached out to this target (see step 5 above), you may also find yourself with a competitive advantage. (Invictus has been part of several recent bidding transactions in which our clients won, even though their bid wasn’t the highest, because of the relationship they had already developed with the target.) Depending on the situation the “soft factors” such as culture and fit can be as, if not more, important than the financial aspects.

New Analytics and New Role for Management

Remember that the post-recession era, marked by the Federal Reserve’s unprecedented policy of quantitative easing, forever changed community banking. (See “Why it Makes Sense to Do a Deal Amid Depressed Bank Stock Prices, page 1.). Reversing these changes through traditional operating procedures is slow and ineffective, while M&A can be a powerful corrective tool for the deposit dilemma. However, using M&A to create the funding needed to grow and preserve loans, reduce liquidity risk, and maximize shareholder value requires a drastic shift in M&A analytics, the role of management and their investment bankers.

But you have a better chance of rapidly and significantly growing your deposit base using this new M&A approach than you do by trying to grow deposits organically with gimmicks such as points on checking accounts, toasters, or any other ‘hacks’ that are out there.

Investment bankers will continue to play an important and essential role. They provide necessary services associated with completing a transaction for the buyer, including acting as the ‘deal manager’ to gather up the target’s shares and provide a fairness opinion. But the structure and resources of most investment banks is geared toward transaction-specific actions. They were not organized or designed to focus on identifying and quantifying the unique financial and operating challenges faced by individual community banks.

The most valuable aspect of any successful transaction is the creation of the right opportunity that fits the holistic strategy of the bank. Without that, there is nothing to do but hope that the right bank comes up for sale. And hoping is not a strategy.   

For information on the Invictus Group’s proactive M&A targeting service, please email