Of Course Your Bank’s Not for Sale
By Gren Blackall
Selling a bank is often the strategy-of-which-we-do-not-speak and thus difficult to keep fresh. Yet a selling strategy can keep an executive team aware of possibilities, prepared if suitors come knocking and better positioned to navigate optimally into the future.
There are many compelling arguments for having a relationship profitability approach to banking. The list is extensive and it is difficult to imagine how some banks manage without them. But this article will discuss one overlooked application of this approach that might not be as obvious: Knowing who your most profitable customers are can significantly improve your bank’s ability to negotiate a higher price with a buyer, when and if the owners decide the time is right to sell.
The analysis below estimates that for every 1 percent in added client retention and every $100 million in assets, the bank can realize an increased price in the $100,000 range. This means the executive management of a $500 million bank can recognize as much as $3 million in value if they can negotiate an additional 6 percent of retained clients, which is quite feasible with good relationship profitability systems. Read on!
Acquisitions Rising Again
From 1994 to 1998, an average of 425 bank and thrift acquisitions took place every year. This pace was reduced by more than 50 percent over the next four years, hitting a low of just over 200 in 2002, due in part to the regulatory and legislative changes of the period and Y2K (a distant memory). Acquisitions during 2003 and 2005 were up 15.5 percent over the low – still way below the peak, but increasing. Even if this means only one out of 30 banks gets acquired each year (and many times, more than that actually do get approached), it still makes sense to manage your market valuation, especially in a market which is increasingly acquisition-prone.
Although bankers tend to treat their acquisition analytics like a secret formula, there are three approaches most common to calculating the value of a bank. Most buyers and merger and acquisition consultants use some form of all three approaches. Two of them are fairly simple and relate to market dynamics and historical behaviors: comparables (like in real estate transactions) and multiples (looking at multiples of book value offered in similar transactions).
The third and most accurate method involves classic financial analysis based on present value of future cash flows. Although highly simplified here, the four major components to this analysis are:
• Projected profitability;
• Plus synergistic take-outs;
• Minus the effect of clients not being retained after the sale; and
• Discounted by the proper rate.
There are volumes that can be written about any one of these, but I want to focus on number three – client retention – as it affects price. Using the kind of analysis you find in a first-year finance textbook, and applying some assumptions about the mix of deposit and loan types, a rule of thumb emerges:
For every 1 percent additional retention in clients, the price can improve by approximately $100,000 per $100 million in assets.
Of course, this rule is fraught with generalizations, but empirically it has proven to be quite useful.
In 2003, a community bank in the Midwest with under $1 billion in assets was for sale (name of bank withheld at bank president’s request). Two suitors approached the bank with very different prices. The selling bank determined that one of the biggest differences in the two offers related to their retention assumptions. One suitor assumed they would lose 25 percent of their business clients (which was about 50 percent of the banking assets of the organization) in the year following acquisition. The next, and best bid, assumed 20 percent accretion.
But here’s the gem! The seller had a relationship profitability culture and knew exactly who their top clients were and had a specific plan to retain them in the acquisition. In fact, it turned out that only 20 business clients constituted 80 percent of their profit. They went to the acquiring bank armed with this information and negotiated down the retention rate to 10 percent, with guarantees. This increased the purchase price by $4 million.
Strategy and history show that one community bank buying another will often assume low attrition, because they spend the time and money to ensure it. A multi-regional giant might use a more aggressive approach and not be as concerned about losing clients, figuring the cost of retention isn’t worth the value and a percent of loyal clients will leave in a big bank purchase regardless. Rates of client loss assumptions on the first offer most commonly range from 35 percent down to 15 percent. A 10 percent rate, as in our example, is rare and seen only at banks that have negotiated convincingly.
The Bottom Line
Who knows when suitors will come knocking – most likely they are already. When that knock comes, you will be well compensated for having good relationship profitability information.
Keeping profitability up and operations efficient will maximize your sale price in the market. But knowing where you make your profit (specifically from which clients) will add a nice premium to the value of your bank.
Gren Blackall is managing director of Clark Consulting, a North Barrington, Ill.-based firm providing compensation, benefits and organizational development solutions to more than 3,800 U.S. corporations, banks and health care organizations.