Opportunistic buyers pounce on big banks’ castoffs.
By Wyatt Jenkins
U.S. banks are closing hundreds of branches each year; between 2010 and 2016, the total number of branches declined by 7,864, a net decline of approximately 1,123 per year. Countless articles have covered changes sweeping the branch landscape, including mobile banking platforms and the choice of some branches to resemble a café more than a bank, with baristas, open floor plans, beanbags, flat screen TVs and iPads.
Even with these changes, strategic branch transactions continue to present opportunities for judicious buyers. Branches will likely continue to play a central role for many banks in a strategic, multichannel approach to business development and customer service, especially for high-value, complex interactions. Branch acquisitions may offer opportunities to gain low-cost, core deposits and strategically enhance the bank’s footprint to further drive profitability.
The Federal Reserve raised its benchmark interest rate in March for the second time and three months, and signaled more interest-rate hikes are on the horizon for 2017; that outlook pushes bankers to anticipate a higher-rate environment and enhances the value of low-cost, sticky, core deposits. The anticipation of a higher interest rate environment has appeared to push deposit premiums paid on branch deals higher through the years, and will likely put upward pressure on deposit premiums paid in the future. From 2015 to 2016, median branch franchise premiums paid on branch deals increased from 2.6 percent to 3.4 percent; that upward trend is likely to continue in 2017.
While deposit premiums paid were up in 2016, branch transaction activity was significantly down year over year. After a strong 2015, when the industry saw a total of 84 branch transactions involving 269 branches, 2016 transaction volume declined 33.3 percent to 56 transactions involving 121 branches.
Most branches closed through the years have been from the largest banks. Branch-closure data indicate 65 percent of the branches closed between 2010 and 2016 were closed by banks reporting more than $10 billion in assets. In addition to branch reduction initiatives from many of the largest banks, the ongoing high level of whole bank merger and acquisition activity drives the need for buyers to rationalize the acquired branch network and reduce expenses to achieve the payback periods investors demand. Together, these forces often generate branch acquisition opportunities for acquisitive banks.
Branch transactions can include a number of different deal components, including the acquisition of deposit liabilities, select loans and fixed assets. Deposit liabilities assumed are typically deposits associated with the branch being acquired. A buyer should carefully consider the type of deposits, terms, cost and maturity as it considers its interest in and the valuation of a transaction.
Deposit run-off can be a significant issue and should be carefully considered with the current banking environment. Average run-off during 2016 was 17.7 percent, a marked increase from the average run-off from 2011 to 2015 of 10.9 percent. Any purchase-and-assumption agreement should include buyer protections for certain levels of run-off and will likely include pre- and post-transaction nonsolicitation provisions targeted at reducing run-off levels.
The building and location also are important in the value proposition of a branch transaction. Buyers should conduct a careful analysis of the branch location, including a competitive analysis, traffic-flow study, infill cost bids, ongoing occupancy expense and an assessment of the location’s capacity to support future growth. As with a greenfield location, buyers should consider market demographics, census trends and trade areas in the decision-making process.
Branch transactions may be offered with loans included or excluded. During 2016, 32 of the 56 (57.1 percent) branch transactions reported including at least some loans. As with a whole bank transaction, loans acquired in a branch transaction can include issues and should be carefully reviewed. The P&A agreement may include a number of provisions related to loans, including put provisions, post-closing loan performance or post-closing buyer due diligence requirements, if loan due diligence wasn’t conducted before closing the transaction.
While transaction complexity can greatly vary, most branch acquisitions offer a relatively straightforward purchase, regulatory approval and integration process. In addition to the natural appeal of a relatively simple acquisition, a branch transaction can help build internal capabilities and know-how for banks that have limited acquisition experience. Building these capabilities is especially important for banks looking at M&A as part of a growth strategy in the future.
Large banks pursuing a branch divestiture strategy are inclined to pursue the transactions that remove the most branches from their balance sheet in the fewest number of transactions possible. Thus, a bank only interested in one or two branches may find itself at a disadvantage to a buyer willing to acquire a much larger group of branches in a single transaction, even if that bank is willing to pay an above-market premium for the branches in which it’s interested.
This challenge in beating out larger buyers in an auction process highlights the need for banks to have a strategic, proactive branch acquisition plan. The owners of the branches a bank is targeting should be made aware the bank is interested and willing to pay a reasonable price for the branch in question. This proactive approach is a long-term play and may not bring results overnight, but it’s likely to highlight some opportunities that a more passive approach would miss.
If a bank is looking to go after one or more branches using a one-off, unsolicited approach, it will likely have to pay a premium to the market. However, it’s also likely that the bank would have to offer an above-market premium to get noticed in an auction process for multiple branches. With the market value of branch deposits somewhere in the 3 to 5 percent range for desirable markets, buyers in unsolicited transactions are possibly looking at a deposit premium north of 5 percent. Nevertheless, the opportunity to strategically build out a bank’s footprint and acquire access to valuable, core deposits could be worth the additional premium on deposits necessary to bring a prospective seller to negotiation.
While branch banking continues to change, branches are still relevant, and branch acquisition opportunities will continue to be available. The most successful players in this environment will be well-informed, strategically proactive and ready to pursue the right opportunities at a moment’s notice.
Wyatt Jenkins is a certified public accountant and vice president, BKD Corporate Finance, LLC. He can be reached at firstname.lastname@example.org.