By Rick Hall, Managing Director, Banking and Financial Services, BKM Marketing
Mergers in the banking industry are steadily making their way back to pre-pandemic levels. In fact, according to a yearly mergers and acquisitions (M&A) survey by Bank Director, nearly half of financial executives say that their bank would make an acquisition in 2022,1 though recent instabilities in the markets may impact this going forward. This number is up significantly from the 33% who said the same in the 2021 survey.2 However, there was one small but important wrinkle to this survey: Those acquisitions were only likely if the banks could find a willing target.
Leaders in the financial industry should take note of this particular caveat. There is an inverse relationship between the increase of mergers and the ability of financial institutions to find targets that fit their financial and strategic objectives. However, in their eagerness to snap up companies in a growing market, many executives might be overlooking this fact — a costly mistake, to be sure.
Now, more than ever, it’s crucial for financial institutions to perform their due diligence to discover whether or not a potential acquirement is actually a quality target. Otherwise, they might find themselves with a serious case of buyer’s remorse.
The critical importance of vetting during financial M&As
There’s an old saying: “Banks are sold, not bought.” This is a reflection of the overinflated view banks tend to have of their value. Sellers in the industry constantly overevaluate what they’re worth. It’s up to buyers, then, to do the footwork necessary to uncover the truth.
Performing financial and credit reviews isn’t enough. For a merger or acquisition to make sense, it has to work on both financial and strategic levels. Every strategy has its own financial calculations that need to be made in order to determine whether a purchase is a smart choice. If you’re taking out a competitor, for example, you might be able to consolidate your number of branches. If you’re moving into a new market, however, you most likely won’t be able to factor in that aspect.
Beyond these considerations, there are the new wrinkles of a post-coronavirus world that need to be taken into consideration. Technological innovation, for example, has become paramount to being competitive. Merging technologies and fintech partners can be a messy and exhausting process during a merger or acquisition. This can be made much more difficult if buyers don’t know what they’re getting into until after everything has been finalized.
There’s also the question of company culture3 — another area made more complicated by the pandemic. Are your employees back in the office full-time? Then you’d better make sure the employees at the company you’re buying are, too. Otherwise, you’re in for a major clash of expectations. In an industry where attracting forward-thinking, technologically driven employees is already difficult, not taking these kinds of factors into consideration can seriously hurt your ability to retain and attract the talent you need.
All of these factors point to the necessity for due diligence — beyond financials and credit quality reviews4 — when considering a merger or acquisition. Jumping in feet first is asking for trouble.
Digging deeper than financials and credit quality to ensure a quality acquisition
Of course, you might be thinking, “This all sounds good in theory, but in reality, this kind of extra research takes too much time and money.” However, it is possible for institutions, regardless of their resources, to perform the due diligence required. Start with these steps:
- Determine who your best customers are.
Before you dig into the details of your potential acquisition’s operations, you first need to understand the people for whom your own institution is built. Model your own best customers. This will give you a baseline that’s crucial for determining what exactly your acquisition target has to offer your business. The difference between who your best customers are versus those of your target will have a serious impact on the value of an acquisition. You can’t just assume that new customers will stick around once you’ve merged.
How do you determine who your best customers are? Dig into the demographic and behavioral information of your customers, such as median age, income, and the ways they use online banking and their debit cards. If you’re a consumer banker, pay attention to the number of customers who also bank with a competitor or a digital bank and the money outflows. These data points will give you a clearer picture of who your most valuable customers are and how you can encourage them to stay with your bank after a merger.
- Understand the customer attributes that drive your finances.
It’s an old general rule that 20% of your customers will drive 80% of your revenue.5 Ask yourself what behaviors of your 20% drive these positive financial impacts. Essentially, consider the value of your customers. What customer attributes contribute to an average return on assets?
Overlay these financial drivers with the information you gather about your current customer base to see the similarities and differences. Then, do the same for the company you’re acquiring. Look not only at their customer base, but also their products and business segments, such as demand deposit accounts (DDAs) and transaction-level attributes. Make sure you have a tangible — but relatively finite — list of what you’re looking for in your target company. It shouldn’t be a “boil the ocean” exercise.
- Compare findings about your institution with those from the target.
All this information that you’ve collected about your business and your potential acquisition can now be used to form a large Venn diagram. You can see where your customer base overlaps with theirs or how metrics such as debit card usage, online banking penetration, mortgage payments, and subscriptions compare. This isn’t a matter of validating whether or not to go through with a merger or acquisition. It’s about figuring out early in the process whether your post-conversion strategy is solid. Without a detailed comparison, you’re just working from speculation.
Make sure to look at every relevant factor. Don’t just assume that because you’re in the same geographical area and have similar customers and behaviors, you match in every other aspect. That will result in getting tripped up by simple, manageable differences. For example, there could be a discrepancy with the percentage of customers who have direct deposit set up in their checking accounts. If you’ve planned and implemented a strategy for making up the difference ahead of time, there’s no reason to worry. If you’re caught off guard after an M&A, however, you might end up with an operational headache that could have been easily prevented.
- Finalize and operationalize your action plan.
The first three to six months after a merger are when customer retention is most at risk. And when people leave during this period, they rarely ever come back. That’s why setting up an action plan early is so crucial to success. Start by operationalizing all the work that’s done in the back office; this involves the technical information that’s necessary for a smooth transition. Do this within the teams that will be working on integration and communication efforts so you can address some of the mystery early in the process.
By figuring out the logistics of things, such as how to move transactions from one bank to the other, you can smooth out any bumps in the road ahead of time. It’s important to remember, too, that you can’t assume you can treat new customers just like your current ones. Part of your action plan needs to incorporate how you’re going to reach out and communicate with these customers differently and meet their needs.
Performing enhanced due diligence is essential for M&A success in the financial industry, now more than ever. By going beyond simply the financials, you can make the best possible decision for your institution’s future. You’ll be glad you took the time to do things right instead of diving into a deal too soon.