Stephen Clinton, President, Capital Market Securities, Inc.

03/2011

2010 in Review
At the beginning of 2010 we wrote to bankers about various items that we felt deserved watching. We felt that these identified items might be at the forefront of issues impacting banking.

We noted:

• Politics. – We were concerned about the political climate that banking faced. We noted that President Barack Obama, calling bankers “fat cats,” set the stage for growing tension between the banking industry and politicians. We are pleased that the banking industry was able to achieve some favorable resolution to many of the punitive proposals as the Dodd-Frank legislation became law.
  
  On the heels of the Dodd-Frank legislation, the negative publicity for banking continued as the problems with the foreclosure activities of larger mortgage services become known. Banking analysts have also provided huge estimates for potential mortgage loan put-back exposure for the banking industry, which adds to the uncertainty surrounding banks.
  
  The banking industry has significantly repaid TARP funds, with approximately 85% of TARP funds provided to banks and thrifts being repaid by the end of 2010, providing a handsome return to the Treasury. Despite the success of the TARP program, many continue to call the program a “bank bailout” and seek to further punish banks.
• Commercial Real Estate. – We wrote that “declining values on commercial real estate looms as the next risk to banking.” This was certainly true in 2010 as banks continued to record loan charge offs and added to their loan loss provisions.
  
• Interest Rate Risk – We predicted that the Fed would remain accommodative for some time. We cautioned bankers to properly position their balance sheets for the inevitable rise in interest rates.
  
• FDIC Insurance Premiums. – We noted our concern that the high number of bank failures might cause additional special assessments to strengthen the insolvent FDIC insurance fund. We have been pleased that the industry has been able to avoid additional insurance premium costs.
  
• Freddie Mac and Fannie Mae. – We expected the Obama administration to unveil its proposal for the GSEs in 2010. Fannie Mae and Freddie Mac continue to be wards of the government since moving into conservatorship in September 2008. Borrowers and bankers have come to rely on an efficient secondary mortgage market. We worry about the impact on home prices and the availability of mortgage funding should GSE resolution plans increase the cost to borrowers for home loans or should the secondary market become less active.

We believe that bankers should continue to keep abreast of the issues noted above. We would add that regulation should be added to the list. It has been reported that the Dodd-Frank legislation is the most extensive overhaul for the U.S. financial system since the 1930s. The law includes nearly 500 required regulatory rulemakings, 81 studies, and 93 Congressional Reports. We are concerned about the added cost of regulatory compliance that banks will face as the rules and regulations are enacted and the new consumer protection agency unfolds. We also hear from many bankers that field examiners continue to take arbitrary positions in the examination process. Finally, we sense that the accounting world is determined to enact rules that could be harmful to bankers and their shareholders.

Market Update
The general stock market recorded improvement in 2010. The Dow Jones Industrial Index rose 11.0% in 2010, compared to the Nasdaq Composite Index’s increase of 16.9%. The improvement in the stock market helped advance the net worth of U.S. households to $54.9 trillion at September 30, 2010. However, this value reflects a 15% loss in net worth held at mid-2007 before the Great Recession began.

Many factors have come into play contributing to the stock market’s performance in 2010.

Specifically:

• The economic recovery, although weak, continued.
  
• Low interest rates continued and the rate of inflation has been low.
  
• The Fed continued to actively support the economy. In 2010 the Fed began a program to buy $600 billion in longer-dated government bonds (“quantitative easing”).
  
• Government spending continues at nearly an all-time high with the U.S.budget deficit in fiscal 2010 (ending in September) reaching $1.294 trillion. This was the second-highest ever, behind the record 2009 deficit of $1.416 trillion.
  
• Market pricing for the banking sector recorded a double-digit improvement in 2010. The Nasdaq Banking Index posted an increase of 11.9%. Smaller banks, those with assets of less than $500 million, recorded a lower price gain, but still were up 7.6%. From a regional perspective, banks in the Southwest recorded the largest price increase, moving up 28.0%, followed by Midwest banks at 22.7%. The chart on the left provides market pricing history for the banking industry compared to selected general stock market indices for 2010.

Note: We recognize that many of our readers may not be affiliated with publicly-traded financial institutions. We do think that managers of privately-traded banks should be aware of market pricing conditions as the market factors impacting the pricing of publicly-traded banks also influence the market value of all banks.

Although banking experienced positive pricing trends for 2010, bank prices are significantly lower than when they reached their highs in late 2007.

The problems facing banks in the last several years have been well chronicled. We have not seen bank failures occurring at this level since the thrift crisis.

Merger and Acquisition Activity
Bank merger activity slowed over the last three years. The depressed pricing for bank stocks made acquisitions less affordable for healthy banks. As the credit crisis stressed most bank loan portfolios, potential buyers have focused on dealing with their loan portfolios rather than adding other banks’ problems to theirs. For the bank sales that have occurred, a majority fall into the “distressed” category. Bank sellers in 2010 averaged a negative return on average assets of 83 basis points compared to a positive 94 basis points in 2007.

The average price to tangible book multiple for transactions involving bank sellers was 112% in 2010, a slight decline from 119% in 2009. This sale pric¬ing is significantly lower than the 251% recorded in 2007.

Capital Market Services
Young & Associates, Inc. has a successful track record of working with our bank clients in the development and implementation of capital strategies. Through our affiliate, Capital Market Securities, Inc., we have assisted clients in a variety of capital market transactions. For more information on our capital market services, please contact Stephen Clinton at 1.800.376.8662 or click here to send Steve an email.

Stephen Clinton, President, Capital Market Securities, Inc.

03/2011

The capital markets provided bank investors some relief in 2010. Bank investors have lost almost one-half of their market value since year-end 2006 (as measured by the broad Nasdaq Bank Index). The early optimism for bank stocks that occurred in April was doused by concerns over the foreclosure mess. The late year-end rally in bank stocks propelled bank pricing towards its year-end gain of 11.9%.

Many investors that followed the bank market in 2010 took advantage of the bank market’s volatility to enhance their returns above those shown above. Investments in companies that were strategic acquirers during the credit crisis performed well in 2010. Certain banks located in the Midwest found investor favor in 2010. Banks that identified their asset quality issues early and moved them toward resolution were rewarded in 2010. Banks that repaid TARP also performed well in 2010.

Young & Associates Inc.’s affiliate, Capital Market Securities, Inc., assumed the management of Financial Institution Partners, LLC, in 2008. Financial Institution Partners principally invests in publicly-traded financial institutions. Financial Institution Partners was able to provide an unaudited annual return to its members of 31.9% in 2010. We provide this example of an above-average market return as evidence that investing in bank stocks remains a good strategy for investors despite the dismal view of the financial services sector that many hold.

We anticipate that 2011 will continue to see bank pricing improvement. Bank earnings are expected to continue to improve as banks are not expected to face the same level of loan losses as economic conditions improve. We expect a number of banks to announce higher dividends once the Fed approves their business plans. For smaller banks, we think the market’s search for undervalued companies will move them higher as well. We expect merger and acquisition activity to accelerate in 2011. Merger announcements tend to push up prices.

Bank investors are encouraged to thoroughly evaluate prospective bank investments. There are risks in the sector. Some banks have conducted stock offerings to repay their TARP that were highly dilutive to their current shareholders. Interest rate risk exposure could create problems for some banks when interest rates rise. Regulatory constraints could depress other bank stocks. In our investing strategies, we place a high value on strong management teams. We look for banks that have a good market position. We currently favor banks that have moved up from their lows but not banks that have high price to earnings or price to tangible book multiples.

Stephen Clinton, President,Capital Market Securities, Inc.

12/2010

Market Update
The general stock market moved upward nicely in the third quarter. The Dow moved up 10.37% while the broader Nasdaq Index moved up 12.30%. Banks did not follow the upward market trend. The Nasdaq Bank Index fell 1.78% in the third quarter. Two major issues depressed banks: concerns over the slow economic recovery, and the issues surrounding foreclosures.

It has become our practice to note items of interest for bankers in this article. Among the items we note are:

• The Federal Reserve data shows that loan balances were less than 57% of total assets on banks’ books, the lowest in “recent memory.”
  
  
• Banks have seen a high number of “failed” equity offerings with 45 SEC-filed security offerings being terminated this year. A lack of demand and an inability to maintain offering pricing were reasons cited for the pulled offerings.
  
  
• While many of the larger banks have repaid their TARP capital, community banks remain stuck in the TARP program. Of the 620 banks remaining in TARP, 73% hold assets of less than $1B. It was reported that 115 banks and thrifts did not make their August dividend payment.
  
  
• According to the Case-Shiller Index, housing prices have fallen 28% from their peak in 2006. It is estimated that commercial real estate prices have fallen by an average of 40% since the credit bubble burst.
  
  
• Low interest rates are impacting many in different ways. Some money market funds have reported that they are unable to generate a sufficient yield to cover their management fees. Sales of fixed-rate annuities fell 45% in the second quarter of 2010, due principally to the low yield offered. Bankers are aware of the low yield available on loans and investments and the heightened refinancing activity lower interest rates have caused.
  
  
• There have been several articles noting that consumers are reducing their debt balances. Revolving accounts, for example, declined $80 billion from June 2009 to June 2010. It is estimated by Evolution Finance that institutions have charged off approximately $20 billion each quarter during that period, an amount equal to the amount of the decline in outstanding credit card debt. This raises concerns as to how much future consumer spending may add to the economy.
  
  
• An article recently reported that commercial real estate (CRE) was the worst-performing loan sector of the 127 banks that had failed through September 24, 2010. They noted that CRE represents, by far, the greatest problem for the smallest banks. The article added that there has been a clear shift in problem loans from construction and land loans to CRE.
  
  
• The Fed has clearly noted its concerns about the poor outlook for the U.S. economy. They appear prepared to provide additional accommodation to support the economy.
  
  
• The mid-term elections provided the Republicans a majority in the House. Republicans also made significant gains in the Senate, eliminating the Democratic 60-vote control. The dramatic gains recorded in the mid-term elections by the Republicans will put pressure on the Democratic agenda and set the stage for battles including health care reform, tax rates, and government spending. Bankers will need to watch the banking committees for events surrounding GSE reform and amendments to the Dodd-Frank legislation.
  
  
• Short-term interest rates remained low in the third quarter, with the 3-month T-Bill ending at 0.16%, compared to 0.06% as of December 31, 2009. The 10-year T-Note ended September at 2.53%, compared to 3.85% at December 31, 2009.
  
  
• The Dow Jones Industrial Index has risen 3.45% in 2010, compared to the Nasdaq Composite Index increase of 4.38%. The banking sector has recorded virtually no change this year as measured by the Nasdaq Banking Index.

Bankers face a challenging environment for the rest of 2010 and 2011. Among items we see as concerns are:

• The new rules and regulations that are required as a result of the Dodd-Frank legislation are likely to add to the cost structure of all banks.
  
  
• The difficult low interest rate period of the last several years has driven down funding costs to a level that will be difficult to reduce further. Many banks may face additional net interest margin pressure as borrowers negotiate even lower loan rates and reinvestment opportunities offer lower returns.
  
  
• Bank shareholders, who have seen an approximately 50% decline in the value of their shares since year-end 2006, may lose patience.
  
  
• Bank regulators are conducting stringent examinations, and in many cases are requiring banks with difficulties to execute agreements that require higher capital levels than are defined by the regulations as “well-capitalized.”
  
  
• Municipal bonds, in some cases, are showing signs of weaknesses as some governmental agencies are experiencing lower revenues. This places another traditional segment of a bank’s balance sheet under pressure from the slow economy.

On a positive note, bank earnings have been improving. The third-quarter earnings announcements indicate a general improvement in credit quality which has allowed many banks to lower their loan loss provision expense. Additionally, net interest margins have improved as funding costs have fallen. Many are also benefiting from higher mortgage banking income due to the high levels of loan refinancing activity.

Merger and Acquisition Activity
Year to date, there were 127 bank and thrift announced merger transactions. Within the merger activity this year are a number of acquisitions by private investors or entities formed to acquire financial institutions. It also appears that the merger market for deals other than FDIC sales is beginning to emerge again. There are signs that some banks have again decided to pursue strategic acquisitions. This could be an opportunity for many institutions that remain undercapitalized and hold underperforming loan portfolios to find a partner before the FDIC assumes control.

The median price to tangible book for transactions involving bank sellers was 99.1%, with a trailing twelve-month price to earnings multiple of 18.1. These multiples are significantly lower than the pricing paid on deals before the credit crisis.

Stephen Clinton, President,Capital Market Securities, Inc.

04/2010

2009 in Review
Pressure on the banking industry continued in 2009 as the damaging impact of the collapse of the housing bubble and the recession caused many banks to continue to record massive losses. Bank pricing declined further in the early part of 2009, before recovering over the later part of 2009. For the year, bank pricing declined 18.5% (as measured by the Nasdaq Bank Index).

There were many in early 2009 who were concerned that our financial system was on the verge of falling apart and that we were on the precipice of a depression. The Federal Reserve took dramatic steps to strengthen the financial system. The new Obama administration and Congress passed a $787 billion stimulus program in early 2009 to infuse the economy with new cash. TARP infusions into banks and others continued in 2009. Bank regulators conducted highly-publicized stress tests of the major banks to estimate the capital they might need to keep from failing. Wall Street and private investors stepped in to provide the capital for the major banks failing to meet the net worth stress test levels. The chart to the left illustrates the dramatic decline in bank pricing from February 20, 2007 through the end of 2009 where bank investors saw a loss of approximately 50% in the value of their holdings. The chart also reflects the stabilization in bank pricing beginning in the middle of 2009.

First Quarter 2010
The general stock market, and the market for bank stocks in particular, enjoyed a good first quarter in 2010. The chart on the next page provides pricing information for general market indicies compared to the Nasdaq Bank Index.

Economic Review

Manufacturing – The U.S. manufacturing index in March registered its best reading since 2004. U.S. auto sales surged 24% in March, helped by a strengthening economy and hefty buyer incentives offered by most manufacturers.

Employment – U.S. employers created jobs at the fastest pace in three years in March. However, nearly one-third of the employment gains were the result of temporary hiring for the Census.

Consumer Spending – Consumer spending, which makes up 70% of demand in the U.S. economy, increased 0.3% in February.

Housing – Home prices in 20 U.S. cities rose in January, providing support for reports that the housing market is stabilizing. The Case-Shiller National Home Price Index climbed 0.3%, matching the increase recorded in December. Sales of existing homes fell 0.6% in February despite lucrative tax credits available to home buyers. Investories of existing homes were reported at a 8.6-month supply at the current sales pace.

Deficit – As of February, the federal government’s fiscal year-to-date deficit was up 10.5% from fiscal year 2009. In February, the government ran its largest ever monthly deficit – $221 billion. The costs of the government’s stimulus programs, along with shrinking revenues due to the weaker economy, has created the large deficits.

Interest Rates – The Fed, to soften the recession, has maintained a highly accommodative policy holding interest rates to historically low levels. Additionally, the Fed has ballooned its balance sheet through the purchase of government debt and mortgage-related securities. The Fed owned $2.0 trillion securities, compared to $497 billion at the beginning of 2009. The Fed ended its program of buying mortgage-backed securities in March, a program begun in 2008 designed to support the weak real estate markets. The program has been given credit for lowering mortgage rates by as much as a percentage point. Mortgage rates are expected to move upward as a result of the end of the Fed’s buying program.

The economy is on the mend. The recession is over, as shown by the January Commerce Department’s announcement that gross domestic product rose a seasonally adjusted 5.7% annual rate in the fourth quarter. Most economists are predicting a slow recovery. It has been estimated that American households lost as much as $14 trillion due to the financial downturn. This loss of wealth is anticipated to constrain consumer spending for the foreseeable future. High levels of unemployment will also keep 2010 economic growth in check.

Concerns for Bankers in 2010

Politics – It has been two years since Bear Stearns collapsed. In that time we have faced the worst financial crisis since the Depression. Millions have lost jobs, housing prices have plummeted, and investors have lost trillions. In response to the banking industry’s responsibility for the crisis, the Senate Banking Committee passed a sweeping financial regulation bill in March. The bill addresses the formation of a consumer protection watchdog, “too big to fail,” transparency and accountability for derivatives and other exotic instruments, streamlined banking regulation, and financial industry executive compensation. When legislation is enacted, the far reaching implications of the final bill will impact every banker.

Commercial Real Estate – Declining values on commercial real estate looms as the next risk to banking. It has been reported that $650 billion of commercial real estate loans are coming due over the next four years, with $150 billion maturing in 2010. It is estimated that 43% of the loans due in 2010 exceed the current value of the properties they secure. The decline in the value of commercial real estate makes restructuring many of these loans difficult.

Interest Rate Risk – The cost of bank funding has benefited significantly by the low interest rate environment. While the Fed is expected to remain accommodative for some time, it is inevitable that interest rates will increase. Banks that have not taken actions to properly structure their balance sheets may suffer in a rising rate environment.

FDIC Insurance Premiums – In total, 140 banks and thrifts failed in 2009, and 41 additional banks were closed in the first quarter of 2010. In 2009, the FDIC entered into 115 government-assisted transactions with a cost to the deposit insurance fund averaging 28% of the failed institutions’ assets. The FDIC has offered loss-share agreements about 70% of the time in purchase and assumption agreements to entice buyers of failed banks. The aggregate cost to resolve failed banks may require additional special assessments in addition to the three-year prepayment of FDIC premiums paid by banks in 2009 to strengthen the insolvent FDIC insurance fund.

Freddie Mac and Fannie Mae – The Obama administration remains unsure how to address the GSEs. Fannie Mae and Freddie Mac were taken over by the government and put into conservatorship in September 2008. The ultimate decision on the resolution of the GSEs could have a significant impact on bank mortgage lending activities and potentially present opportunities.

TARP – Over 700 financial institutions participated in TARP’s Capital Purchase Program. Total distributions to financial institutions participating in the CPP totaled approximately $300 billion. Approximately $150 billion has been repaid. SNL Securities has estimated that, for companies that have fully exited TARP including settlement or government sale of their warrants, the government earned an 8.5% annualized return. On the negative side, 74 TARP participants missed their February dividend payment. The Congressional Budget Office estimates that the cost of the entire TARP program will be $109 billion. The bulk of these losses are expected from non-banks including AIG's $36 billion, and the auto manufacturers' $34 billion. The general public perception of the bank “bail out” from TARP and the associated cost to U.S. taxpayers are misconceptions that must be addressed by bankers.

2009 Merger and Acquisition Activity
Consolidation of the banking industry, which slowed in 2008, slowed even further in 2009. In 2009, there were 122 merger transaction (exclusive of bank failures), compared to 159 deals in 2008. This lowered activity compares to the 288 deals announced in 2007. The median price to tangible book for transactions involving bank sellers was 117%, with a trailing twelve-month price to earnings multiple of 18.2. The price to book multiple is down approximately 27% from 2008.

Bank Market Pricing - March 2010
As of the end of March, the Dow Jones Industrial Index rose 4.1% in 2010, compared to the Nasdaq Composite Index’s rise of 5.7%. The banking sector improved even more, with the Nasdaq Banking Index posting an increase of 13.1%. Banks benefited by the general belief that the loan losses are coming to an end and that bank profitability for 2010 will significantly improve.

Stephen Clinton, President, Capital Market Securities, Inc.

12/2009

Market Update
The U.S. economy ended the recession with the third-quarter GNP growing 3.5%. The strength of the recovery remains of concern as government pro¬grams designed to stimulate the economy near their end. The following issues highlight certain areas of the economy that merit watching:

• Unemployment - The jobless rate reached 9.8% in September, its highest level in 26 years. Unemployment is expected to remain high for some time as employers are expected to be hesitant to hire new employees until further strengthening of the economy is evident.
• Interest Rates - Short-term interest rates remain at historical lows while long-term rates have increased approximately 150 basis points since year end. Banks have been the beneficiary of lower rates as net interest margins have widened.
• Commercial Real Estate - Economists, among others, continue to express con¬cern over declining commercial real estate values due to the struggling economy. Capmark, one of the largest real estate lenders, filed for bankruptcy protection in October. Capmark, formerly the commercial real estate lending division of GMAC, was principally a lender on office towers, strip malls, and hotels. Vacancy rates at malls and shopping centers have risen to multi-year highs.
• Home Sales - Home sales in September climbed to the highest level in two years. Purchases jumped 9.4%. Partial credit for the improvement was being given to the first time homebuyer's tax credit that was scheduled to expire. (In October, legisla¬tion was being discussed to extend and/or expand the homebuyer’s tax credit.)
• Federal Reserve - The Fed has ballooned its balance sheet to $2.1 trillion from $870 billion prior to when the credit crisis began. The Fed has purchased close to $1 trillion of mortgage-backed securities since the start of the year, driving down mortgage rates. As the Fed plans to exit from this buying activity and ultimately move to reduce its holdings of mortgage-backed securities, where mortgage rates go is uncertain.
• Oil Prices - Oil prices rose 9.1% in October, ending at $77.00. Oil inventories have moved to near the highest levels in decades as the recession has significantly reduced the demand for oil. Short-term interest rates ended October with the 3-month T-Bill ending at 0.05%, down from 0.11% as of December 31, 2008. The 10-year T-Note as of the same date was at 3.41%, compared to 2.25% at year end 2008. The yield curve has steepened as long-term rates have moved up more than longer-term rates.

As of October 30, the Dow Jones Industrial Index had risen 10.7% in 2009, com¬pared to the Nasdaq Composite Index’s improvement of 29.7%. The banking sector, conversely, declined, with the SNL Banking Index posting a decrease of 3.2%.

Merger and Acquisition Activity
Through October 31, 2009, there were 102 bank and thrift announced merger transactions. This level of activity is lower than in prior years. The median price to tangible book for transactions involving bank sellers was 124% with a trailing twelve-month price to earnings multiple of 19.5. These multiples compare to 160% and 23.4 respectively for 2008. There have been 115 bank failures so far in 2009, the most since the savings and loan crisis in 1992.

Stephen Clinton, President of Capital Market Securities, Inc.

07/2008

It should come as no surprise to bankers that the credit crunch has taken its toll on financial institutions. Banks have been hit with loan losses, lower lending volumes, and higher loan loss provisions, leading to declining profitability for the industry. Market prices for banks have nose-dived as a result.

It was not too long ago that banks were flush with capital, and access to the capital market was welcomed. Banks routinely adopted share repurchase programs to lower their net worth ratios. Dividend payouts were regularly increased. Trust-preferred security offerings frequently provided banks with an alternative source of capital to fund growth. The capital market viewed the financial services industry in a favorable light.

Shareholders and regulators have become more focused on capital adequacy, as the credit crisis has worsened. We regularly hear about examiners demanding higher provisions for loan losses and strengthened capital positions. We have seen the prices of banks plummet, as rumors of the need for additional capital surface. In the second quarter, banks and thrifts raised over $90 billion in capital. Approximately 20% of the capital raised was common stock, preferred equity totaled 45%, senior debt totaled 23%, trust preferred securities was at 9%, and subordinated debt was at 3%.

The vast majority of the capital raised in the quarter was by major banks. Citigroup itself raised 23% of the total. Major banks have also announced reductions in dividends in another effort to preserve capital. Others have resorted to selling assets to generate capital or to shrink their asset base.

Community bankers must be prepared for the heightened focus on capital adequacy. Lower earnings will provide less capital than in prior years. Higher losses and a struggling economy will lead to higher loan loss reserve requirements. Access to the capital market will be more expensive and dilutive and, for some, unavailable.
We encourage community bankers to increase their attention on capital issues in their budgeting and strategic planning processes. With a higher scrutiny on capital by regulators and investors, issues surrounding profitability, growth, dividend policies, and capital contingency plans require increased focus. We are prepared to assist financial institutions evaluate these issues. For more information, please contact me at 1.800.376.8662 or click here to send an Email.

Stephen Clinton, President, Capital Market Securities, Inc

04/2008

Bank directors are charged with a variety of responsibilities. Shareholders expect the directorate to represent their best interests. Regulators demand that directors assume responsibility for the bank’s operation in a safe and sound manner and in compliance with a myriad of consumer protection regulations. The bank’s customers expect the directors to lead the bank in a manner where the bank operates as a good citizen, promoting the welfare of its community by providing for the market’s credit and investment needs. Employees want the directors to maintain their jobs and to promote a good working environment.

Should You Sell?

With responsibilities to such a diverse collection of parties, the role of a director can become very cloudy when the bank begins to consider whether the time is right to consider a sale. In a perfect world, the analysis should be straight forward. A bank is a corporation owned by its shareholders.
Therefore, the board of directors should compare the economic impact on the shareholders of a sale with the economic impact on the shareholders of remaining independent.

Typically, when considering a sale, the bank will employ a financial advisor to assist the board in evaluating a sale. The advisor will conduct an analysis of the financial prospects of the bank remaining independent and make an assessment of value implications to shareholders. Often, a range of values might be forecast using a variety of projection assumptions. Giving consideration to various risk factors, the advisor will compare the projected financial implications to an estimate of the sale value of the bank.

In my experience as an advisor to banks conducting such an analysis, rarely is the sale decision made based solely on what is the “best” financial alternative to the shareholder. Considering the variety of parties that directors represent, it is not surprising that other factors beyond the shareholders’ economic interest become involved in the decision matrix. The sale analysis typically evolves from a financial analysis to a judgment call.

The following examples detail instances that a bank decides to remain independent, even though the financial analysis indicated that shareholders would economically benefit from a sale:

• The board of directors is controlled by management. This may be the result of the recruiting process of directors where they feel an obligation to management for their positions, the level of ownership held by management, or due to other factors. Often, management may base their position regarding a sale on personal factors and on how a sale might impact them, the bank’s customers, and/or its employees, rather than from a shareholder fiduciary perspective.
• The board lacks a meaningful ownership position in the company. In this case, it is easier for directors to accept substandard bank performance or base their sale decision on other factors rather than shareholder best interest.
• Directors often “fall in love” with their prestigious positions and consider their personal position in the community derived from being affiliated with the bank. Two considerations typically surface: 1) directors don’t want to be the one to sell the local bank and 2) they don’t want to give up their status.

Young & Associates, Inc. is a bank consulting firm that is a strong advocate for community banking. We believe that community banks can operate successfully for the foreseeable future and strive to assure that we provide the support to help our clients remain independent. However, we also recognize that there are banks that should be seeking merger partners.

The profile of such bank sellers include the following:

• Banks experiencing regulatory problems where the resolution of the issues appears unlikely
• Banks who regularly fail to achieve average industry performance results
• Banks with weak management that are unwilling to upgrade management with proven leaders
• Banks that have achieved their corporate goals and lack the ambition or desire to reach for new goals
• Banks that are not competitive in today’s sophisticated financial marketplace and lack the resources to bring themselves up to a competitive level or are unwilling to make such a commitment

The Value of Strategic Planning

We believe that banks should regularly conduct strategic planning. The strategic planning process often includes an unbiased assessment of the sale analysis. Banks that believe in the strategic planning process and achieve their stated goals find the sale analysis typically leads to the conclusion that a sale is not in the shareholders’ best interest. Reaching a sale decision within this corporate philosophy becomes relatively simple for a director.

For banks that are not regularly assessing the decision concerning a sale, we encourage them to begin such a process. Board members should insist that this process be conducted as it provides evidence that the bank is focused on its fiduciary duty to shareholders. If the bank desires to avoid a sale and hopes not to be confronted with activist shareholders promoting a bank sale, the bank should become aware of the factors that require attention to justify continued independence. Thereafter, the directorate should monitor progress toward addressing such factors.

If you have questions about this article or would like to discuss our conducting an independent sale analysis for your bank, please contact me at 1.800.376.8662 or click here to send an Email.