MERGERS AND ACQUISITIONS IN A DOWN ECONOMY

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MERGERS AND ACQUISITIONS IN A DOWN
ECONOMY Western Independent Bankers June 2,
2009 Presented By Dave Muchnikoff and Barry
Taff Silver, Freedman Taff, L.L.P. 3299 K
Street, N.W., Suite 100 Washington, D.C.
20007 [phone] dmm_at_sftlaw.com btaff_at_sftlaw.c
om
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LOCAL BANKS FACE BIG LOSSES

• Journal Study of 940 Lenders Shows Potential for
  Deep Hit on Commericial Property
• Wall Street Journal Headline May 19, 2009

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Who Is Selling?

• Community Bank
• Unlikely to sell in down market - succession may
  be only reason to sell
• Distressed Bank
• Acquire at a large discount to book value
• Stalled De Novo
• Acquire undeployed capital at a minimal cost

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Why Buy Today?

• Bank stocks are down many trading below book
  value
• Lower trading multiples
• Weak earnings
• Targets forced to sell
• Alternatives are limited
• Limited competition
• Capital is king
• Cost savings and cross-marketing opportunities
• Expand branch/ATM locations, improve customer
  access

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Why Not Buy Today?

• What are you acquiring? -- Unknown Asset Quality
  -- How big is the hole?
• Dont want to acquire someone elses problems
• Capital is more expensive
• Possible Regulatory problems
• Limited secondary market

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Who Should Be Buying?

• Well Capitalized Banks with
• Strong capital/credit
• Good standing with regulators
• Experience
• Good asset quality and generation
• Private Equity with
• Large amount of money raised
• Varied strategies
• Minimum return expectations approach 20 or more
• Bank holding company status can be an obstacle
• Over Capitalized De Novo
• Alternative strategy to deploy excess capital
• Limited universe of suitable targets
• Banks interested in a Merger of Equals

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Merger-of-Equals

• Double the size of the company
• Create a stronger acquiror and more valuable
  target
• The likelihood of the displacement of fewer
  employees (as compared to a sale of the company)
• The possibility for retention of local identity
• The opportunity to significantly expand the reach
  of the franchise
• Enhanced liquidity and visibility
• Execution risk is higher than acquisition
• Must share power (management, Board)
• Potential for third party interlopers
• Not many available candidates hard to find other
  banks with similar size, valuation and culture

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• Principal Social Issues in a Merger of Equals
• Board / Committees
• Board representation based on equity, assets,
  income?
• Advisory board?
• How is board succession handled, for how long?
• CEO/key officer succession
• Who will be the CEO, CFO?
• Severance payments, consulting agreements and
  succession plans?
• Determining who stays and who gets fired

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Deal Considerations

• Typical Compensation and Benefit Issues
• Salary adjustments
• Creation of new officer positions
• Employment contracts (1-3 years, with CIC
  protection)
• Change-in-control/severance payouts (1-3x
  payments)
• Retirement plan enhancements (SERPs)
• Post-merger consulting contracts
• Merger transaction bonuses stay bonuses
• Advisory/emeritus boards/board retirement plans
• Agreements regarding participation in future
  stock plans

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Legal / Regulatory Considerations

• Typical Compensation and Benefit Issues
• Regulatory issues developing if compensation to
  Board or officers appears gratuitous or
  extraordinary
• General Rules
• If plan / agreement in place before merger and
  benefits are reasonable and customary then
  should be upheld
• Increases in salary or benefits generally
  permitted if levels are brought up to acquiror
  levels
• Special TARP Issues

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Tax Considerations

• Understand IRC Section 280G may have a
  significant impact on deal costs and post-merger
  consulting agreements
• Any change-in-control related payments in
  excess of 3x 5-year average taxable income may
  result in
• 20 excise tax to executive and
• Loss of tax deduction for acquiror
• All payments triggered or accelerated by
  transaction may be included (accelerated vesting
  of stock grants, SERPs, insurance and health
  care)
• Bona fide post-merger payments typically are not
  included in 280G analysis, such as payments under
  consulting and non-competition agreements, new
  employment contract or board fees

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Typical Merger Agreement Terms

• Structure and pricing of transaction
• Representations and Warranties
• Restrictions on operations pending closing
• Board seats, committees and advisory board
• Employment / change in control contracts / other
  severance and branch arrangements
• Termination provisions and termination fees

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Typical Due Diligence Documents

• Regulatory exam reports / correspondence
• Corporate minutes
• Audit reports / correspondence
• Internal audit reports / correspondence
• Underwriting policies and procedures
• Large loan files / classified or watch list loans
• Corporate governance documents (charter, bylaws)
• Litigation / personnel files
• Environmental reports
• Material contracts

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FDIC FAILED BANK TRANSACTIONS

• There are three alternatives
• 1) Purchase and Assumption with Loss Sharing
  Buyer acquires all loans at book value after
  reversal of reserves, certain marketable
  securities at fair market value and a limited
  amount of other assets at book value including
  OREO, and assumes deposit liabilities and certain
  indebtedness for borrowed funds, with the
  acquired loans being subject to loss sharing with
  the FDIC. This is the type of transaction we will
  be discussing today.
• 2) Purchase and Assumption without Loss Sharing -
  Buyer acquires all loans based upon the discount
  contained in its bid, certain marketable
  securities at fair market value and a limited
  amount of other assets, and assumes deposit
  liabilities and certain indebtedness for borrowed
  funds. In this case, Buyer is not entitled to any
  loss sharing payments from the FDIC and assumes
  complete risk with respect to the assets acquired
  based upon its discounted bid.
• 3) Clean Bank Buyer acquires marketable
  securities, a limited amount of other assets (but
  excluding loans other than overdrafts and loans
  secured by assumed deposits), and assumes deposit
  liabilities and certain indebtedness for borrowed
  funds. The Buyer has an option for thirty (30)
  days after closing to acquire the loans of the
  failed bank at book value. This transaction is a
  deposit acquisition with an option to buy loans.

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• HOW DO I RECEIVE INFORMATION ABOUT BUYING A
  FAILING BANK FROM THE FDIC?
• You must be a financial institution who is
  approved to bid by its primary federal regulator
  and the FDIC Division of Supervision and Consumer
  Protection
• You are provided password access to an FDIC
  designated website
• Through the FDIC website you can access bid and
  transaction information and documentation
  relating to the failing bank that will be offered
  for sale after you electronically agree to the
  FDIC Confidentiality Agreement
• This information is normally posted on the FDIC
  website approximately 4 weeks prior to the due
  date for bids

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WHAT TYPE OF INFORMATION WILL I
RECEIVEELECTRONICALLY FROM THE FDIC
REGARDINGTHE BID PROCESS AND THE FAILING BANK?

• Confidentiality Agreement
• Bid Instructions
• Bid Forms
• Transaction Summary
• Transaction Recap
• Recent Call Report Information
• Purchase and Assumption Agreement
• Single Family Loss Sharing Agreement
• Non-Single Family Loss Sharing Agreement
• Purchaser Eligibility Certification

WILL I BE PERMITTED TO DO DUE DILIGENCE?
You have a choice of doing due diligence of the
loan files over the internet for two days or
on-site for two days.
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WHAT WILL I BE BUYING?

• Assets To Be Acquired
• Loans and outstanding loan commitments
• OREO
• Marketable securities
• Capital stock of an acquired Subsidiary, if
  applicable
• Certain prepaid expenses
• Cash and receivables due from other financial
  institutions
• Federal funds sold and repurchase agreement
• Credit card business, if applicable
• Safe deposit boxes and related services
• Trust business, if any
• Books and Records
• Amounts owed to the Failed Bank by an acquired
  Subsidiary
• Rights with respect to Qualified Financial
  Contracts
• Rights to provide mortgage servicing for others
  and to have mortgage servicing provided to the
  Failed Bank.

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WHAT WILL I BE BUYING? (contd)

• Purchase Price of Acquired Assets
• The purchase price for the assets is book value
  other than marketable securities which are
  purchased at fair market value. The book value
  of loans is calculated after reversal of specific
  and general reserves.
• Option Assets
• Buyer has a 90 day post-closing option to acquire
  the following assets at fair market value
• Bank owned premises
• Furniture, fixtures and equipment
• Other equipment
• Option Contracts
• Buyer has a 90 day post-closing option to assume
  or reject the following contracts
• leases for bank premises
• data processing leases (to the extent assignable)
• third party service agreements

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WHAT WILL I BE BUYING? (contd)

• If Buyer exercises its option to acquire bank
  owned premises or assume a lease on bank
  premises, in either case it must purchase the
  furniture, fixtures and equipment located at such
  bank premises for fair market value.
• Assumed Liabilities
• Either all deposit accounts or insured deposit
  accounts only, as elected by the Buyer
• Borrowings from the Federal Reserve Banks and
  Federal Home Loan Banks
• Ad Valorem taxes applicable to any asset acquired
• U.S. Treasury tax and loan note option accounts,
  if any
• Liabilities secured by or otherwise related to
  the assets acquired and contracts assumed
• offensive and defensive litigation liabilities
  relating to an acquired loan but limited to the
  Buyers loss sharing obligation with respect to
  such loan

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HOW DOES LOSS SHARING WORK?

• FDIC covers 80 of the losses on acquired loans
  and OREO up to a specified dollar threshold
  amount and 95 of the losses above the threshold
  amount
• the threshold amount is normally provided by the
  FDIC to potential bidders approximately 1 week
  before the bids are due
• Only 90 days of accrued interest on a loan is
  included in the loss coverage
• Loss sharing payments are made by the FDIC on
  single family loans for up to 10 years during the
  month following a short sale, realization of
  final proceeds on a foreclosure sale, a loan
  modification or restructuring, or a portfolio
  sale.
• Loss sharing payments are made by the FDIC with
  respect to non-single family loans and OREO on a
  quarterly basis based upon charge-offs at the 80
  coverage rate. To the extent that the FDICs
  coverage obligation is 95, the additional 15 is
  paid at the end of 8 years.
• Loss sharing on non-single family loans and OREO
  applies to charge-offs during the 5 year period
  following the closing and recoveries are shared
  with the FDIC for an additional 3 years.

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HOW DO BIDDERS KNOW WHAT TO BID?

• You bid a specific amount as an asset premium or
  discount and separate amount as a deposit
  premium. Normally, the asset bid is a negative
  (discount) amount and the deposit bid is a
  positive (premium) amount.
• In many instances, the bidding has been
  competitive. In some cases, there have been no
  bids.
• Most winning bids contained a net negative
  (discount) bid that was less than the winning
  bidders loss exposure on the acquired loans.
  For example, if the winning bidder is liable for
  20 of the losses on 100 million of acquired
  loans (i.e., 20 million) and 5 on the remaining
  300 million of acquired loans (i.e., 15
  million), the winning bidder requested a payment
  from the FDIC that was less than 35 million.
• Other Examples -- Risks

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WHAT ARE THE BID AND CLOSING PROCEDURES?

• A bid must be submitted on the form provided by
  the FDIC together with the Purchaser Eligibility
  Certification and a certified copy of resolutions
  adopted by the board of directors of the bidder
  approving the bid and authorizing the execution
  of the bid by the person signing the bid form on
  behalf of the bidder, and approving the
  transaction and the transaction documents, and
  authorizing the execution of the transaction
  documents by the persons who will be signing such
  documents on behalf of the bidder.
• Bids are normally due at 1000 a.m. on a
  specified Wednesday and the winner is notified by
  300 p.m. on the same day.
• On the next day, Thursday, FDIC personnel will
  discuss the entire closing process with the
  winning bidder in person or by telephone.
• On the following day, Friday, the transaction is
  closed at 500 p.m. The FDIC closing team will
  meet in person with the winning bidders closing
  team during the day to review closing procedures
  and the roles to be performed by FDIC personnel
  and the winning bidders personnel, respectively,
  in connection with the closing.

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WHAT ARE THE BID AND CLOSING PROCEDURES? (contd)

• Prior to closing, the FDIC and the winning bidder
  will execute the transaction documents.
• Immediately prior to closing, the FDIC places the
  failing bank in receivership.
• At closing, the winning bidder must have at least
  one of its personnel at each branch of the failed
  bank working with FDIC personnel on the transfer

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DOES THE WINNING BIDDER PAY MONEY TO OR RECEIVE
MONEY FROM THE FDIC?

• The winning bidder will not pay any money to the
  FDIC. If the First Loss Tranche is a positive
  number, then the winning bidder will absorb the
  first losses on the acquired loans up to such
  positive amount and then loss sharing starts.
• If the First Loss Tranche is a negative number,
  the winning bidder will be paid the negative
  amount by the FDIC by wire transfer before the
  end of the first business day following the
  closing
• The First Loss Tranche is the sum of (i) the
  winning bidders asset premium (discount) bid as
  reflected in its bid, plus (ii) the winning
  bidders deposit premium bid as reflected in its
  bid, plus (iii) the dollar value of the assets
  being acquired (book value, except marketable
  securities are at fair market value) less the
  dollar amount of the liabilities assumed, which
  may be a positive or negative amount.

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DOES THE WINNING BIDDER PAY MONEY TO OR RECEIVE
MONEY FROM THE FDIC? (contd)

• Example 1
• Negative Asset Bid lt15 milliongt
• Positive Deposit Bid 2 million
• Positive Net Equity
• of Assets Acquired
• minus Liabilities Assumed 5 million
• First Loss Tranche lt8 milliongt
• Since First Loss Tranche is a negative number,
  the negative amount (i.e. 8 million) is paid in
  cash by the FDIC to the winning bidder.

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DOES THE WINNING BIDDER PAY MONEY TO OR RECEIVE
MONEY FROM THE FDIC? (contd)

• Example 2
• Negative Asset Bid lt15 milliongt
• Positive Deposit Bid 2 million
• Positive Net Equity
• of Assets Acquired
• minus Liabilities
• Assumed 14 million
• First Loss Tranche 1 milliongt
• Since First Loss Tranche is a positive 1
  million, the winning bidder absorbs the first 1
  million of losses on acquired loans before loss
  sharing starts.

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Who We Are

• Silver, Freedman Taff, L.L.P.
• Washington, D.C. based law firm specializing in
  financial institutions
• Mergers and acquisitions
• Regulatory and Enforcement Matters
• Debt and Equity Securities Offerings
• Recapitalizations
• Compensation and Employee Benefit Matters
• Securitizations
• Credit Union to Thrift Conversions
• Mutual to Stock Conversions
• Charter Conversions
• Holding Company and MHC Formations/Reorganizations
  
• Bank and Thrift De Novo Formations

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