Introduction: Kelly Coughlin is CEO of BankBosun, a management consulting firm helping bank C-Level Officers navigate risk and discover reward. He is the host of the syndicated audio podcast, BankBosun.com. Kelly brings over 25 years of experience with companies like PWC, Lloyds Bank, and Merrill Lynch. On the podcast Kelly interviews key executives in the banking ecosystem to provide bank C-Suite officers, risk management, technology, and investment ideas and solutions to help them navigate risks and discover rewards.
And now your host, Kelly Coughlin.
Greetings, this is Kelly Coughlin. I'm the program host of the syndicated, biweekly podcast, 'BankBosun.com: Helping Community Banks' C-Suite Officers Navigate Risk and Discover Reward.' As most of you know, we like to focus on three primary categories here, the three 'R's, Risk, Regulation, and Revenue Creation. I think just about all the critical things a bank does can be captured in one or more of these three categories, Risk, Regulation, Revenue Creation. Nowhere else does the results of how a bank does with these three categories, than in the valuation of that bank.
I think Jack Welch, in the eighties, first made popular the notion of shareholder value. He didn't create this concept, but he sure popularized it. I think, since then, we've kind of expanded it to include more than just shareholders, but stakeholders, and stakeholders might include all range of people and enterprises, ranging from suppliers to entire community ecosystems. At its core, we still get back the valuation, the equity value of the enterprise. With that in mind, I'm going to introduce George Thompson, a forty-year, seasoned vet in the bank deal business. George is managing director of The Capital Corporation. George, are you there?
Good morning, Kelly. How are you?
I'm fine, thanks for joining us today. George, rather than me kind of get into summarizing your background, education, etc, can you give us a minute on who George Thompson is, and why you're the seasoned vet in the banking valuation deal business?
I would be pleased to do so. Kelly, I graduated from the University of Missouri in Columbia, in 1976. Accountancy was my major. I went to work for one of the large accounting firms in Kansas City right out of college, and three years later, joined an individual out of Arthur Anderson, that was wanting to build a CPA practice specifically for community banks in the Midwest. I joined him in 1979, and we built that firm for the next twenty years, ended up selling it when H&R Block and RSM McGladrey were doing their accounting from roll-ups. In about the year 2000, we sold that accounting firm and it merged into RSM McGladrey here in the Midwest.
Since that time, I've been in banking and investment banking, right now, managing director, as you said, with The Capital Corporation. About 85-90 percent of our business is sell-side work. In other words, we work with the sellers of financial institutions, although we do work a little bit with buyers, and will contract with banks to go find them a bank to acquire. Appreciate the invitation to talk about the things that kind of drive value in banking.
George, how many deals have you been in the middle of?
Our firm, all we work with is banks. We do not do investment banking for small businesses. We do only banks. We have been involved, either whole-bank or branch transactions, over the past fifteen years, with approximately 125 to 140 whole-banks to branch transactions. Probably about seven and a half billion in assets changed hands during those transactions.
Right. I want to go immediately to net interest income versus other income, non-interest income.
You know, the goal here is to come away with some ideas on, how can, if I'm a CEO or a board member, how can I increase the value of my bank? Now, the obvious things are, well, increase revenues and profits and free cash flow. But I need something better than those things. So I want to go to net interest income and Other Income. Because net interest income, other than getting more quantity, more assets, and more loans, there's a price. You're kind of stuck with the yields that are in the market, right? Other income gives more variability, I should say. My question to you is, in terms of valuation can a bank fetch a higher multiple in valuation, whether that be based on assets or revenues or free cash flow or earnings through an increase in non-interest income versus net interest income. Is there any difference in that?
The answer is yes. I can talk about a couple of specifics. We are working with a bank right now, that has built a program that they refer to as a contract services division, but it is a community bank that has built ties to the servicing, not making credit card loans, but has ties to the credit card industry. And as they service the debt that's on the outside, they are the servicer, they are the administrator. They do not hold the debt, so they do not have the credit risk, but they have built substantial contracts, for revenues. It is recurring revenue, and it has substantially increased what our asking price, and what we expect to get in the marketplace, when we ultimately can get a transaction done.
We have seen other banks that have built substantial mortgage generation machines and divisions, that, it's harder to sell and get a full value for a mortgage division, from the standpoint of, buyers look at those mortgage divisions as more transactional-based, not quite as recurring. Now, if you do it year after year after year, there is value there, but it's not the value that, perhaps, someone would pay for a truly recurring revenue.
Right, so it's this other income, this non-interest income, is it fair to say that the quality of earnings, I don't know if you use quality, in earnings, is higher in other income? I guess it depends on the permanence, and how long it's been on the books, et cetera, but
It’s the recurring nature and, you know, can a buyer look at that potential selling bank, and are they willing to pay a multiple of that because they believe it will be recurring for year after year after year? Or is it transactional-based, to where, you know, if there's a downturn in the economy or change in interest rates, I think right now, everybody's waiting, as far as, I mentioned mortgage producing machines are revenue generators, if interest rates go back up, which is kind of anticipated now for a few years, some of that mortgage revenue is going to drop, and buyers anticipate that, so they will pay less of a premium with that.
Yeah, I guess, part of, in full disclosure, part of my reason to get right to that, is that, I was at one of these, you know, bank conferences, and there was, I'm not going to mention who it was, but this broker who's in the business of kind of promoting municipal bonds, made the argument that bankers might have to extend duration a little bit to get the yield they need to fetch here.
I asked him, offline, I said, "Well," in full disclosure, I'm in the, I work through independent consulting work with Equias Alliance, and we are in the bank-owned life insurance business, and I said, "Well, wouldn't the recurring nature of bank-owned life insurance, more predictable, recurring, et cetera, other non-interest income, wouldn't that be better for the bank's valuation?" He said, "No, I prefer that interest income." When I go back to my Cooper's days of doing some bank valuation work, I thought that other income would increase the value, but ...
It does. There's no doubt that it does. Now, we do not see BOLI being, in any way, a detriment to get a deal done. At the same time, we do not see BOLI being anything that will drive a transaction price higher. I'm involved in a transaction right now that will be announced within the next couple of weeks, whereas the seller, I believe, probably has six to ten million of BOLI already on their books. The buyer is not worried about that, is not concerned about that, welcomes that earning asset as we move forward. In that case, the BOLI certainly, I wouldn't say it helped driving price, but they like the, the buyer likes the earnings off that BOLI, that's for sure.
Now, this wasn't mean to be a shameless plug for BOLI, but it's one of those things that did come into my mind, and as I'm looking at banks that hold muni bonds versus BOLI, and I just wanted to kind of get that clarified with you. Let's go to another question I have. When you see a deal, what do acquirers like to see, or not see, in terms of locking up staff, how they're dealing with high-producing staff or low-producing staff, I mean, what are you seeing out there in terms of staff like that?
Our buyers, especially in, size matters in this relationship, but as the buyers get larger, as the sellers get larger, normally, you have a group of people, or a handful of people, that are really helping drive earnings and drive the revenue of the seller, which is what the buyer's interested in acquiring. They'll want those revenue streams and customer contacts to continue. We often see that that definitely comes into play with a buyer and a seller, where they want to try to lock up that staff, whether it be with some type of employment agreements. We have seen transactions where the buyer has pretty much made it a demand, as a part of the contract, that one, two, three, four people, sign employment agreements before they're willing to put their name on a contract to pay a real high price. They want to make sure those people are locked up.
Now, it's very difficult to get a pure non-compete. You can certainly get a non-solicitation. We've seen agreements like that, for sure. A lot of our transactions are community banks based, here in Midwestern states, and oftentimes, the primary seller, one of the largest shareholders, if not the single shareholder family, is the president and CEO. Many times, the buyers will, whether they hire them full-time, and we are seeing that more, where some of the bankers are looking ahead, asking themselves, "Who is my buyer? Where are the buyers? Perhaps I should sell this bank now, I'm sixty years old. I would have waited til sixty-five or sixty-eight, but if I sell it now and work three to five more years for the new buyer, one, I get my price, two, I get to keep working, and kind of lock in the liquidity, and not have to worry about it. I can kind of turn that over to a new buyer.
We are seeing that a little bit more often, where the president, CEO, primary seller, does get locked into employment agreements, non-compete agreements, non-solicitation agreements. The buyers want those people locked down.
Yeah. That goes, probably, in terms of the food chain, it goes down to the producing professionals, the credit guys, and the guys that are doing deals.
Once in a while, you'll see a COO or CFO that falls into that fold, but many times, it is the chief lending officer, the major loan producers, that are bringing the revenue to the table.
Right, right. How does the cyber security risk, it's one of those big, contingent risks, and potential contingent liabilities out there, any trends, anything that you're seeing going on there, on how they deal with the cyber security risk?
The buyer certainly comes in and looks at what kind of auditing processes, what programs, what compliance, you know, what does the seller have in place that has been protecting cyber security? What programs do they have that's monitoring it, you know, every second, every minute of every day, to protect the customer data and protect the bank from an intrusion? That certainly is a piece of the puzzle when a buyer is doing its due diligence.
Yeah. Are you finding, on the deals that you're working on, do they typically hire an outside consulting firm to help on that? That isn't the kind of expertise that you'd normally get on an accounting due diligence team.
The inside people for the buyer, you know, the operations people, will get out the audits, get out the contracts, get out the intrusion tests, and really review that hard. They may pursue it, if they see something, you know, "Why didn't you do this, this, this, and this?" We have not seen them go hire, at this point, outside technology companies to come in, during due diligence, and do intrusion testing, or testing of those. They're pretty much relying on what the bank has been doing to satisfy the regulatory agencies.
Okay. Good. Have you seen any deals collapse because of cyber security?
We have not, in our practice.
Okay. What are the top five things a bank can do to increase enterprise value for a sale? Looking forward a year. They meet with their board, they say, "Okay, we're going to position this for sale a year from now. Or, two years from now." Other than the obvious, increase revenues, profits, and cash flow, what could a bank do?
Yeah, and let's be honest, Kelly, there are many times that banks are sold and they didn't look out one, two, or three years in advance. I'll touch on a couple of things where the pricing could have been helped. My first comment to anybody that contacts me about selling their bank is asset quality. It seems common sense, but oftentimes, bankers that are wanting to sell, they may be trying to put the smallest amount possible, and we're not, we don't want them to put excess bad debt reserves, or allowance for loan lease losses in their financial statements, but make sure that bad debt reserve is adequate, that you've taken the marks on any problem loans you have, that you've taken the marks on your other real estate owned, or OREO. Just, fewer items to be argued by a potential buyer, with respect to asset quality, will help pricing, will help things go much smoother.
Tied to that is loan file documentation. We've actually seen a couple of transactions within the last year, where the buyers got into the loan review, and had some significant issues, and one of them was one-rated bank. Some significant issues with the loan file documentation, and the lack, in their mind, that the regulators had kind of, let that seller kind of glide along, just because they'd had very few loan losses, had kept giving them one ratings. Their loan file documentation was very poor, so I suggest sellers, or potential sellers, to clean up loan files, and make sure that all the docs are there.
Low-cost activity, too.
It is. It's something that, you know, you probably have the personnel to go through loan files, dig through them, "We don't have this tax return, we don't have this credit report," you know. "We don't have this debt service coverage calculations." Seems like common sense, but there's, oftentimes, a lot of that loan file documentation just, it doesn't get done, or loan file memos.
Vendor contracts, Kelly. We have seen vendor contracts come up and bite sellers. You know, maybe they didn't think about that contract, that seven-year contract they signed three years ago, and now they're ready to sell their bank. "Oh, by the way, you have a four-year penalty to pay off the core processor, or the ATM company, or the debit card company." Sometimes, those penalties can be substantial. As some of these groups are aging, the stockholder groups, the ownership groups, the management groups, if selling your bank is something that you're thinking about doing, frankly, any time in the next three to five years, you need to be thinking about that when you sign any of these vendor contracts, because these penalties can have a significant bite on the amount of premium you get.
Branch networking. We are seeing people worry more about the viability of some Midwestern towns, Midwestern communities. At the same time, we're seeing people that love to be in the, in county seat towns, and will continue to pay good premiums for locations that are in county seats, that are stable, growing, but there are some real communities that, you know, are losing population, may not be in a county seat, and it really is impacting the premiums that are paid by buyers in some of the communities that really aren't showing future viability. I guess ...
Are you saying they should be looking at closing those down, in an advance anticipation of the sale?
The answer is, that question should be asked, you know. If you're, let's say you're in a small town, and over the last decade, that small branch has just steadily dropped in deposits and loans. You know, maybe you're down managing it now, with two or three people, and you don't want to close it, you don't want to let people go as far as their jobs, but if a potential buyer walks in and looks at that, and says, "Well, they're just leaving it for me to close," it will cost you, when you go to sell the institution, if the buyer has to be the one that has to be the bad guy, that maybe is taking a banking service away from a community, or from other people. They're going to take that into account when they're calculating what they're willing to pay you.
Yeah, I guess they take the political hit, don't they, if they have to do it?
That's exactly right. Probably the last thing we touched on, is employment issues, a little bit, but, you know, it goes without saying that a buyer certainly wants key management to stay, they don't want to be the bad guy, firing poor performers. Many times, if there are some poor performers, the buyer will ask the seller to take care of those people before closing, so that the buyer isn't perceived as completely the bad guy.
Tied to the employment issues, unless a buyer has some long-term contracts or long-term deferred compensation contracts, if the seller has those and the buyer doesn't, many times the buyer will ask the seller to get those paid off, and pay off those employees, those long-term, let's say, deferred compensation arrangements. Because it's pretty tough for a buyer to bring home, and say, "Well, we've got three or four people, in the bank we just bought, that have long-term deferred compensation arrangements, but we don't have it here, and we're not going to give them to you, our current set of employees." Sometimes, not always, but sometimes, those deferred compensation arrangements can come into play between buyers and sellers.
This would be, like, non-qualified benefit plans, you're saying?
It would be. It would be.
You're saying, those can be considered somewhat negative, depending upon the culture of the acquiring bank.
If the buyer has them, and the seller has them, it can be okay. If the buyer doesn't have them, and the seller does, normally the buyer is not going to take in those long-term deferred compensation arrangements, and have things, employee benefits for new people, that they're not even giving to their current people.
Right. I know, we at Equias, we like those things, because they help, the non-qualified deferred plans, because they help the bank compete and retain good talent, and, of course, we use the bank-owned life insurance as a way to, kind of, fund those things. It doesn't have a significant impact on their cash flow, but ...
Well, and, you know, a bank has to, you're trying to protect somebody, and you may have had that in place for somebody for ten or fifteen years. It probably did what it was set up to do at the time, which was help you keep that person. Now, if you're in the position, after that ten or fifteen year period, you've protected the people, you provided for them, now they're going to get, maybe, an early payout, then it's up to the buyer to make arrangements to keep that person if they're making the seller cash out that deferred compensation arrangement. I'm like you, Kelly, I've seen it used very positively, many times, in a lot of banks, whether it's deferred director's fees, deferred compensation arrangements with key lending and financial officers. Don't take my comments that they're bad, complication in a deal.
They're a complication. Right. Got it. Okay. All right. Anything else you wanted to add? That covers most of my questions on this kind of high-level overview of valuations. One of the things I ask you to do is, be prepared to tell me, give me either your favorite quote, or, what I prefer is, George, tell us one of the stupidest things you either said or did in your business career.
You know, I try to never be too stupid, but, you know, going back, a saying I had, and it goes back to high school, and if you found my 1972 yearbook from my high school graduation, what it stated under my name was, "Lead, follow, or get out of the way." I've tried to live that as I've, kind of, been in my professional career. Now, what I gave them, back in 1972, to put in my yearbook, was, "Lead, follow, or get the hell out the way." In rural America, in a little religious farm town, they wouldn't put the H-word in the high school annual, but they wouldn't use the H-word in the high school annual in 1972.
That's good. You didn't need that on your record, anyway. But now it will be on your record, so there it goes.
Yeah, it's out there now, isn't it?
It's out there now. All right, George, I appreciate it. Thanks for your time, and we'll get this posted, and published, and syndicated on iTunes and Google Play Store, and there you have it.
Kelly, thanks so much for allowing me to be part of the podcast today.
Okay. Thanks, George.
We want to thank you for listening to the syndicated audio program, BankBosun.com The audio content is produced by Kelly Coughlin, Chief Executive Officer of BankBosun, LLC; and syndicated by Seth Greene, Market Domination LLC, with the help of Kevin Boyle.
Video content is produced by The Guildmaster Studio, Keenan Bobson Boyle. The voice introduction is me, Karim Kronfli. The program is hosted by Kelly Coughlin.
If you like this program, please tell us. If you don’t, please tell us how we can improve it. Now, some disclaimers.
Kelly is licensed with the Minnesota State Board of Accountancy as a Certified Public Accountant. Kelly provides bank owned life insurance portfolio and nonqualified benefit services to banks across the United States. The views expressed here are solely those of Kelly Coughlin and his guests in their private capacity and do not in any other way represent the views of any other agent, principal, employer, employee, vendor or supplier of Kelly Coughlin.