Business Law Currents: You are a banking lawyer. Tell us about your area of specialization. Do you do things like syndicated loans and securitization, or are you more concerned with M&A deals?
MD: I specialize primarily in community bank mergers and acquisitions. I work in Lindquist & Vennum’s Financial Institutions practice group. We’re a little different because financial institutions groups at many firms focus solely on lending. We do lending work here at Lindquist & Vennum, and I do a little lending work myself, but my focus is community bank mergers and acquisitions.
There are quite a few small community banks in the Midwest with asset sizes of between $30 million and $2 billion. We work with these banks and help them acquire other banks, open new branches, sell branches and deal with the regulatory cycle from start to finish.
Business Law Currents: Did the bank crisis of 2008-2009 have much of an impact on the community bank M&A market?
MD: I think it had a dramatic impact on the community bank M&A market. Before 2008, community banks had access to trust preferred securities and bank stock loans to finance acquisitions. Since 2008, these sources of funding have completely dried up.
Business Law Currents: Was that a result of regulation?
MD: It was more because of the economic downturn. When financial institutions began to suffer losses, they stopped paying amounts due on their trust preferred securities. As a result, the securities went down in value and became unattractive to investors. Further, correspondent lenders decided not to lend money to community banks. Because banks no longer had access to financing, pricing dropped and the marked stagnated.
Business Law Currents: Did the community banks get involved in mortgage-backed securities, doing some credit default swaps or credit default obligations? Or were they pretty traditional?
MD: We did not see many community banks involved in acquiring or selling mortgage-backed securities, credit default swaps or credit default obligations. One fairly traditional banking activity did, however, cause a great deal of trouble for community banks in the Midwest and across the United States -- the purchase of out-of-market participations in larger loan facilities.
Before the economy deteriorated in 2008, the Midwest loan market was tight. Community banks were not attracting quality loans from their marketplace, and many small banks were buying pieces of loans originated in hot markets like Arizona, California, Georgia, and Florida. Unfortunately, these bankers didn’t know that market, and they had very little control of the loan because they only own a small piece of it. The community banks that purchased these out-of-market participations are having a great deal of trouble because many of these loans are in default and facing huge losses. In addition, many of the originating lenders are failing.
Business Law Currents: Do you focus solely on banking M&A?
MD: I would say that 75 percent of my practice is traditional community bank mergers and acquisitions. In the last several years, when that market has been fairly quiet, we’ve had other non-traditional forms of bank M&A such as FDIC-assisted transactions.
We’ve worked on several deals where our client is bidding to purchase assets and assume liabilities of a failed bank from the FDIC. They are very interesting transactions because it’s a high-risk, high-reward proposition. It is very difficult for a bank to spend a limited amount of time looking at a troubled bank’s assets and liabilities and be able to fairly predict the losses in that troubled bank’s loan portfolio. If you are the winning bidder, you may be able to make a lot of money off those assets, but if they get it wrong there could be a substantial downside.
The large financial institutions active in the failed bank market are not interested in small community banks because it’s not worth the time and expense. There is, however, a submarket of midsized community banks that are stepping in and making quite a return on these community bank failures. Although we have seen several failures in recent years, this practice may slow down in the next year or so because banks’ capital positions are improving.
Business Law Currents: How has the M&A market been here in the Twin Cities?
MD: It was very slow, but it’s picking up. There are many more deals that start but fail due to lack of financing, asset quality concerns or disagreements about pricing. Before, we would work on five deals and four of those deals would close. Now it seems like you work on five deals and one, maybe two, will close and the others will fall apart.
Business Law Currents: What have been the main types of deals you’ve worked on in the past several years?
MD: In this market there are the three key types of deals that we’re doing regularly for community banks -- branch transactions, bank sales and FDIC-assisted transactions.
When a bank is facing financial difficulties, one of the hurdles is improving capital ratios. Bank regulations require that community bank to maintain certain financial ratios. One way to improve those ratios is to shrink the bank, so a bank facing some trouble will usually look at selling one or more of its offices. That’s a branch transaction. It’s an asset sale, not a merger, and it’s a pretty easy way for a bank to shrink in size and improve those ratios.
That’s the most common transaction we’re doing right now. It’s good for the seller because the bank’s financial ratios improve, and it’s good for the buyer because the buyer acquires a new office and typically gets to keep the quality loans without the risks associated with a merger transaction. It’s a win-win situation.
The second transaction we’re doing fairly regularly, although less than in past years, is a traditional bank sale transaction. When financial institutions are in a death spiral, we’re seeing that the owners would rather sell the institution for a minimal purchase price than have that institution fail and face the possibility of an FDIC claim against the board of directors, officers, and owners.
Business Law Currents: In other words, it’s a fire sale.
MD: Right. There are a lot of investors that are exploring these opportunities. They will go in and do due diligence on an institution to see if they can make it work. Usually, they conclude that the unknown risks are too great. But sometimes they will buy that institution for a nominal purchase price. More frequently they end up as a bidder in the FDIC auction if that institution fails.
BUSINESS LAW CURRENTS: Which is your third point.
MD: Exactly. FDIC-assisted transactions have been commonplace in recent years. You can buy the assets and the liabilities of that institution for a fixed amount, which is like a negative discount, or you can enter into a loss share agreement with the FDIC.
For example, let’s say you have a $50 million dollar bank, a really small community bank. If that bank is likely to fail, the FDIC will tell you what their estimate for the loss will be. The bidder will look at that number, do their own due diligence investigation, and make a bid -- say $30 million dollars -- for the assets and liabilities of that institution. Alternately, the can enter a very complicated loss share arrangement with the FDIC where the acquiring bank shares the losses with the FDIC. The loss share agreement requires a great deal of paperwork, and although it minimizes some of the downside of the transaction, it also eliminates some of the upside because the FDIC is able to claw back some of the winning bidder’s profits from the transaction.
The FDIC has been making the loss-share arrangement less and less attractive over the past few years. As a result, banks are becoming comfortable bidding on these transactions without the loss-share. It’s not necessarily that the loans are getting any better, it’s just that banks are becoming better at estimating losses and less willing to partner with the FDIC in a loss-share arrangement.
We typically help our clients navigate through the bidding process and help them decide whether they should do a whole bank transaction or a loss share transaction. In addition, we help them understand all of the various documentation that goes along with the FDIC assisted transactions.
Business Law Currents: You’re a young partner and you’re also a young father. How do you juggle the two demands?
MD: It’s a challenge, but one of the things that brought me to Lindquist is the work-life balance. One of the pillars of the firm is the idea that, in order to be an effective lawyer, you need to be well –rounded and have interests outside of the law. Balance is the key. And it lets me spend the quality time with my wife and our four young kids.
This interview was conducted by Chris Longley, a Senior Business Development Executive at Thomson Reuters.
Mark Dietzen is a partner in Lindquist & Vennum’s Minneapolis office and is a member of the firm’s Financial Institutions practice group. Mark regularly represents financial institutions in connection with mergers and acquisitions, reorganizations, charter conversions, relocations, regulatory matters, and capital-raising transactions. In addition, he works extensively with both lenders and borrowers on various commercial lending transactions, including agricultural lending, asset-based lending, secured and unsecured commercial lending, and structured finance. A more complete biography is available here.
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