Capable Boards and Value Creation

Edward D. HerlihyRichard K. Kim, and Matthew M. Guest are partners at Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell publication by Messrs. Herlihy, Kim, and Guest.

Directors of regulated financial institutions have exceedingly difficult jobs with many demands. The aftermath of the financial crisis led to countless new regulatory requirements and expectations, many of these unwritten and evolving based on political currents or varying views at different levels of the regulatory hierarchy. Governance processes and actions are examined and second-guessed like never before. For many companies, new and shifting compliance burdens tend to crowd out other business on board agendas.

At the same time, these boards have faced prolonged operating and economic challenges. Initially, defaults and delinquencies in loan portfolios and low interest rates choked financial performance. While these conditions have improved dramatically, many banks continue to face tepid loan growth. Others have encountered challenges in responsibly and profitably growing deposits. The best performing boards have responded throughout this period by demanding and overseeing more detailed and sophisticated strategic plans. The boards have then acted on these plans decisively, and remained committed to their plans even when confronting daunting obstacles.

Three of the largest, most newsworthy deals announced over the last year are striking examples of this great planning, decisive action and steadfast commitment. Capital One agreed last fall to acquire the captive Cabela’s credit card bank, comprised of a card portfolio, related assets, and brokered deposits. This was part of a broader, multi-party transaction that also involved the sale of Cabela’s retail stores and related businesses to Bass Pro. The deals followed a lengthy, extensive and closely watched auction process originally initiated by shareholder activist pressure. In addition to being a favorable deal for all parties involved, it would further the bank regulators’ longstanding objective of eliminating another captive credit card bank.

Like too many large U.S. financial holding companies, Capital One was subject to a public consent order relating to anti-money laundering compliance processes and systems. This had not interfered with routine card portfolio acquisitions, and was not expected to pose a problem for the Cabela’s transaction. However, when Capital One learned of unanticipated regulatory timing issues that would jeopardize receipt of approvals within the one-year term of the contract, it did not give up. Capital One instead dealt openly and creatively with its counterparties, while at the same time enforcing its contractual rights and adhering to its contractual and regulatory obligations. Capital One initiated a creative restructuring of the bank transaction by reaching out to Synovus, a capable and sophisticated institution that saw significant strategic and financial value in the deposits and partnering in the transactions. Facing skepticism from many observers, which was regularly reported in the deal press, Capital One and the other parties to the transactions pushed forward and successfully completed the deals. This is just the latest example of Capital One’s unwavering commitment to its strategic decisions, following the precedent established with the Hibernia acquisition post-Katrina and the Chevy Chase acquisition in the height of the financial crisis.

Astoria Financial’s board, after a careful and broad process, determined in 2015 that the best alternative for its shareholders and other constituencies was a merger with New York Community Bancorp. Contrary to expectations, NYCB was unable to obtain regulatory approvals within 14 months. Conventional wisdom holds that targets that are parties to failed deals usually experience cultural and personnel crises, and suffer from strategic uncertainty and depressed values. Astoria’s board and management refused to let this happen, and instead actively planned for strategic alternatives in the immediate aftermath of the NYCB termination. Just over two months later, Astoria delivered a 50% increase in value to its shareholders over the implied NYCB consideration at termination, by striking a deal with Sterling Bancorp, a high quality institution with an exceptional record of closing and integrating deals. Sterling lived up to its reputation as a highly skilled acquirer by closing the transformative Astoria acquisition within seven months.

As was reported in our previous memo, the PrivateBancorp Board encountered many obstacles on its way to completing the merger with CIBC. That situation demonstrated clearly that a board cannot control exogenous factors like a U.S. presidential election’s effect on equity markets, the trading strategies of arbitrageurs or the illogical thought processes of third party observers. Faced with that series of unanticipated events, the Board relied on the analytical rigor of its process and resulting decisions, the relationship and cultural fit with CIBC, and the openness of their communications with shareholders to confidently carry out their fiduciary and contractual duties. Decisive commitment to their strategic plan created a more than 20% increase in consideration value for their shareholders and preserved their franchise while the deal was pending.

Exactly the same type of planning and commitment is being demonstrated by numerous banks across the country. Repeat acquirors are acting on their longstanding, disciplined strategies to create value through deals. Many smaller banks, encountering narrow margins and high compliance costs, are announcing conventional mergers that preserve the cultural strengths, community presence and talents of the organizations while taking advantage of the benefits of scale. To be successful, each deal requires planning by the Board and management far in advance. Recognition of the essential value of executive and employee talent to what are fundamentally people-driven organizations is a key part of this advance planning. Planning for any type of strategic action is incomplete if arrangements for retaining and motivating talent at both one’s own institution and any with which one may partner are not closely evaluated. Many deals not properly integrated make clear that talent will look elsewhere following the disruption of a transaction, and the inevitable incursions by competitors, if not appropriately incentivized to stay.

Every deal or strategic decision by a board entails risk and eventually encounters obstacles. Outstanding boards, like those noted above, are not shaken by these challenges. Instead, having planned carefully, they press forward with conviction. In each case the boards and their management teams had a clear-eyed view of their fiduciary duties, and with that foundation can create value, preserve and enhance their franchises and reputations and adhere to their regulatory obligations.

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