Summer, 2011

Lessons from the Front: 15 Months in the Life of a Community Bank Investment Banker

From Michael Iannaccone, President & Managing Partner, MDI Investments, Inc.

The Cold, Hard Truth of Saving Community Banks and Their Customers in 2011

I recently attended a seminar titled “Is the Distressed Industry Distressed?”

Discussion focused on the surprising lack of activity emerging since the financial crisis started.  We have seen fewer bankruptcies, forced liquidations and M&A than the experts had predicted.  Why? Reasons include: (1) changes in bankruptcy law over the past three decades (2) monetary easing and its effect on interest rates (3) policies of ‘amend-pretend-lend’ (4) bid-ask spread on distressed assets to be sold and (5) access to or lack of capital.

Presenters included bankers from JP Morgan Chase, Regions Bank and Bank of Montreal; attorneys from Greenberg Traurig, Perkins Coie and Kirkland & Ellis; and advisors from Alvarez & Marsal and Commercial Recovery Associates.  Many of the speakers cited the “delusion” of many business owners.  Their word, not mine.

But the presenters had good reason to be harsh, saying that many business owners are pretending that their problems will be solved by (1) downsizing (2) delaying capital expenditures and (3) time.  Items 1 and 2 will help conserve cash/capital and hopefully allow a company to stay profitable, but those steps do nothing to solve the company’s key problems.  Hoping things will get better is a strategy, but not a wise one because problems typically do not go away by themselves; they have to be worked out.

In MDI Investments’ opinion, unfortunately, many community banks are suffering from the same denial.

Distressed Asset Pricing

Distressed asset pricing is a bit better than a year ago.  Some specifics:

  • 60% to 68% of UPB (unpaid principal balance) for income-producing property loans (multi-family and occupied commercial real estate).  Pricing for these assets a year ago was in the low 60% of UPB range, at best.
  • From as low as 50% of UPB all the way up to 80% of UPB for distressed residential loans—same as last year. This pricing depends on a home’s size and characteristics and the geographic market.  One-off transactions by the bank are on the high-end of the range while bulk sales tend to be in the high 50% of UPB.
  • Construction & development loans are still below 25% of UPB, unless there are unusual circumstances.
  • Land or land loans are still below 10% of UPB.

Performing Asset Pricing

Performing asset pricing has improved the most — moving from the mid 70% of UPB last year to as high as mid 90% of UPB this year. The high end is for income-producing property loans in urban, densely populated markets. Additionally, CRA loans — whether performing or distressed—receive much better pricing that a year ago.

The Real Culprit to Depressed Pricing—No Growth

The economy is not really growing.  It’s a jobless recovery with unemployment still close to 9.0%.  Yes, companies have cut costs and are profitable. But when (not if) interest rates rise, costs will increase (directly for companies with leverage and indirectly for companies without leverage via any vendor/suppliers with leverage).   And with the U.S., state and municipal economies all in distress, we are not recovering quickly.

Therefore, in MDI Investments’ opinion, pricing multiples for all companies – especially banking – are not returning to historic norms for several more years.  The real question is can companies survive, retain customers and maintain profitability until that time.

Market Insights from Recent Assignments

For the past 15 months, MDI Investments has been busy with many assignments, and we’ve gleaned key insights into the market.  Let us share them with you:

  • The regulators’ overall strategy has changed from closing all distressed banks to closing the ones that are sickest and getting worse.  The less distressed banks will be managed and given incentives to shrink, work down criticized assets and maintain high capital ratios.
  • Regulators are willing to listen to plausible solutions and work with professionals to achieve those solutions.  Remember, they have a thick rulebook that they follow religiously.  If you create a solution within the rules, they will try to help you succeed.
  • Capital is scarce for large and small deals.  A solution for a distressed bank must involve a strategy beyond capital.  Regulators want to see (1) additions to management (2) revision of the business plan to a viable, sustainable model and (3) strength behind the initial capital so there are resources to tap if additional capital is needed.
  • Owners/management/directors are beginning to understand that selling control or super-majority ownership to avoid failure and probable personal pursuit by the FDIC is a huge win for them.
  • Complex solutions that can be broken down into simple phases are embraced.  A recent MDI Investments' solution for a client involved finding buyers for NPAs that resulted in: leaving some equity at the bank; selling bulk assets at a net premium, which left the smaller bank with relatively better capital ratios; and then finding a new investor to recapitalize the smaller bank.
  • Bankruptcy and 363 sales are becoming viable options for certain banks in ultimate distress.
  • Healthier banks and bigger banks are selling criticized assets at discounts to redeploy assets into interest-earning vehicles and improve ratios.
  • Decreasing NPAs, improving the Texas ratio, maintaining profitability (thereby adding equity) and maintaining high capital ratios are key to achieving higher CAMELS ratings, superior acquisition and trading multiples and reduced debt pricing.
  • The FDIC is considering letting acquirers of failed banks buy out loss-share agreements.

How a Bank Can Attract Capital from 230 Viable (Proof of Funds) Investors

MDI Investments’ client work over the past 15 months has put us in touch with 4,900 investors in financial services.  We knew many of these investors from previous engagements while others represent new entries to the space.  We ended 2010 with 230 viable (proof of funds) investors with realistic criteria and structure for investing in the banking space and the list is growing modestly in 2011.

Here is a summary of positive and negative issues.

Positive Effects Upon Value

Negative Effects Upon Value

Operational Efficiency

Legacy Risk

Franchise Value

At Risk Asset Marks


Lack of Proper Systems

Above ‘Under-capitalized’ Capital Ratios

Lack of Proper Procedure and Management

High Reserves

Regulatory Rating

History of NPA Write-downs

Pooled TPS

Construction, Development & Land Loans Less than 10% of Total Loans

Senior and Subordinated Debt

Adherence to Standard Underwriting Guidelines


Viable Plan to Decrease Texas Ratio to Below 60%


How Capital Sources Examine Risk

Capital sources are most concerned with legacy risk.  These sources will look at a bank target’s assets with an objective (harsh) eye. So their estimate of which assets are ‘at risk’ will typically be greater than the bank’s.  These capital sources will perform enormous due diligence on the entire portfolio to determine which loans are priced correctly and can survive, which risks can be worked out and which ones needs to be sold or written down.   Any workouts and sales will create negative marks against equity and reserves.  Lack of proper systems, procedure and management will cause negative marks to equity.

Transactional risk is the second largest concern.  The solution involves settling with the bank’s other stakeholders including the senior debt, subordinated debt and trust preferred (TPS).  If a bank is distressed and holds pooled TPS, the likelihood of a capital raise is difficult because pooled TPS cannot be negotiated with for a settlement.  The only known solution here is having the holding company file bankruptcy and conduct a 363 sale.

Despite the risks, capital investors will pursue solutions depending upon the achievable scale and efficiency of the planned institution, the current and potential franchise value, the current capital levels and the current profitability of the institution.

Profitability and growth are the ultimate goals of any bank investor. Sustainable, superior profitability will lead to higher business value.  Growth, be it from organic means, FDIC-assisted transactions or standard M&A, should lead to larger, enhanced franchise value and therefore higher business value. By purchasing at the right price, focusing on wise growth and sustainable profitability and using the bank’s leverage capability, business value should more than double or triple in five years and could quadruple or more in ten years.  These are the returns investors seek.

Questions Current Bank Shareholders Must Ask

Knowing these expectations, the bank’s current shareholders need to ask several questions: (1) Do they want to own 100% of a company that will struggle to compete in the next three to five years or own a smaller percentage of a larger company that will be healthier, able to prosper and have access to needed equity, management skill sets and strategy? (2) Can they achieve superior pricing with a smaller entity compared to a larger entity? 

Larger franchise value entities have historically achieved higher valuation multiples (i.e a $300 million asset bank earning 1.50% ROA at 15 times earnings multiple = $67.5 million versus a $600 million asset bank earning 1.35% ROA at an 18 times multiple = $145.8 million).

Shareholders could achieve the same ultimate value of $67.5 million in the larger entity if they owned 46% of the business.  Of course, they would need to weigh the risks associated with both strategies in achieving their goals.

Moving Forward With Regulators

Regulators Want: People … Plan … Strength

MDI Investments has built a stellar relationship with regulators at state, regional and national levels.  Our reputation of providing viable solutions within the parameters of the regulators’ rulebook allows our professionals to gain insights from regulators where others have failed.

MDI Investments believes that regulators need three requirements satisfied to consider approval of a transaction.

1. Management – experience running CAMELS 1, 2, possibly 3 institutions in the recent past; directors with similar experience.
2. Viable plan with approved business practices; nothing new or risky.
3. Strength – capital and source of strength behind it.

The Right Next Steps for Banks

Banks need to reinvent themselves by borrowing something from their past, harnessing the present and being able to change for the future.

MDI Investments believes that a return to stricter underwriting standards of ‘the banking industry past’ is crucial to returning banks to consistent performers with “fortress balance sheets.”  Banks need to embrace the financial market rule changes and harness the business lines that developed outside the bank in the last two decades (mortgage banking, asset-backed lending, C&I lending, credit card/debit card issuance and specialty lending) by bringing them in-house and using more entrepreneurial reward systems.

Many of these business lines can increase fee revenue while exposing the bank to little credit risk or providing adequate return for that risk.  Banks also need to fully understand their strategy and be nimble enough to exploit it when opportunities arise.

The team at MDI Investments is ready and willing to personally structure solutions to restructure your balance sheet, conduct asset disposition, improve performance and regulatory ratios, find a strategic partner or raise capital/debt.

MDI Investments' Client Work 2010-2009


  • Performed strategic planning advice on evaluating regulatory capital solutions.
  • Advised on capital raise.
  • Performed due diligence and valuation for capital introductions or M&A transaction.
  • Advised on purchase of bank.
  • Advised on supervisory conversion merger.
  • Advised on regulatory capital solutions, asset disposition and M&A alternatives.
  • Advised on capital raise, investor introductions and alternative bank acquisitions.
  • Advised on capital initiatives.
  • Advised on strategic initiatives.
  • Performed loss migration analysis on loan portfolio.
  • Advised on distressed bank solution through a toxic asset sale, bulk sale of balance sheet and recapitalization. 
  • Advised on debt and capital raise.


  • Advised on purchase or investment in savings bank.
  • Advised on investment in a community bank holding company and purchase of a community bank.
  • Performed analytical review and investments analysis on bank target.


  • Educated and advised on banking industry issues and how to assist minority-owned banks.