MAB Bankshares, Inc. Targets Southern Federal Savings Bank of Bridgeton A Regional Bank Acquisition Case Study by Peter Bergevin, Karin Roland, and S. Andrew Ostapski

The authors of this case study, Dr. Peter Bergevin, Professor of Accounting, Dr. Karin Roland, Assistant Professor of Finance, and  Dr. S. Andrew Ostapski, sostapsk@valdosta.edu  Associate Professor of Management. are on the faculty of the College of Business Administration, Valdosta State University. 

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The Case

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"We were acquisition minded," according to Mark Pafford, President and CEO of MAB Bankshares, Inc., a bank holding company with two community banks. "We were actively looking, and we wanted to be opportunistic," he told his constituents in early 1999.  He stated that MAB's goal was to "maximize returns on investments in good markets," which included those areas served by regional banks and thrift institutions located within a two-hour drive of MAB’s corporate headquarters in Azalea, Georgia.

Southern Federal Savings Bank of Bridgeton (Southern Federal) was an attractive target for acquisition. After analyzing this southwest Georgia savings bank, Pafford felt sure it would make an excellent addition to the MAB banking family. He believed that Southern Federal was financially strong because it had done business safely over the years. Moreover, this savings bank, located 90 miles to the west of Azalea, would give MAB the opportunity to enter a new market. Mark Pafford’s conviction about Southern Federal was about to be tested because he was going to recommend acquiring it to MAB’s Board of Directors.

A Changing Environment

"It might cost a little more, but people like the service," Mark often said as he explained how his two community banks competed with the superregional banks, which recently expanded into South Georgia. He knew, however, that there was a limit to the cost differentials that customers were willing to pay to bank at MAB. Along with the pressure coming from the superregional banks, MAB competed with other local community banks for the distinction of being the hometown bank. To further trouble the once tranquil banking industry, both the large and small banks doing business in Azalea were actively engaged in merger and acquisition activities.

Pafford knew that now was not the time to stand back and watch the changing environment. He felt that MAB had to expand its presence to remain viable as a South Georgia financial institution. The Chief Executive Officer’s critical evaluation of the marketplace, honed by over thirty year’s experience in South Georgia banking, supported his gut feeling that immediate action was necessary. Pafford explained his views:

Johnny Boyd and the rest of the Board of Directors were open minded, however, about acquiring other financial institutions. They knew the banking scene was changing rapidly, but the directors were also cautious about jeopardizing their profitable business. The argument that growth for the sake of growth to keep up with other banks would not, by itself, sway the board. The deal had to improve MAB’s financial position. Pafford had to back his takeover plan with concrete evidence that the Southern Federal acquisition would increase the wealth of MAB shareholders. He felt the time was right to convince the Board that it was in MAB's best interest to do so.

MAB Bankshares, Inc.

MAB Bankshares owned two banks in South Georgia: The Madison Avenue Bank in Azalea and the Commercial & Agricultural Bank of Delphi. The holding company was formed in 1982, the year in which federal banking regulations were liberalized, to acquire 100% of Madison Avenue Bank stock. Johnny Boyd had founded this bank in the early 1950s and, 15 years later, converted it to a regulated certificate bank. Then, in 1974,  the bank began operations as a state-chartered commercial banking institution.

In 1989, MAB acquired the financially ailing Commercial & Agricultural Bank of Delphi (Delphi Bank). The commercial bank, chartered in 1939, was both unprofitable and undercapitalized when it was first acquired. MAB infused Delphi Bank with capital, rectified its operations and returned it  to profitability. The Madison Avenue Bank remained the larger and more profitable of MAB’s two banking subsidiaries, but the addition of Delphi Bank increased the operating efficiencies and financial performance of the bank holding company.

MAB focused on community banking by providing a broad array of financial services to individual, professional, commercial and agricultural customers in its markets. Each bank held deposits and provided loans primarily to the residents of its host county, Downes county for Madison Avenue Bank and Baker county for Delphi Bank. Consistent with its community-banking orientation, MAB maintained separate management, officers and boards of directors for each bank.. MAB’s Bankshares financial data are presented in Exhibit 1.

Downes and Baker counties shared many of the characteristics common to the rest of South Georgia. These predominantly rural counties fell below the national averages in most socio-economic categories. The population growth rate in Downes county, however, approximated the national growth rate and was forecast to exceed it in the next five-year period. The population for Baker county, on the other hand, was stagnant and would remain so in the foreseeable future. One bright spot was that forecast per capital and median household incomes for the two counties approximated the national averages. Demographic information about MAB’s market area is presented in Exhibit 2.

Acquisition Overture

Southern Federal Savings Bank of Bridgeton was chartered in 1938 as a federal mutual savings and loan association (commonly called a thrift institution). It was converted into a federal stock savings bank when it began issuing stock in 1994. The activities of Southern Federal were conducted through its main office in Bridgeton, Georgia and a branch office in Alexandria. Business originated from the citizens and businesses of contiguous Cater and Harvey counties. Southern Federal Savings Bank’s financial data are presented in Exhibit 3.

The population and economic characteristics of Cater and Harvey counties resembled those of Downes and Baker counties to a great extent. The current population was small and not projected to grow very much. Income levels fell far below the national averages, but their rates of growth approximated the national rates. Demographic information concerning Southern Federal’s service region is contained in Exhibit 4.

Mark Pafford first expressed interest in acquiring Southern Federal  in 1995, and discussions began in earnest two years later. Mark pointed out that "Sometimes events that have little relation to business influence deals." In this case, it was the declining health of Southern Federal's president, who served at its helm for thirty years. He was diagnosed with cancer, and Southern Federal’s Board struggled to find an acceptable replacement. Consequently, Southern Federal Savings Bank became more receptive to possible merger with or acquisition by another financial institution.

Changes at MAB also facilitated the possibility of a deal. Many of the original MAB Board members had retired, and members, more inclined to growth,  had replaced them. Among these acquisitive board members was Will Watson, the new President of Madison Avenue Bank. Watson, previously employed at the much larger SuperBank of Charlotte, N.C.,  brought to MAB an external expansion perspective.  Internal growth at MAB increased pressure on the holding company to become a more efficient distributor of its services. Madison Avenue Bank had moved its main office into a much larger banking facility and it contemplated adding branches to better serve its customers in Downes county. Delphi Bank had also upgraded its facilities. Such requirements  increased MAB's overhead with no sign of decline into the foreseeable future. MAB needed to become a more efficient banker to face these challenges and the ever increasing cost effective competition from other banks.

Due Diligence

Pafford  had to confront a number of  important  considerations, including financial issues,  related to combining MAB with Southern Federal.  His response to the concerns, which the MAB Board would surely raise, could make or break the deal.  As the Board meeting approached, Mark discussed these matters with Will Watson over lunch.

Structuring a deal was a key element in acquiring Southern Federal. MAB could use cash, stock or a combination of the two to effect the transaction. Regardless of the way the deal was consummated, Mark knew that his Board would focus on the expected purchase price for Southern Federal. He had to determine what the bank was worth to make a workable offer. Pafford did his homework in this area by considering three valuation models. He and his staff prepared handouts for the Board members detailing the asset, income and market approaches to determine the value of Southern Federal Savings Bank.

The asset approach considered the net asset value of Southern Federal, after marking its assets and liabilities to market, based on current market values. After determining the net asset value, an intangible value was added to determine the total value of the company. For financial institutions, the intangible value usually represents a deposit premium, expressed as a percentage of core deposits (all deposits, less those of $100,000 or more). Certain other adjustments were made as deemed necessary by the analysts.

Southern Federal has a desirable deposit mix and net asset value, and it is attractive demographically. Based on net asset value of $13,062,000, MAB’s analysts believe that a 3% to 6% deposit intangible range is appropriate for valuing Southern Federal.
 

Southern Federal Savings Bank's financial performance was modeled with input from management for the next six years. These earnings projections were capitalized or discounted to determine bank value. The projections assumed a 3% deposit growth with a stable deposit mix. Various levels of cost savings were assumed to derive the price ranges. The results are summarized below.
 

The market approach was used to examine the value of other thrift acquisitions in the market. There were 68 known pending thrift acquisitions, and these are summarized as follows:
 

Doing the Deal

The structure of the transaction would also create a financial reporting issue. Mark knew that there were two ways to account for an acquisition, and these alternative methods affected the financial performance of the combined entity. The Southern Federal acquisition could be accounted for as either a purchase or pooling-of-interest. Under the purchase method of accounting, MAB could use cash, stock or a combination of the two to acquire Southern Federal. To the extent that the purchase price exceeded the fair value of Southern Federal's tangible assets, goodwill would be created. Any such goodwill would be charged against the future earnings of the combined enterprise over a period not to exceed forty years. Under pooling-of-interests, the combination would be viewed as a merger of the two shareholders groups’ interests into one umbrella organization. As such, the net assets of Southern Federal would be folded into MAB’s at its historical cost rather than at its market value. Consequently, no goodwill would be created if the deal were accounted for as a pooling.

Pafford knew that the proposed merger also would generate qualitative issues that could not be ignored. Eventually, these qualitative issues would affect MAB’s financial performance. For instance, he was concerned that the Board would perceive the organizational culture of Southern Federal as a poor fit for MAB. Members of his Board tended to view savings banks as unduly conservative. Bankers called it the "thrift mentality." Mark could almost hear certain Board members saying, "Their products and activities are different. They aren’t business-development oriented or customer-service oriented."

Increasing MAB shareholder value was the ultimate goal as far as Mark and the Board were concerned. As Pafford contemplated the acquisition, he realized that such gains would only occur if the combined operation would be more efficient than the operations of the two separate entities. Laying off redundant employees, closing inefficient buildings and combining information-processing activities were all ways in which Mark envisioned reducing operating costs and driving up shareholder value. He was concerned, however, that his community banks might not be as adept as the superregionals were at cutting costs. Mark wondered if his holding company could restructure its operations, including the elimination of redundant jobs, and still maintain its image as a community bank.

Mark Pafford was not sure of all the answers or even all the questions, which were sure to arise, when he would recommend to his Board that it bid for Southern Federal Savings Bank. However, he  was sure of one thing. The MAB Bankshares Board of Directors meeting certainly was going to be very interesting. 

Mark Pafford, CEO of  MAB Bankshares, Inc., is preparing to recommend acquiring Southern Federal Savings Bank to his Board of Directors. Mark feels that MAB, a bank holding company with two banks in South Georgia, needs to expand in order to remain competitive. Southern Federal, located 90 miles away in Bridgeton, Georgia, appears to be a good fit, but there are some unresolved issues. The student is placed in Mark’s position as he prepares to bring his proposal to the members of the Board and anticipates their concerns. Central to the case is that a bid price for Southern Federal must be established. This task is complicated because neither entity is publicly traded. Furthermore, the acquisition must be made without diluting MAB’s earnings. In order to effect the transaction, MAB must decide on one of two financial reporting alternatives, each with its own repercussions, in accounting for the acquisition. Moreover, as a community bank, MAB must insure that any cost cutting efforts do not alienate its small-town stakeholders. Finally, MAB must be comfortable with incorporating the thrift culture of Southern Federal with its more aggressive banking culture.
 

This case is designed for use at the undergraduate level, and it is oriented toward courses in finance and accounting. It is appropriate for financial management, financial institutions, financial statement analysis and strategic managment courses.

The objectives of this case are to

• Provide insights about the heightened level of merger and acquisition activity taking place in the banking industry.
• Explore the factors affecting the market value of an entity when its stock is not publicly traded.
• Address the potential of earnings dilution in bank acquisitions.
• Determine which financial reporting method is appropriate to use in the acquisition of an entity.
• Consider the behavioral consequences for a community bank when it engages in acquisition activities.

Discussion Questions and Analysis

1. What are Mark Pafford's reasons for wanting to acquire Southern Federal Savings Bank?

Pafford feels that MAB must grow to remain competitive. The superregional banks (e.g., Bank of America) had established operations in South Georgia, and other community banks were growing stronger through mergers and acquisitions. Mark felt that MAB needed economies of scope and scale in order to compete. The acquisition of Southern Federal would result in an expanded market, additional revenue streams and the potential to lower costs.

If the course deals with a subject other than financial institutions, the instructor may want to provide background on bank mergers and acquisitions. There are a number of good references, including Spiegel et al. [2], which provide a general discussion of industry trends due, in large part, to deregulation. Furthermore, to emphasize the point, the instructor may introduce many examples of larger or more prominent bank mergers and acquisitions. Examples could include: NationsBank/Bank of America (two superregional banks), Citicorp/Travelers Insurance (an expansion of financial services and markets), and Duetsche Bank/Bankers Trust (an international bank acquisition).

2. What are some of the potential problems associated with the acquisition of Southern Federal?

Responses to this question fall roughly into three categories: marketing, managerial and financial. The authors recommend a detailed discussion of the first two areas while treating the financial problems only briefly.  Subsequent questions examine the financial aspects in greater detail.

Marketing:

Market area – point out that Southern Federal is located 90 miles away from MAB’s current market area,  which is beyond its assumed area of expertise.

Demographics – demonstrate the relatively weak demographics of Cater and Harvey counties (Exhibit 4). Unlike Downes County, notice that the population in Southern Federal’s markets is projected to be stagnant for the next five years. [4].

Products – understand that First Federal’s array of financial services differs from MAB because it is a thrift institution instead of a bank.

Managerial:

Organizational culture – integrate the relatively non-aggressive thrift culture of Southern Federal with the more aggressive banking culture at MAB.

Restructuring – deal with the potential repercussions for a community-oriented bank if employees, who are local citizens in the small towns in which the bank operates, were fired as a result of the acquisition.

Leadership – find  a suitable president to run Southern Federal’s operations.

Financial:

Valuation (Southern Federal) - determine the worth of Southern Federal and establishing a bid price.

Valuation (MAB) – compute the value of MAB’s stock, if it were used to effect the transaction.

Transaction – structure the deal as a cash, stock,  or cash and stock transaction.

Financial Reporting – select either the purchase or pooling-of-interests method to account for the deal.

3. Determine a purchase price for Southern Federal Savings Bank.

This discussion question presupposes everyone agrees with Mark’s decision to bid for Southern Federal. A few contrarians may argue against the purchase, and these views should be encouraged. The case is relatively silent as to the overall disposition of the board to merger activity, and it does not address other potential targets. The instructor should point out that not acquiring another financial institution or seeking other targets are viable options for MAB.

Assuming Mark’s position that a merger or acquisition is needed and Southern Federal is the target, answers to this question will vary. A good exercise to start this discussion is to have students write down the price they would pay to acquire Southern Federal, and record them (or a distribution of  prices) on the board. From that point, the instructor can probe students for their justification. Student justification should be based on the information contained in Exhibit 5 [4]. Firm valuation based on the asset, income and market approaches should all be discussed in detail. The instructor should emphasize that all three approaches have advantages and disadvantages. Furthermore, all three approaches provide for a wide range of firm values, depending upon the assumptions used in the approach to create firm value. As a general rule, most responses tend to cluster in the mid-range for each of the three valuation approaches. It should be noted that such a selection implies an acquisition premium. Now, the instructor should lead a discussion as to why MAB would pay a premium for Southern Federal, and why the thrift shareholders should demand a premium.

There is no correct answer as to the price that MAB should pay for Southern Federal. This stark reality is what MAB and Southern Federal, or other consolidating enterprises, face when they consider combining their operations. It is important for students to understand that the purchase price will ultimately depend upon what Southern Federal and MAB can agree. As Mark commented on the negotiated price after MAB acquired Southern Federal, "We struck a price and had to make it work as best we can."

4. How do you think Mark should recommend financing the acquisition to the Board?

Answers will vary. It may be wise to determine a consensus purchase price from the discussion in question 3, before structuring the deal. Regardless of the consensus bid price, a key point to underscore is that MAB does not  have enough available cash  (Exhibit 1 [1]) to prudently purchase Southern Federal . A number of alternatives could be pursued, including stock-for-stock, cash and stock for stock, and cash and debt for stock. The advantages and disadvantages of each method may be discussed.

If MAB stock were to be used in the transaction, its market price must be established. One of the apparent limitations of this case is that there is insufficient information to determine a stock price for MAB. Students can approximate MAB’s value by using the information contained in the valuation approaches for Southern Federal (presented in Exhibit 5 [5]).

5. Which consolidation method should be used for the transaction? Why?

The answer will depend upon the type of transaction selected in question 4. The instructor should point out that only a stock-for-stock transaction can be accounted for as a pooling-of- interests. Students should understand that no goodwill would be created under a pooling-of-interests; therefore, there would be no drag on earnings due to goodwill amortization. This treatment would be a major factor for MAB to consider when acquiring another financial institution; consequently, treating the consolidation as a pooling of interests has merit.

Any use of cash or debt to finance the acquisition requires the use of the purchase method of accounting. Inasmuch as the responses from questions 3 and 4 argue for a premium to be paid for Southern Federal, EPS will be reduced due to the amortization of goodwill. Students can approximate the amount of goodwill by subtracting $13,062,000 (Southern Federal's marked-to-market net tangible asset valuation, stated in Exhibit 5's asset approach) from a class-derived consensus acquisition price. The annual reduction of earnings would then be a function of the number of reporting periods used to amortize goodwill.

One of Pafford’s concerns was that the acquisition might  produce diluted earnings. Goodwill amortization, stemming from the purchase method of consolidating the entities, dilutes earnings. But, it is not the only matter that affects EPS. In fact, it may not even be a significant one. Students should be aware that earnings could be diluted, even if the pooling method were used. For example,
 

• MAB simply could sacrifice too much for Southern Federal's acquisition,
• The savings bank could underperform and not meet MAB’s projections, or
• The combined entities could fail to successfully integrate their operations.

Madison Avenue Bankshares acquired Southern Federal Savings Bank for a purchase price of $16.06 million, one-half of which was paid in cash and the other half in MAB stock. The purchase method of accounting was used to effect the transaction because the deal was not stock-for-stock. Goodwill was created because the purchase price exceeded Southern Federal's tangible market value. The purchase price or the write-off of this premium did not had a dilutive effect on MAB’s earnings. Early indications are that the acquisition enhanced MAB’s shareholders’ value.  The stock is now publicly traded.

MAB eventually converted Southern Federal to banking status. No employees were fired as a result of the acquisition. Personnel restructuring was accomplished through attrition. Subsequent to the Southern Federal acquisition, MAB has acquired other financial institutions in South Georgia. True to the intent of its founder, MAB has not been taken over; it remains an independent bank holding company.

Click here to go to the case.

MAB Bankshares, Inc., Form 10-KSB, 1996-1998.

Spiegel, G.,  J. Garret, and V. Garret. Banking Redefined. New York:  Irwin, 1996.

Stickney, C. P. and P. R. Brown. Financial Statement Analysis: A Strategic Perspective,       Fourth Edition. Fort Worth:  Dryden Press, 1998.

Strident Financial Services. MAB Bankshares, Inc. Analysis. Raleigh NC:  Strident Financial Services, 1998.

Strident Financial Services. Southern Federal Savings Bank Analysis. Raleigh NC:  Strident Financial Services, 1998.