MC Bancshares overcomes mark-to-market deal math with unique price structure

MC Bancshares Inc.'s planned acquisition of Heritage NOLA Bancorp Inc. included a creative provision that can help break the current bank M&A logjam by motivating buyers and sellers to follow a similar approach.

The Federal Reserve's aggressive interest rate hikes that began in early 2022 put a freeze on bank M&A as buyers grappled with the impact of marking sellers' balance sheets, including their underwater securities portfolios, to market. But MC Bancshares overcame that hurdle through a unique pricing structure.

Heritage NOLA Bancorp shareholders will receive a per share price based on the company's adjusted tangible shareholders' equity at the time of closing plus $6.5 million. According to the press release, the seller's shareholders are estimated to receive a cash consideration between $19.50 per share and $20.50 per share based on Heritage NOLA Bancorp's equity at March 31. However, shareholders "should not assume" they will get that price, as the final price hinges on various factors like the seller's transaction costs, the cost to terminate contracts and after-tax unrealized losses in the company's securities portfolio, the press release read.

At a time when buyers are extra sensitive to changes in closing equity of M&A transactions after the Fed's campaign of rapid rate hikes and investors and regulators' focus on underwater bond portfolios, creative provisions like this one can be key to breaking up the bank M&A logjam.

"Deal creativity helps deals get done," said Robert Klingler, a Nelson Mullins partner advising financial institutions. Klingler did not advise on this transaction.

MC Bancshares and Heritage NOLA Bancorp declined to comment for this story.

Overcoming dealmaking obstacles

This approach to pricing helps mitigate the the punitive mark buyers are required to take on the seller's securities portfolio at closing, deal advisers said. MC Bancshares is likely anticipating the potential for additional bond portfolio impairment if the Fed hikes rates further, said Will Brackett, managing director of investment banking at Performance Trust Capital Partners, in an interview. Brackett did not advise on this transaction.

"Let's say interest rates went up further than from when they struck the deal, the securities portfolio would be marked down beyond whatever it's marked down today. So it's a way to ensure that the seller delivers or the seller has the baseline amount of equity at closing," said Jeff Davis, the managing director of Mercer Capital's financial institutions group. Davis did not advise on this transaction.

Heritage NOLA Bancorp's available-for-sale (AFS) securities totaled about $16 million at March 31. The company's unrealized losses on its AFS securities totaled $2.3 million.

A handful of bank deals have fallen apart in recent weeks, largely due to changes in the economic environment that have altered the original financial allure of deals at announcement. In the three to six months it can take a deal to close, the condition of a bank can change, but a provision like this one mitigates risk, Klingler said.

The pricing structure gives MC Bancshares the flexibility to pay the book value at closing and locks in a $6.5 million premium, Klingler said. Meanwhile, Heritage NOLA Bancorp shareholders will either bear the costs of underperformance, higher transaction expenses or higher interest rates or reap the benefits if those costs are less than expected, he added.

"Then they will get all of that benefit plus the $6.5 million premium," Klingler said. "Doing it this way, the Heritage shareholders might get less than that, but they also might get more."

Becoming more common

Provisions such as this one are not terribly unusual in an environment such as the current one in which there is a high potential for variability, Brackett said. Klingler estimates that about 20% of deals have such a stipulation.

They are often more common in smaller deals to ensure the seller delivers on a baseline of equity at closing, Davis said.

"Buyers are much more sensitive to movements in the closing equity given the movement in interest rates," Davis said. "It's all part of this mosaic of additional movement in the factors that could negatively impact equity at closing."

Given the current operating environment, future deals are likely to have similar provisions that address current risks, Klingler said.

"To the extent we see more deals, it is likely to have provisions like this that allocate that risk a little bit differently," Klingler said.