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To hedge against bad surprises in a seller's portfolio, some buyers are making part of the payout contingent on the performance of certain loans or batches of them. If things go well, the practice can help the seller, too.
September 22 -
With wild swings in the stock market, negotiations over protections form big changes in the stock values of buyers and sellers are bogging down an already slow deals market.
August 19
Freestar Bank's
The $400 million-asset lender outside Chicago and its prospective buyer, First Financial Corp. of Terre Haute, Ind., essentially agreed this week to a floating purchase price.
The final tally will come down to how much money Freestar, of Pontiac, Ill., earns between now and yearend when the deal is scheduled to close.
First Financial would give Freestar shareholders $47 million in cash if the value of its loans, securities, and other tangible assets are worth $28.43 million to $28.99 million at closing. If they are worth less than that, shareholders would get less money. If its tangible assets are worth more, First Financial would pay more.
That kind of price adjustment differs from the buyer and seller
Freestar's final deal price largely depends on its profits rising or falling. That is because the bank is relying on money coming in to cover deal expenses and loan charges, among other things.
In other transactions, the final price has been hitched to the value of the
Freestar and First Financial settled on a slightly different kind of protection clause for a few reasons. It is a cash deal, so a stock-price adjustment would not make sense. Freestar has a relatively low ratio of delinquent loans, so First Financial is not overly worried about surprise losses.
First Financial also agreed to pay a substantial premium — 166% of Freestar's book value — because Freestar is a good moneymaker. Its returns on equity were a relatively high 12.78% during the first half.
The initial price tag is pricey considering most community banks are going for just over or under book value, so First Financial wants the flexibility to pay less if Freestar's profits decline.
Profit-based protection clauses — which investment bankers also refer to as net worth calculation — were relatively common in bank mergers prior to the recession. They have become rarer because few strong banks have been changing hands, and most bank mergers are partially paid with stock.
Norman Lowery, the vice chairman and chief executive of First Financial, said Tuesday it negotiated the pricing hedge with Freestar even though "we don't really think" the book value is "going to change much."
Like the environment it seeks to hedge against, the formula is complex. The deal price would move up or down about $1.66 million for every $1 million the company loses from, or adds to, tangible book value relative to a set range. For example, the purchase price will decrease by an amount equal to 1.657 times the difference between PNB Holding's tangible book value and $28,431,000.