Sunday, 2 December 2012

Preamble to a Bank Strategic Alternatives Analysis

Bloggers pepper me with insights on how to be a more successful blogger. One such insight is to create a compelling title. In this regard, this blog's title is an outright fail. Try to say it three times fast!

I recently sat in front of a client board committee reviewing the bank's strategic alternatives (see a prior post on performing such analysis here). Before you think this bank is on the auction block, think again. This bank's board was delivering on its fiduciary duty to shareholders to maximize value.

Before getting into the details, I prefaced my analysis on where a strategic alternatives analysis fits in the overall scheme of executing strategy. Because, my readers, it occupies a far too important perch than you might think.

The following is my paraphrased preamble to the analysis:

"Strategic Alternatives Analysis is a critical component to strategy development and execution. For example, we see various planning tools as subsets to your overall strategic plan: Marketing and IT Plans, ERM/Risk Appetite, Capital Plan, Budget, and a Strategic Alternatives Analysis. All are linked.

'We espouse multiple projection scenarios when developing strategy. The first, we typically call the base scenario. The base represents the likely outcome of executing your strategy. In banking parlance, this is the basis for your budget. It is the starting point for the remaining scenarios. You should have a 50%-75% confidence level you can achieve the base scenario.

'The second is the stress scenario. Here you are trying to gauge what could go wrong based on relevant and defensible stressors, such as credit or interest rate shocks. This scenario is important to determining the risk-level of your strategy and the adequacy of your capital to withstand shocks. Your capital plan, of course, will have additional scenarios to identify the most attractive capital augmentation strategies should the stress case come to pass.

'The third projection scenario is the stretch. When developing strategy, it is critical to envision what success would look like upon successful execution. Rare is the case that achieving your vision would result in solely hitting your budget. You want to envision what success would look like in financial terms, too. Your management team should have a 30%-50% confidence level you can achieve stretch goals. Stretch projections should be your base for a Strategic Alternatives Analysis.

'Evaluating strategic alternatives goes beyond what you can pay for a target or what a buyer can pay for you. True, it is an important element of it. But the decision to buy should be based on your perceived inability to achieve stretch goals on your own. It is a lower risk strategy to achieve earnings and tangible book growth organically than through acquisition. But if your strategy does not deliver the shareholder value improvement you desire, then perhaps buying a competitor can bridge that gap. The strategic alternatives analysis shows the targets you have the greatest opportunity to buy.

'How do you know if you should sell? This analysis will show what buyers can likely pay. Normally, and in this case, the values are greater than where your bank currently trades. So, absent additional analysis or other considerations such as employees and customers, you should sell, right? Not so fast.

'Stretch projections should be discounted back to present day to determine the present value of successfully executing your strategy. If such an analysis delivers a present value in acceptable proximity to your take-out value, then your Board may conclude that it is best to remain independent and execute your plan. This keeps the keys to your shop in your hands, where you may have greater confidence than in somebody else's hands. Without developing stretch projections, how would you know if and when to sell? How would you know that there is a value gap and your management team must develop more aggressive strategies? You wouldn't. You would be guessing.

'This is the critical link to strategic planning and strategic alternatives analysis. It keeps the management team focused on delivering value to shareholders, keeps the Board focused on their fiduciary duties, and models successful execution of strategy, in financial terms. It is the very definition of your right to remain indepenedent, or is the basis to putting M&A as a critical component to your strategy."

Does your FI perform routine strategic alternatives analysis?

~ Jeff

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