Sale and merger transactions involving community banks were infrequent in 2023. Transaction volumes were lower than prior years, both regionally and at the national level. However, the merger and acquisition market related to insurance agencies, both those affiliated with community banks and those not affiliated with community banks, saw increased activity in 2023. This article identifies some reasons for these divergent trends and discusses factors that owners and management of community banks should consider when exploring the possible sale of an affiliate insurance agency.

Part One: Recent M&A Market Activity

Lack of Community Bank Activity
There was minimal community bank acquisition and sale activity in Nebraska in 2023.¹ Transaction volume was similarly significantly reduced on a national level compared to 2022. Many reasons led to this lack of activity. Most prominently, increased economic uncertainty and the Federal Reserve’s response to inflationary conditions created a difficult transaction environment. As economic uncertainty increased, community bank buyers became more conservative in their valuation of target institutions. To the extent buyers were previously willing to ascribe value to earnings projections, they became less willing to do so. Instead, buyers increased their focus on the current tangible book value of target institutions as the primary focus for valuation.

As readers of this article are well aware, community bank balance sheets have been stressed in 2023 due to rising interest rates. These higher rates have required would-be buyers to place more scrutiny on target bank’s allowance for loan losses. Additionally, and perhaps more importantly for the bank transaction market, rising rates have led many community banks to experience unrealized losses in the value of their securities portfolios.

These unrealized losses created a chasm between the valuation expectations of would-be buyers and owners of community banks. Given the current environment, buyers argued that held-to-maturity securities should be marked to market for purposes of transaction valuations, while sellers countered that such losses are temporary in nature and a full market valuation adjustment is unwarranted. There are numerous ways to find a middle ground on this issue, and transaction activity on a national level has picked up during the second half of 2023 — perhaps signaling that buyers and sellers have begun to agree on an approach.

Increased Insurance Agency Activity
While the community bank transaction market was relatively quiet in 2023, transactions involving independent insurance agencies were numerous. Sellers of insurance agencies have found many willing buyers, including several national insurance conglomerates that are aggressively expanding. Competition among buyers, coupled with increased insurance premium prices in the industry, produced increased sale premiums for insurance agencies in 2023.

Capitalizing on these trends, some community banks with affiliate agencies have chosen to sell such agencies² at these elevated valuations and contribute the sale proceeds to bank capital to strengthen their balance sheets.³ This has been a popular capital-raising strategy across banks of all sizes in 2023.⁴ There have also been several insurance agency acquisitions from non-financial institution sellers in Nebraska and the surrounding states in 2023.

Part Two: Factors to Consider when Contemplating Selling an Affiliate Agency

Local and national buyers will likely continue to call on Nebraska banks with affiliate insurance agencies in 2024 in hopes of putting together transactions. These transactions present exciting capital-raising opportunities but may also present post-closing operational risks for the selling bank. To assess these risks, potential sellers should consider a number of factors when contemplating whether to pursue a transaction.

1. Impact on Bank Earnings
   Affiliate insurance agencies may provide a boost to bank earnings from a non-core business segment.⁵ While an immediate capital injection from transaction proceeds is appealing, it is important to also assess the loss of future earnings. Pro forma financial statements should be prepared to reflect the overall impact of the transaction and should be evaluated by bank management and its external accountants. Banks should also consider the amount of bank business generated by insurance agency customers. Incremental bank business may be lost if agency customers move their insurance business elsewhere following a transaction.
   
   
2. Scope of Restrictive Covenants
   Customer relationships are the foundation of any insurance agency business. Agency buyers will require non-competition and non-solicitation agreements from sellers in acquisition transactions. While a deal is unlikely to be completed without some restrictive covenants, there is usually some room to maneuver. A seller bank must carefully consider the scope of the restrictive covenants to which it can agree. In doing so, a seller bank needs to consider not only its own future business plans as they relate to the insurance industry but also whether any non-compete provision would burden a future acquirer or merger partner of the bank. To the greatest extent possible, these restrictive covenants should exclude the activities of future transaction parties from their scope. Without this exclusion, a potential future acquirer of a seller bank that operates its own insurance agency business may be unwilling to pursue a transaction during the restricted period.
   
   Members of bank management may also be required to sign restrictive covenants if they are equity owners of the affiliate agency or provide services to the agency. These individuals also must consider, among other things, whether their restrictive covenants would prevent them from providing services to a future bank acquirer with insurance agency operations.
   
   
3. Future of Shared Employees
   Many individuals providing services for bank-affiliated insurance agencies are not direct employees of the insurance agency itself. When an insurance agency is a division of the bank, such persons are likely to be employed by the bank. If the insurance agency is a subsidiary of the parent holding company, such persons are likely leased employees from the affiliate bank. An agency buyer, particularly an out-of-market buyer, will likely require that these individuals become employees of the buyer following the closing of a transaction. Sellers must consider whether the bank will require the services of these individuals following closing. If any will be required, the selling bank should make this known to a potential buyer at a very early stage.
   
   
4. Shared Information Technology and Co-Mingled Records
   Banks must consider how the insurance agency’s technology and records would transfer to a potential buyer. If the information technology resources are provided to the insurance agency by the bank, the bank should contemplate whether (and for how long) this service will continue following closing. Many insurance agencies utilize servers, computers, phone systems and other equipment owned or leased by affiliate banks. Additionally, some banks co-mingle the digital records of the bank and its affiliate insurance agency through storage on common servers. In these instances, the seller bank will need to consider whether segregation of such information is possible and ensure that it can be done without jeopardizing bank records and data.
   
   Oftentimes, transaction parties will negotiate a Transition Services Agreement whereby the seller bank will assist for a period of time post-closing to ensure the smooth transfer of information technology and agency records. Sellers often over-promise and under-charge for their services in these agreements. It is important to set reasonable buyer expectations for the scope and duration of these services and sellers should not be afraid to be aggressive with the rates to be charged for these important services.
   
   
5. Other Shared Assets
   Affiliate insurance agencies are often physically located within bank branches, and buyers will typically require a lease of such space for at least a transition period. A selling bank should consider whether it would be difficult to lease such space to another party if the buyer would not renew the lease in the future. Additionally, as future business relationships are unpredictable, seller banks must consider the circumstances in which they would want to terminate a buyer’s lease early. Any lease should also include terms regarding the use of office furniture, equipment, parking stalls and any other assets owned by the seller bank to be used by the buyer following closing.

While the community bank transaction market remains slower than in prior years, community banks with affiliate insurance agencies may have an opportunity to sell affiliate agencies at elevated valuations. The benefits of these transactions must be weighed against the operational challenges they produce. Banks with affiliate agencies should consider the previous factors when evaluating divestment opportunities in 2024.