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Sunday, 18 January 2015 22:00

A Matter of Scale: Lake Michigan Financial deal with Chemical unlocks higher lending limits

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The driving force behind Lake Michigan Financial Corp.’s proposed $184.1 million sale to Chemical Financial Corp. represents a contrast to what’s been driving most of the consolidation in the banking industry.

A need to bulk up to serve clients who are growing after the recession and who require more commercial credit drove the Holland-based Lake Michigan Financial to sell. Once the deal with the Midland-based Chemical Financial (Nasdaq: CHFC) closes, businesses that now bank with Lake Michigan Financial will have access to a lending limit more than twice the present size.

The deal comes after Lake Michigan Financial, the parent company for The Bank of Holland and The Bank of Northern Michigan, posted two straight years of double-digit growth and “business has been very good and very strong,” President and CEO Garth Deur told MiBiz.

“As is often the case, many times a business’ challenges come from its success, and as we have continued to grow and as we have continued to add customers, there are some things that we needed to do to remain relevant and to increase the scale and scope on which we can serve these clients,” Deur said.

Partnering with Chemical Financial brings that scale to Lake Michigan Financial as well as significantly broadens the banks’ offerings with services such as treasury and wealth management and consumer products.

Chemical Financial has a legal lending limit of a little more than $90 million for one customer and an in-house limit of $20 million to $25 million, said Chairman, President and CEO David Ramaker. By becoming a larger bank, Ramaker sees the in-house limit bumping up to “anywhere between $25 million to $30 million, or maybe even from $25 million to $35 million to any one particular customer.”

“We just need to look at that a little closer and start to factor all of that in, but that just seems logical to me and makes sense,” Ramaker said in a conference call to discuss the deal. “The West Michigan market in particular is very full of opportunities in that particular size and range.”

The Bank of Holland and The Bank of Northern Michigan each have a legal lending limit of about $14 million for a single borrower and both have a number of commercial and industrial borrowers where they share the loan with one or more banks, Chemical among them, Deur said. The banks in the last few years even lost a handful of clients that came out of the recession “on a very strong growth trajectory (and) we were no longer able to meet their needs as they outgrew our capacity to provide all of their credit facilities,” Deur said.

“Some of them have outgrown our ability to meet their credit needs because their business has grown so significantly,” he said. “So we have a number of clients, current clients, who we can now take over, or at least approach them with respect to taking over the rest of the relationship. And we have several clients who, over time, we believe are going to continue to grow and will drive that credit need.

“So really, for us, having this incremental lending capacity is not just a hope for the future. It is something that we can take advantage of very, very quickly.”

DIFFERENT DRIVERS

The acquisition would give Chemical Financial larger positions in the Western and Northern Michigan banking markets. Under terms of the deal, shareholders at the privately held Lake Michigan Financial will receive 1.326 shares of Chemical common stock and $16.64 in cash for each of their shares.

Chemical Financial has been a key consolidator of smaller community banks in Michigan. Last fall, the company closed on a $121 million deal for Northwestern Bancorp Inc. in Traverse City that expanded its presence in the northwestern Lower Peninsula. Chemical Financial subsequently agreed to the $26 million acquisition of Monarch Community Bancorp in Coldwater, which should close by mid-2015 after securing regulatory approval just prior to the new year.

The Lake Michigan Financial deal is expected to close early in the second half of 2015, pending regulatory and shareholder approvals, Ramaker said. The Bank of Holland and The Bank of Northern Michigan will operate under the Chemical Bank name after the closing.

The deal is the third in 12 months and the fifth since 2010 for Chemical Financial, which is poised to become the largest bank based in Michigan in terms of deposits and the seventh-largest bank operating in the state.

The transaction is not the result of the primary drivers of many bank mergers today, which include high regulatory compliance costs, margin pressures and limited growth opportunities.

“None of those had anything to do with this,” Deur said. “This is all about taking the business to the next level.”

As of Sept. 30, 2014, Lake Michigan Financial had $1.22 billion in assets, $998 million in deposits, and $923.4 million in loans.

Once the Lake Michigan Financial and Monarch Community deals close, Chemical Financial will have about $8.9 billion in assets, $6.6 billion in loans and $7 billion in deposits with 188 branches in 47 counties in southwestern, central and northern Michigan.

FOCUS ON INTEGRATION

The Lake Michigan Financial deal will slow but not completely halt Chemical Financial’s acquisition strategy.

The corporation will continue to seek additional deals amid consolidation in the banking industry, although the primary focus now is integrating the Northwestern acquisition and executing the two pending deals, Ramaker said.

“The execution on a go-forward basis is extremely important to make sure we are maximizing what we need to bring to the shareholders for all three of these transactions combined,” Ramaker said. “Now as it relates to other opportunities, because of this capstone event, quite frankly, we can be selective and opportunistic in what we do from a standpoint of acquisition. So I wouldn’t say this necessarily takes us fully out of the game, but we are going to be very selective in what we do because we need to keep our eye on the ball as it relates to execution on these deals.”

Chemical Financial will pay a premium for Lake Michigan Financial — a price-to-earnings multiple of 16.2 times forward earnings — but Ramaker said the price “is not only merited but fair.” He cited Lake Michigan Financial’s history of strong and predictable earnings and its record of maintaining profitability during the recession, plus its position in attractive markets.

The Bank of Holland has offices in Holland, downtown Grand Rapids, and Grand Haven. The Bank of Northern Michigan has offices in Petoskey and Traverse City.

Lake Michigan Financial had net income of $9.0 million in 2013, $8.4 million in 2012, and $7.3 million in 2011. The corporation’s net income through the third quarter of 2014 totaled $6.9 million.

Ramaker said Chemical Financial is “establishing this partnership with a very high quality financial institution.” The deal will result in an estimated 10 percent earnings per share accretion in the first full year for Chemical Financial.

“We feel that this partnership will enhance Chemical’s position as the preeminent Michigan-based retail banking franchise with the addition of one of the state’s leading entrepreneurial relationship-oriented commercial banks,” Ramaker said. “We are very bullish on both the overall Lake Michigan Financial franchise and the markets that they operate in.”

COMMERCIAL ACCESS

The Bank of Holland and The Bank of Northern Michigan are primarily commercial banks that focus on commercial lending for small and mid-sized businesses and the personal banking of their owners and executives and high-net-worth individuals.

Commercial and industrial, construction and development, and commercial real estate loans accounted for 75.5 percent of Lake Michigan Financial’s total loan portfolio as of Sept. 30. At Chemical Financial, those three lending categories comprised 46.8 percent of total loans.

The acquisition would not only add to Chemical Financial’s branch footprint but provide a platform to delve further into business banking and commercial lending.

“But we are not going to abandon the small business customers, the small retail customers (or) our mortgage customers by doing this transaction,” Ramaker said. “It just allows us to really continue the diversification of our portfolio and continue to meet more and more needs of the various markets that we serve.”

When the deal closes, Deur will become executive vice president at Chemical Bank responsible for community banking. Lake Michigan Financial Chairman Rich Lievense, who founded The Bank of Holland in 1998 and later The Bank of Northern Michigan, also will join the Chemical Financial board and continue to run InSite Capital, a Lake Michigan Financial unit that helps businesses find alternate sources of financing.

Chemical Financial will incur about $15 million in pre-tax expenses related to the deal, most of it coming in 2015, and cost savings of 40 percent off of Lake Michigan Financial’s operating expenses, CFO Lori Gwizdala said. The corporation is targeting annualized cost savings of $10.8 million, three-quarters of which will phase in over a six-month period following the closing.

The deal will result in the consolidation of at least two branch locations, Ramaker said.

Investment banking firm Keefe, Bruyette & Woods Inc. and the law firm of Warner Norcross & Judd LLP in Grand Rapids advised Chemical Financial on the deal. Lake Michigan Financial was advised by investment banker Sandler O’Neill & Partners LP and Varnum LLP.

The deal came about after Chemical Financial first invested in Lake Michigan Financial years ago.

When Lake Michigan Financial sought to raise capital in 2007, Chemical Financial invested in the company by buying the preferred trust securities it offered. Ramaker has met regularly ever since with Deur and Lievense and received quarterly financial statements.

“Garth and Rich and I have been meeting at least twice a year, talking about various issues in the industry, as well as various issues for our banks. And so, we have a very strong relationship and a very great amount of knowledge and a lot of respect for each other’s companies,” Ramaker said.

When the decision came for Lake Michigan Financial to seek a suitor, Chemical Financial was an obvious partner.

“Because of our long relationship with Chemical, they were a natural first choice for us,” Deur said.

 

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