There are a lot of technology nightmares that follow a merger, but untangling contracts for software and other systems is one of the biggest.
Jack Deano, an executive vice president and chief technology officer with Iberiabank Corp. in Lafayette, La., knows this firsthand. The $11.4 billion-asset bank bought two smaller banks in May, forcing the company to decide which software platforms to phase out and which to keep.
Technology contracts "can be very onerous and many times there's little to no wiggle room in them," Deano says. For example, "if the bank you're acquiring has just signed a brand new five-year deal, you're looking at some pretty hefty buyouts."
Converting the target to the buyer's existing programs is standard procedure. That was the path that Iberiabank chose.
But before making those decisions, banks must read the fine print of the acquired banks' contracts to determine when to phase out systems and how much such moves will cost.
That advice applies to all conversions, but experts are sounding louder warnings in anticipation of more deals. Though a wave of M&A did not occur this year as predicted, and the number of banks on the Federal Deposit Insurance Corp.'s list of troubled institutions has declined, "I do expect M&As … will continue to pick up," says Paul Schaus, the president of CCG Catalyst Consulting Group in Phoenix.
"The price of bank stocks is depressed," he says. "You've got the regulatory pressure. … It's just like, 'Get me out of this.' "
The first step in reviewing contracts is actually locating them, which is easier said than done, according to Quintin Sykes, a vice president in Hitachi Consulting's U.S. financial services practice. Finding all the appropriate documents that spell out contract terms, termination fees and terms of service can be a challenge, depending on how good an acquisition target was at record keeping.
A buyer's executives "have to double-check the inventory of contracts against the inventory of systems that the bank is using," Sykes says. "If you don't have a contract for a given system, sometimes you have to go back to the vendor and say, 'Hey, we don't know where that is.'"
This process can also uncover hidden expenses.
"I found out in one deal we were paying for a time-and-weather [phone] number in a branch that we had bought," Sykes says of an experience he had while working for a bank prior to his consulting career. "We wound up getting the renewal because we didn't provide notice" to the vendor.
Some banks hire vendors to help them assess an acquired institution's overall technology inventory.
Citizens South Bank, the $1.1 billion-asset subsidiary of Citizens South Banking Corp. in Gastonia, N.C., uses software from Safe Systems Inc., an Alpharetta, Ga., vendor.
"The goal is to get the bank's arms around the IT infrastructure of what they're taking over," says Zach Duke, the executive vice president of business development at Safe Systems.
Contracts can go unnoticed before an acquisition because "many times you're only dealing with the upper levels of the bank you're acquiring," Deano says.
Fees related to extracting data housed in a software program, known as deconversion fees, are a major concern, Schaus says.
Vendors charge fees when a bank decides to end a contract early. The details depend on how aggressive a bank is at negotiating the initial terms. The fees are usually tied to the length of time remaining in the contract.
Generally, an acquiring bank wants to move fast on conversions to receive the cost savings that drive any merger. But fees can at times prompt a buyer to continue operating multiple systems for a while, Schaus says.
This is the case with one bank Schaus is advising, he says. The buyer is not moving the acquired institution to a new system for a year because the licensing fees are cheaper than the lump-sum termination fee.
"The contract doesn't really come up until June of 2013, but their break-even [date] on the savings on the acquisition is August," Schaus says.
A buyer might also decide to maintain another bank's contracts and systems if it intends to run the acquired institution as a subsidiary with a separate brand. That may happen when a buyer buys an out-of-market bank with a distinct customer base, says Susan Geiss, the senior director of operations at Jack Henry & Associates Inc.
"The size of the institution has a definite impact on the amount of time and effort it's going to take to make sure that you have your arms around that," Geiss says.
Though most banks do not anticipate they will be sold when they enter tech contracts, bank IT executive Dennis Cox says financial institutions should consider that possibility any time they sign an agreement with a vendor.
In nearly all cases, tech contract costs will not derail an acquisition, but they can affect the costs and projected savings that bankers hope to get out of a merger, says Cox, a senior vice president and manager of information systems for Citizens South.
If they think that they might sell their bank, they should negotiate hard for favorable termination and deconversion fees, Cox says. He also urges banks to enter shorter-term contracts than the five- to seven-year terms that are standard for major payments- and core-processing systems.
"I rarely ever sign a contract or recommend that a bank enter into a contract for more than three years," Cox says. Shorter contracts allow a bank to take advantage of technology advancements.
Of course, how a bank handles contract decisions can vary greatly when taking over failed institutions.
For example, a buyer would have little time to determine whether to take over a failed bank's contracts. If the buyer decided not to maintain the other institutions' systems, they would not have to pay termination fees, experts say. However, in many cases, they would have to pay the vendor fees to get data out of the systems.
Such fees can be a "profit center" for vendors in contracts for core processing systems, Cox says. "They make sure that it doesn't end up costing them money to have a bank convert off."