Bank M&A

Industry Overview: Size Doesn’t Matter, but Profitability Does

2-3-Emilys-AOBA.pngBank executives, boards and industry experts have long debated—and disagreed—on exactly how big a bank needs to be to survive in today’s harsh operational and regulatory environment, with bank CEOs typically reporting that the perfect size is “a little bigger than [their bank],” quipped Curtis Carpenter, managing director at Austin, Texas-based Sheshunoff & Co. Investment Banking, during a presentation to more than 500 attendees. But William Wallace, vice president of equity research at Raymond James & Associates Inc., would argue that the size of the bank doesn’t matter.

“You don’t have to get bigger. You need to get more profitable,” said Wallace during a separate session.

The Acquire or Be Acquired Conference, held January 26-28 in Phoenix, attracts many banks seeking to make deals—many as a buyer, some as sellers. Most attendees were bank CEOs, senior executives, chairmen or directors, with an average bank size of $682 million in assets.

If size is indeed any indicator of strength, then banks with assets between roughly $1 billion and $15 billion have seen rising stock values and have the currency to make deals. John Duffy, vice chairman at Keefe, Bruyette and Woods, a Stifel Company, told the audience that banks with between $5 billion and $10 billion in assets are the most highly valued and profitable, making this size the sweet spot for investors. Many banks of this size are regional banks, whose stocks Duffy said have “exceeded our expectations both for the overall market and the banking sector.” Carpenter predicted that institutions with more than $2 billion in assets will be tempted to pursue an initial public offering (IPO) after seeing the high pricing commanded by similarly sized institutions—particularly those active in the M&A market.

The market responded more positively to deals in 2013, making both all-stock deals and strategic mergers more attractive. Carpenter noted that the response was particularly positive when those deals resulted in market expansion for the surviving bank, at a median stock price gain just shy of 6 percent 20 days after the deal was announced, versus almost 4 percent when there was a partial overlap in the market and little gains—less than 0.5 percent—when the deal was entirely in-market.

Overall, the industry could be looking at brighter days ahead as banks emerge from the dark days of the credit crisis. Margin pressure likely won’t get much better, but net interest margins have stabilized, though they remain historically low, said Duffy. And many institutions have learned to live with shrinking margins, Billy Beale, CEO of $7.1-billion asset, Richmond, Virginia-based Union First Market Bankshares Corp., said during a panel discussion. Rates are expected to rise this year, albeit gradually, and higher rates should result in greater profitability for the industry. For board members, executives and investors at small and mid-cap banks, there is much to be optimistic about: The industry saw deposit growth of 6.2 percent, despite low rates on deposits, and Duffy predicted that these banks will see better loan growth than bigger banks.

2-3-Emilys-AOBA-2.pngOverall the industry is healthier, with FDIC–assisted deals shrinking from a high of 157 in 2010 to just 24 in 2013, according to Carpenter. Credit has improved. “Asset quality issues are becoming a thing of the past,” said Duffy. And healthy sellers will command a better price in the market, though coming to terms on price will likely remain a point of contention for buyers and sellers.

“Things feel better today,” Frank Cicero, managing director at Jefferies LLC, said during a panel discussion of bank stock analysts.

However, banks with less than $1 billion in assets face challenges. According to Duffy, these small banks are less profitable, with a median return on assets of 0.47 percent, half that of mid-cap banks with between $5 billion and $10 billion in assets. The diminished importance of branch networks underlines the importance of further investments in technology. Small banks barely trade at book value, and they are less efficient. Ben Plotkin, vice chairman at Stifel Financial Corp. told attendees that banks with less than $1 billion in assets have a median efficiency ratio of more than 71 percent. In contrast, banks with between $5 billion and $15 billion in assets had a median efficiency ratio of 59.8 percent.

Given these challenges, it’s not surprising that banks with less than $1 billion in assets comprised 89 percent of total deals in 2013. Ben Plotkin expects further shrinking in the industry, predicting that there will be less than 5,000 banks in the next 5 years.

Smaller banks need to gain size and scale to absorb costs and increase profitability, or resign themselves to selling to another bank.


Emily McCormick

Vice President of Editorial & Research

Emily McCormick is Vice President of Editorial & Research for Bank Director. Emily oversees research projects, from in-depth reports to Bank Director’s annual surveys on M&A, risk, compensation, governance and technology. She also manages content for the Bank Services Program. In addition to regularly speaking and moderating discussions at Bank Director’s in-person and virtual events, Emily regularly writes and edits for Bank Director magazine and She started her career in the circulation department at the Knoxville News-Sentinel, and graduated summa cum laude from The University of Tennessee with a bachelor’s degree in Spanish and International Business.