Blowing the Lid off of M&A

Bankers have long complained that the Dodd-Frank Act’s $10 billion and $50 billion asset size thresholds distort the bank merger-and-acquisition market.

At those levels, additional regulatory oversight, reporting requirements and other costs kick in, naturally forcing boards of institutions near the thresholds to think twice before doing deals.

“You’ve got enhanced regulations and costs on one side of an asset number, and reduced regulations and additional earnings abilities on the other side,” says Robert Klingler, an Atlanta-based partner with the law firm Bryan Cave. “If you cross that line, you stand to lose a lot.”

Now Washington is abuzz with talk that the thresholds will be raised. Does that mean the bank M&A market is poised to surge, as well? Tariq Mirza, national leader for compliance and risk management at Grant Thornton, says interest in M&A already is on the rise.

“We’ve seen more proposals and calls about M&A activity this year than in the previous five years combined,” Mirza says. “There’s still trepidation about crossing the thresholds … but also an expectation that an improving economy and changes in the White House will lead to increases in those thresholds.”

Under Dodd-Frank, banks that go above $10 billion in assets must conduct annual stress tests. They are subject to on-site examinations by the Consumer Financial Protection Bureau, caps on their debit-card interchange fees under the Durbin Amendment and higher Federal Deposit Insurance Corp. risk assessments.

“The rule of thumb is that going beyond $10 billion will cost you about 10 basis points on assets,” says Tom Killian, a principal at Sandler O’Neill + Partners, an investment bank. “If you’re going to pass that threshold, you need to justify it with more cost savings or synergies than otherwise would be the case.”

It’s impossible to say just how many banks have been dissuaded from crossing $10 billion via acquisition, but Sandler O’Neill + Partners says that as of mid-June, of the 44 banks that have crossed that threshold since 2010, only five have done so organically.

The current logjam of about a dozen historically acquisitive banks with assets of between $9 billion and $10 billion includes Banner Bank of Walla Walla, Washington ($9.9 billion), Kalispell, Montana-based Glacier Bancorp ($9.7 billion) and Capitol Federal Savings Bank in Topeka, Kansas ($9.3 billion).

The threshold “is the No. 2 consideration on the list when boards discuss an acquisition,” behind strategy, Klingler says.
Raising the $10 billion threshold to $50 billion (or even $100 billion, as some have suggested) would take those added regulatory costs and hassles out of the equation. It could not only embolden buyers but also allow them to pay more.

The median price paid for a bank in the first four months of 2017 was up 23 percent over year-earlier figures, and exceeded 1.8 times tangible book value in the West and Southeast, according to S&P Global Market Intelligence. If it gets a little push to get over 2 times book, analysts say, the market will likely heat up.

But as with everything in banking today, things can be more complicated than meets the eye. Seventeen of the 44 banks that have acquired their way past the $10 billion mark since 2010, for example, did so via a relatively large deal to gain scale efficiencies. Thirteen have done so through a series of smaller acquisitions. Nine have sold their way to a higher threshold.

In a perverse twist, eliminating some of the regulatory costs that come with the threshold could reduce the urgency felt by some boards to get bigger.

United Community Banks of Blairsville, Georgia, nudged past the $10 billion threshold in 2016 with its acquisition of Tidelands Bancshares. Jimmy Tallent, the company’s chairman and CEO, figures crossing the threshold costs United Community about $3 million per quarter in added compliance costs and lost debit-card fees, and that’s made him more interested in deals.

“Once you get past the threshold, you want to add more earning assets and get economies of scale,” he says.
Increase the threshold, Tallent adds, and United Community’s costs would be lower, and it would likely feel less compelled to do a deal.

In short, observers say, boosting the small-bank threshold could be a wash for the smaller-bank M&A market, with roughly the same deal volumes as before and perhaps a modest boost in some pricing, since the compliance costs would be lower.

“I don’t know if it changes volumes in the M&A market, but it will change the nature of the deals,” Klingler predicts.

There’s little such ambivalence on the big bank side, where passing the $50 billion mark brings the dreaded “systemically important financial institution,” or SIFI, designation.
SIFI banks must submit to arduous stress tests, higher capital and liquidity requirements, living wills, stiffer loan concentration limits and more.

Since Dodd-Frank was passed, no banking company has gone over the $50 billion threshold via acquisition. “It’s a huge deterrent to M&A,” Mirza says.

The list of banks sitting on the threshold’s doorstep includes the likes of Silicon Valley Bancorp in Santa Clara, California, People’s United Financial in Bridgeport, Connecticut, and New York-based Signature Bank, all of which are above $40 billion in assets.

New York Community Bancorp in Westbury, New York, has been delicately managing its balance sheet around the $49 billion asset mark for several years, waiting for the right opportunity to move past it. Company officials estimated in 2016 that moving past the threshold would cost it $26 million, or 5 cents per share.

If the SIFI threshold rises to $250 billion, as many-including the law’s co-author Barney Frank (now a Signature director) and former Federal Reserve Governor Daniel Tarullo-have suggested, “we will be very active on growing our balance sheet,” New York Community’s CFO Thomas Cangemi said in the company’s first quarter conference call.

Collyn Gilbert, an analyst with Keefe, Bruyette & Woods, notes that it’s not only costs that keep banks from surpassing the thresholds, it’s also the scrutiny.

New York Community tried to blow past the $50 billion mark in 2016, but its proposed deal for $15 billion asset Astoria Financial Corp. got bogged down, in part, over regulator concerns about concentrations of commercial real estate loans, Gilbert says.

SIFI liquidity requirements that would have forced the company to hold more low-yielding securities on its balance sheet and potentially cut the dividend were another concern.

“If the SIFI threshold gets lifted, they would be much more likely to do a deal, because it would be easier to get approved, and they wouldn’t have to incur those costs,” Gilbert says.

There are some important caveats to all this, not the least of which is the political environment. Despite some initial support for the idea from House Republicans and the Trump White House, Democrats are likely to oppose efforts to raise the thresholds.

And while the thresholds might be boosted for stress testing, that’s not to say all regulations will go away for $10 billion banks. The CFPB may continue to examine banks at the $10 billion level, and the Durbin amendment may still cap debit-card fee income for those banks. “We try to be realistic with our clients,” Killian says. “This would be helpful, but it’s not a panacea.”

In the end, Mirza says even loosening some of the regulatory constraints on size should motivate buyers higher up on the food chain, which will then trickle down through the rest of the system.

“M&A is a natural part of banking,” Killian says. “If you lifted these thresholds, I think you would see a pretty pronounced effect on industry consolidation.”