The Growing Imperative of Scale


bank-scale-2-1-16.pngWhy are there so many people attending Bank Director’s 2016 Acquire or Be Acquired Conference this year, which at over 900 people is the largest number of attendees in the 22 years that we have been holding this event? Clearly the participants are interested in learning about the mechanics of bank M&A and the trends that are driving the market. But something seems to be different. I sense that more boards and their management teams are seriously considering M&A as a growth plan than perhaps ever before.

The heightened level of interest could certainly be explained by the continued margin pressure that banks have been operating under for the last several years. The Federal Reserve increased interest rates in December by 25 basis points–the first rate hike since 2006. But Fed Chairman Janet Yellen has said that a tightening of monetary policy will occur gradually over a protracted period of time, so any significant rate relief for the industry will be a long time in coming.

Other factors that are frequently credited with driving M&A activity include the escalation in regulatory compliance costs – which have skyrocketed since the financial crisis – and management succession issues where older bank CEOs would like to retire but have no capable successor available. But these challenges have been present for years, and there’s no logical reason why they would be more pressing in 2016 than, say, 2013.

What I think is different is a growing consensus that size and scale are becoming material differentiators between those banks that can look forward to a profitable future as an independent entity and those that will struggle to survive in an industry that continues to consolidate at a very rapid rate.

In a presentation this morning, Tom Michaud, the president and CEO at Keefe, Bruyette & Woods, showed a table that neatly framed the challenge that small banks have today in terms of their financial performance. Michaud had broken the industry into seven asset categories from largest to smallest. Banks with $500 million in assets or less had the lowest ratio of pre-tax, pre-provision revenue as a percentage of risk weighted assets – at 1.41 percent – of any category. Not only that, but the profitability of the next four asset classes grew increasingly larger, culminating in banks $5 billion to $10 billion in size, which had a ratio of 2.27 percent. Profitably then declined for banks in the $10 billion to $50 billion and $50 billion plus categories. Banks in the $5 billion to $10 billion are often described as occupying a sweet spot where they are large enough to enjoy economies of scale but still small enough that they are not regulated directly by the Consumer Financial Protection Bureau or are subject to restrictions on their card interchange fees under the Durbin Amendment.

Size allows you to spread technology and compliance costs over a wider base, which can yield valuable efficiency gains. It makes it easier for banks to raise capital, which can be used to exploit growth opportunities in existing businesses or to invest in new business lines. And larger banks also have an easier time attracting talent, which is the raw material of any successful company.

There will always be exceptions to the rule, and some smaller banks will be able to outperform their peers thanks to the blessings of a strong market and highly capable management. But I believe that many banks under $1 billion is assets are beginning to see that only by growing larger will they be able to survive in an industry becoming increasingly more concentrated every year. And for banks in slow growth markets, that will require an acquisition.

Four Predictions for Bank M&A in 2016



M&A pricing and shareholder activism are both on the rise as 2015 comes to a close. In this video, Peter Weinstock, a partner at Hunton & Williams LLP, outlines his predictions for bank M&A in 2016.

  • Will sellers command a higher price in 2016?
  • How will deals be structured?
  • Will there be more shareholder activism?
  • Where will community banks find growth opportunities?

Surviving in a Consolidating Industry



Several headwinds, including compliance costs, cyber threats and regulatory burdens, have taken the fun out of the business for many banking executives and boards. In preparation for our upcoming Acquire or Be Acquired Conference in January 2016, we asked Steve Hovde, chairman and CEO of the Hovde Group, to share his insights on the future of bank M&A deals. In this short video, Hovde looks at how community banks who are struggling to generate organic growth can survive in a consolidating industry.

Opportunities in Growth and M&A


acquisition-7-31-15.pngMost banks would like to grow but some have found it easier than others. Let’s look at a few perceptions and statistics about growth and a few opportunities to exploit it as well.

Many bankers feel that given the legislative and regulatory environment coupled with low rates, low margins, low loan demand and high competition, growth is very difficult. For those who experience this, they should consider selling. Far too many banks are seeing their franchise value diminish by not doing so. The good news is they can sell for a nice price and even receive stock from an acquirer improving their future growth and returns potential. Plenty of banks are able to do this. Bank stocks have outperformed the S&P 500 for the first six months of 2015 (8.56 percent vs. 1.09 percent), and should continue to do so based on their relative intrinsic values.

While the nation’s top five largest banks have over 80 percent of the industry’s assets, community banks, on average, have grown six times faster in terms of revenue growth. Assets of banks between $100 million and $1 billion have grown 27 percent from 1985 to 2013. Assets of banks larger than $10 billion have grown only 4 percent.

The banks showing the most growth have created that growth from three areas:

  • Organic loan origination
  • Mergers and acquisitions including branch acquisitions
  • Fee-related businesses such as:
    • Cash management.
    • Trust and wealth management
    • Brokerage services
    • Insurance and other related offerings

Growing by acquisition is much easier for smaller banks than larger ones, which suffer from “too big to fail” scrutiny and acquisition limitations. Of the 301 deals done in 2014, only five had deal values in excess of $500 million. Most of the activity is in small banks. While the total number of financial institutions has shrunk from 15,158 in 1990 to 6,419 today, the number of banks between $100 million to $10 billion in assets has grown from 4,194 in 1995 to 4,400 at March 31, 2015: a growth rate of 5.9 percent, representing over 68 percent of the number of financial institutions.

The M&A activity will remain healthy for the next several years as those who do not have the ability to grow and cope with the pressures will have to sell.

The keys to good M&A transactions are having ready access to debt and capital, an ability to strike quickly and efficiently, and a reputation for execution. A good capital plan can deal with the first issue, having capital available in all forms: senior/junior debt, preferred stock, privately placed retail and institutional capital, as well as public offerings. Pricing and placing the capital varies among investors and investment banks and can be more inefficient than most would think. The biggest inefficiency is placing subordinated debt with origination costs varying 1 to 3 points and rate differences of 2 to 3 points, even among banks whose funding capabilities should be equal. The ability to make a purchase offer quickly is an internal issue and is based on structure, experience and fast decision making processes. Quite frankly, most bankers are not as good as they think they are, and unfortunately this affects the issue of buyer reputation.

An open, honest assessment of the banker’s capabilities can do wonders for improvement of an acquisition success rate. There are many investment banks and consultants ready to help if asked and most would charge little or nothing for the added opportunity to be the advisors on the next deal.

The leading non-interest income area of growth targeted by banks is trust/wealth management. Yet far too many banks enter trust/wealth management without a proper assessment of what is realistic for time frames, opportunities, profitability and competitive advantage in products. There are good products, bad products, low margin and high margin in both, as well as high and low levels of competition. Most think they have the expertise to deal with all the new products and opportunities, but few do. Entering into niche opportunities such as alternative assets, 401(k) programs, or asset allocation models, while showing the most promise, are fraught with roadblocks and disappointment if not executed correctly.

By optimizing capital levels, opportunity sets and product lines as well as pursuing M&A opportunities, a good, clean, well run bank with a green light from regulators can grow at a very rapid rate over the next few years, increasing franchise value for the community bank and its investors.