Small-Bank Takeovers Unlikely to Match '98 Pace

The pace of community bank acquisitions is expected to remain sluggish this year after cooling significantly in the fourth quarter.

Bruised stock prices and a lack of willing buyers limited announced deals among banks with less than $1 billion of assets in the fourth quarter to 86, according to Sheshunoff Information Services Inc. That is the fewest for any quarter in at least five years.

"We won't see the level of activity this year that we saw in the first half of 1998," said James T. Hill, managing director of investment banking at Sutro & Co., Los Angeles.

With bank stocks trading at all-time highs early last year, a record 250 community bank deals were announced through June 30. Then bank stocks tumbled amid Wall Street woes, and dealmaking slid by 38% in the second half.

Wall Street's gyrations affected pricing-the average price-to-tangible book value for acquisitions dropped 12% in the fourth quarter-and terminated at least a half-dozen transactions.

"The deals that got done late in the year were by banks that still had strong currency," said Nick Barbarine, senior vice president at Hovde Financial Inc., a Washington investment banking firm. Some deals that were put on hold late last year will likely be fulfilled this year, he said.

If any transactions are to be completed, industry sources said most are likely to be concentrated among the smallest banks. Faced with shrinking net interest margins and lack of fee income, smaller banks will have to pair up to cut overhead costs, boost lending limits, and grow earnings per share.

Such transactions could produce combined operations that are more attractive to future buyers, industry sources say.

"It will be an active market for deals with banks that have less than $300 million of assets," said Jean-Luc Servant, managing director at Hoefer and Arnett, San Francisco. "They are convinced that they must increase their size to become competitive and viable investments."

Moreover, many of the larger banks that in the past have been big acquirers have been sold or no longer want smaller operations, bank observers add.

"Eighteen months ago a small bank had six or seven offers," said Jim Baxter, partner at Baxter & Fentriss, a Richmond, Va., investment banking firm. "Now they may have two."

Another roadblock to deal-making is that community banks still want asking prices of three times book-out of reach for most acquirers.

"We're holding discussions but it has become difficult to price the deals," said Dan Speight, president and chief executive of Flag Financial, a $550 million-asset bank in LaGrange, Ga. The firm made five acquisitions last year.

With bank stock prices depressed, the percentage of cash deals rose to 32% in the fourth quarter, up from 19% in the second quarter, according to Hovde Financial Inc., a Washington investment bank.

That trend could continue this year. Cash is typically used to buy closely held banks.

Acquiring banks may prefer cash acquisitions if they have excess capital built up from strong earnings of the past few years, bank observers added. But cash deals have their downsides.

For the seller, cash deals trigger an immediate 20% capital gains tax. The chief setback to cash deals for buyers is goodwill-a nontax deductible asset that is amortized over 10 to 15 years. Goodwill is written off the balance sheet each quarter and decreases a bank's earnings per share.

"Acquirers are willingly to use cash for smaller banks, but they won't pay outrageous prices," said Jeffrey C. Gerrish, a banking lawyer in Memphis.

The current price-to-earnings multiples of larger buyers will also impact the merger market this year, industry sources said. Past acquirers that are now trading under 20 times earnings may have to stand on the sidelines.

"P/E ratios will select who does the buying," said Jon Holtaway, senior vice president at Danielson Associates Inc., a Rockville, Md., financial advisory firm.

For instance, BB&T Corp. of Winston-Salem, N.C., is trading at about 22 times earnings, and it expects to continue acquiring community banks.

Last month BB&T announced that it would acquire Mason-Dixon Bancshares of Westminster, Md., for $257 million in stock and First Citizens Corp. of Newman, Ga., for $126 million in stock.

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