Merger Wave Will Swell in 2013 to 2015 as Weak Banks Succumb, Firm Predicts

The gap between healthy banks and those that remain in the doldrums will fuel acquisition activity in the coming years, a Virginia investment management firm predicts.

FJ Capital Management LLC this week published an updated version of a 2011 white paper that argues an M&A wave is coming, even though the activity last year was a letdown. Martin Friedman, co-founder of FJ Capital and a former director of research at Friedman, Billings, Ramsey Group, wrote the paper.

Last year 159 open-bank deals were announced, down from 175 the previous year. Friedman, however, is undaunted.

"Our view was and continues to be that the next M&A cycle will rival the last major U.S. bank consolidation wave in the mid-1990s," he wrote. "We expect activity to increase modestly through 2012 and pick up steam in the 2013 to 2015 time frame."

The rebound could even eclipse 1994, a blockbuster year for M&A following the economic downturn of the late 1980s and early 1990s, he added. That year 526 deals were announced.

The strong have the opportunity of a generation to pick up market share, while the stragglers will likely realize — if they haven't already — they cannot make it on their own, Friedman wrote.

"In short, not all banks are equal, with many banks performing well or well enough, and many other banks facing almost insurmountable challenges to manage problem loans, rising expenses and major growth headwinds," Friedman wrote. "Clearly, many banks are facing industry challenges much more successfully than others."

Friedman cited SNL data that show the disparity between the best and worst banks by return on average assets. The top half had an average return of 1.03% for the third quarter of 2011, while the bottom half had an average of negative -0.37%.

Friedman also listed several other reasons for the expected boom, including pending regulations from the Dodd-Frank Act, the low interest rate environment, lack of loan growth and a general fatigue among bank directors who are worn out from the economic downturn, which is approaching its fifth year.

He added that activity has been more tepid than expected because of the slow pace of government rulewriting as well as the difficulties in establishing appropriate credit marks.

"The irony is that the same challenges… eventually will lead to a pickup in M&A activity," Friedman writes. "Smart executives and boards of community banks that lack the scale to handle these exogenous factors will grow more weary of the tough operating and regulatory environment and depressed equity valuations."