A quest for low-cost deposits is starting to spur industry consolidation.

Financial institutions that were once drowning in deposits after the financial crisis are finally sensing a need for more liquidity as the economy improves.

Total loans at banks with less than $10 billion in assets rose by nearly 17% between 2012 and 2017, surpassing the roughly 5% increase in deposits over that time, according to data from the Federal Deposit Insurance Corp.

Rising interest rates and evidence that big banks are looking to stock up on deposits are putting even more pressure on some acquirers to target deposit-rich institutions.

“Low-cost core funding is a priority for us,” Dennis Shaffer, president and CEO of Civista Bancshares in Sandusky, Ohio, said in a recent interview. “We can continue to invest and meet all the loan demand in the rural communities that we serve. We can then take the excess deposits from these markets and lend them out into the more robust urban markets that we operate in.”

The $1.5 billion-asset Civista's recent deal to buy United Community Bancorp in Lawrenceburg, Ind., for $114 million would immediately bring in more liquidity. The $543 million-asset United Community's 62% loan-to-deposit ratio at Dec. 31 contrasts significantly with the Civista's 93% ratio, according to FDIC data.

Obtaining United's sticky low-cost deposits was the "first and foremost” reason for the deal, Shaffer said. Five of United’s branches are in the Cincinnati area, rounding out Civista's access to Ohio's five biggest markets.

A number of recently announced deals have involved the sale of deposit-rich banks, including Medina Savings and Loan in Medina, N.Y.; First Trust & Savings Bank in Marcus, Iowa; and First National Bank in Camdenton, Mo.

“Deposits will be one of the things that banks are looking for,” said Kevin Reevey, an analyst at D.A. Davidson. Acquirers “will be looking for franchises with low-cost, sticky, attractive deposits that they could leverage into their asset-generating machines.”

The loan-to-deposit ratio for banks with less than $10 billion of assets has increased as loan growth outpaced deposit gathering, rising from 77.8% to 86% between late 2012 and the end of last year, according to FDIC data.

“Given the current rate environment, deposits are a hot topic recently,” said Nicholas Cucharale, an analyst at Sandler O’Neill. “The bottom line is a strong deposit franchise has significant value."

There are several things buyers should take into consideration before going after a specific bank.

Banks based in more urban or suburban centers may look to buy institutions in more rural markets where lending opportunities are more limited, said Timothy Johnson, who leads the U.S. financial services deal advisory practice at KPMG. Such deals can often be difficult to reach, because many rural banks are run by local leaders and boards that might be reluctant sell.

The deals that do happen often involve sellers with aging boards and management teams.

Other considerations come into play when urban-centric banks court rural institutions, said Sharon Dogonniuck, senior managing director of financial services at Ernst & Young Capital Advisors. Buyers should review a new market's demographics and lending opportunities, along with the seller's asset mix.

“There's a large focus around funding that is taking precedent ... but you have to be in markets that you will be ultimately able to grow,” Dogonniuck said.

Acquirers eager to add deposits should also look at the type of borrowers at a target.

Commercial real estate borrowers are not the best source of deposits, said Rolland Johannsen, a senior consulting associate at Capital Performance Group. Rather, banks with a large number of commercial clients, particularly small businesses, offer a better chance of building the liability side of the balance sheet, he said.

Banks that offer services such as treasury management also present an opportunity to develop deposit relationships.

“The funding challenge is really a question of customer mix,” Johannsen said.

Due diligence is also important to determine how adhesive a bank's depositors are and when their accounts might reprice, industry experts said.

A buyer should consider how an integration could impact deposit levels, Johannsen said. For instance, a decision to nix a popular checking account could drive away customers and diminish a deal's value of the deal, he added.

“Everything from product set to distribution channels to digital apps" needs to be reviewed, Dogonniuck said. "Think about ... what's best for the customer and the bank.”

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